2010-03-02_002759_Funding_Budget

2010-03-02_002759_Funding_Budget - Sheet1 Funding budget...

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Unformatted text preview: Sheet1 Funding budget shortfalls As part of your personal budgeting process, you have determined that in each of the next 5 shortfalls. In other words, you will need the amounts shown in the following table at the end of the given year to bal inflows equal outflows. You expect to be able to earn 8% on your investments during the next 5 years and wish to fu next 5 years with a single amount. End of year Budget shortfall 1 $5,000 2 4,000 3 6,000 4 10,000 5 3,000 a. How large must the single deposit today into an account paying 8% annual interest be to provide for full coverage shortfalls? Cash Flow Required (Budget Present Value Shortfall) Factor @8% Present Value $5,000.00 0.9259 $4,629.63 $4,000.00 0.8573 $3,429.36 $6,000.00 0.7938 $4,762.99 $10,000.00 0.7350 $7,350.30 $3,000.00 0.6806 $2,041.75 Total Present Value So amount of single deposit that should be made is $22,214.03 $22,214.03 Year 1 2 3 4 5 b. What effect would an increase in your earnings rate have on the amount calculated in part a? Explain. If earning rate is increased then the amount calculated in part a would decrease because the increase in interest decrease the 2. Loan amortization schedule Joan Messineo borrowed $15,000 at a 14% annual rate of interest to be repaid over 3 three equal, annual, end-of-year payments. a. Calculate the annual, end-of-year loan payment. PV Rate N Annual Payment -15000 14% 3 $6,460.97 b. Prepare a loan amortization schedule showing the interest and principal breakdown of each of the three loan paym Year 1 2 3 Beginning Balance Interest for the Year Payment Made $15,000.00 $2,100.00 $6,460.97 $10,639.03 $1,489.46 $6,460.97 $5,667.52 $793.45 $6,460.97 c. Explain why the interest portion of each payment declines with the passage of time. Interest of each payment decline with the passage of time as Principal loan balance outstanding is reducing with each payme Page 1 Sheet1 3. Monthly loan payments Tim Smith is shopping for a used car. He has found one priced at $4,500. The dealer has with a down payment of $500, the dealer will finance the balance of the price at a 12% annual rate over 2 years (24 accepts the dealer's offer, what will his monthly (end-ofmonth) payment amount be? Monthly Payment would be = Amount / PV factor of Ordinary Annuity at 1% and 24 Periods) Monthly Payment = 4000/21.24339 = $188.29 b. Use a financial calculator or Equation 4.15a (found in footnote 9) to help you figure out what Tim's monthly paym willing to finance the balance of the car price at a 9% annual rate. PV Rate N Monthly Payment -4000 0.75% 24 $182.74 4. Basic bond valuation Complex Systems has an outstanding issue of $1,000- par-value bonds with a 12% coupon i annually and has 16 years remaining to its maturity date. a. If bonds of similar risk are currently earning a 10% rate Complex Systems bond sell for today? FV PMT (Payment Per Period) N Rate PV -1000 -120 16 10.00% $1,156.47 So the Bond must sell for $1,156.47 b. Describe the two possible reasons why similar-risk bonds are currently earning a return below the coupon interest bond. Two possibel reason could be 1) The current real interest rate is 10% 2) Credit rating of similar bond is higher (that is they are less risky). Page 2 Sheet1 c. If the required return were at 12% instead of 10%, what would the current value of Complex Systems' bond be? C findings in part a and discuss. FV PMT (Payment Per Period) N Rate PV -1000 -120 16 12.00% $1,000.00 If the required return is 12% then current value of bond will trade at $1,000. The current value of bond at 12% is low Also when the coupon rate of then bond is higher than the required return then the bond is more valueable (than it fa same as required rate the price of the bond is same as face value 5. Common stock valuation—Zero growth Scotto Manufacturing is a mature firm in the machine tool component ind common stock dividend was $2.40 per share. Because of its maturity as well as its stable sales and earnings, the firm will remain at the current level for the foreseeable future. a. If the required return is 12%, what will be the value of S Value of Common Stock = D1/(r-g) = 2.4/(.12-0)= $20 b. If the firm's risk as perceived by market participants suddenly increases, causing the required return to rise to 20% value? Value of Common Stock = D1/(r-g) = 2.4/(.20-0)= $12 c. Judging on the basis of your findings in parts a and b, what impact does risk have on value? Explain. As the risk increase the required return increase and value of stock falls. As seen above as risk required retunr increa stock fell from $20 to $12 per share. Page 3 Sheet1 have determined that in each of the next 5 years you will have budget g table at the end of the given year to balance your budget—that is, to make nts during the next 5 years and wish to fund the budget shortfalls over the 4,000 3 6,000 4 10,000 5 3,000 al interest be to provide for full coverage of the anticipated budget calculated in part a? Explain. ecause the increase in interest decrease the presesent value of the amount. annual rate of interest to be repaid over 3 years. The loan is amortized into year loan payment. breakdown of each of the three loan payments. Principal Payment Ending Balance $4,360.97 $10,639.03 $4,971.51 $5,667.52 $5,667.52 $0.01 ge of time. ce outstanding is reducing with each payment made. Page 4 Sheet1 und one priced at $4,500. The dealer has told Tim that if he can come up ce at a 12% annual rate over 2 years (24 months). a. Assuming that Tim ount be? 1% and 24 Periods) you figure out what Tim's monthly payment would be if the dealer were 00- par-value bonds with a 12% coupon interest rate. The issue pays interest ilar risk are currently earning a 10% rate of return, how much should the arning a return below the coupon interest rate on the Complex Systems Page 5 Sheet1 t value of Complex Systems' bond be? Contrast this finding with your . The current value of bond at 12% is lower than the current value at 10%. hen the bond is more valueable (than it face value) but when coupon rate is re firm in the machine tool component industry. The firm's most recent ll as its stable sales and earnings, the firm's management feels that dividends return is 12%, what will be the value of Scotto's common stock? causing the required return to rise to 20%, what will be the common stock risk have on value? Explain. s seen above as risk required retunr increased from 12% to 20%, value of the Page 6 ...
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