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Unformatted text preview: Page 1 of 1 week a Complete all of the below activities by no later than Midnight. Eastern time on Sunday 0 Read an understand the syllabus. o Read chapter 3 & 4 in the textbook. Listen to the lecture presentation for Week 2. 0 Answer the below questions and submit to the proper drop box according to the directions outlined in the syllabus. a Participate in the Week 2 threaded discussion. There is a grading rubric for threaded discussions under the doc sharing tab. 0 If you have questions regarding the materiai, post them in the Week 2 Q&A threaded discussion or email me at [email protected] . Answer the assigned questions and problems below: Chapter 3, pages 82 - 85, review questions 1, 3, 5 & 7, problems 3, 5, 6 & 11 Chapter 4, pages 121 - 127, review questions 2, 3, 5 & 6, problems 2, 3, ‘10 & 19 http://msofficecontent.next.ecollege.conflpub/content/c4adf70f—9b67-483 1-901 l-ebaca687... 7/15/2010 82 Part 2 interest Rates and Valuing Cash Flows E The rate at which we can exchange money today for money in the future by borrowing or invest— ing is the current market interest rate. E The present value (PV) of a cash flow is its value in terms of cash today. 3.5 The NPV Decision Rule E The net present value (NPV) of a project is PWBen‘efits) — PV(Costs) % A good project is one with a positive net present value. p The NPV Decision Rule states that when choosing from aniong a set of alternatives, choose the one with the highest NPV. The NPV of a project is equivalent to the cash value today of the project. 9" Regardless of our preferences for cash today ver~ Su's cash in the future, we should always first 5 maximiae'NPV. We can then borrow or lend to shift cash flows through time and find our most - preferred pattern of cash flows. Campfire .3 future value, p. 72 interest rate, p. 70 interest rate factor, p. 70 present value (PV), p. 72 time value of money, p. 70 =a_-==r.-,(mwm“WNW—yangfiumgzwaa—osmmefis("mzamwm=u_=unr_ r n an. .x -_-., , 3.6 The Law of One Price 9 Arbitrage is the process of trading to take advan- tage of equivalent goods that have different prices in different competitive markets. 9 The Law; of One Price states that if equivalent 'go'ods 'or securities trade simultaneously in dif- ferent competitive markets, they wiil trade for the same price in each market. This law is equiv~ alent;"to"saying that no arbitrage opportunities should exist. h The price of a security should equal the present value of the expected future cash flows obtained from owning that security. Net Present Value (NPV), MyFinanceLab p. 74 Study Plan 3.5 NPV Decision Rule, I p. 75 arbitrage, p. 78 MyFinanceLab arbitrage opportunity, p. 78 Law of One Price, p. 78 transactions costs, p. 80 Study Plan 3.6 2. How important are our personal preferences in valuing an investment decision? \4 3. Why are market prices useful to a financial manager? 4-. How does the Valuation Principle help a financial manager make decisions? \4 5. Can we directly compare dollar amounts received at different points in time? 6. How is the Net Present Value Rule related to cost—benefit analysis? Eliapter 3 The Valuation Principle: The Foundation of Financial Decision Making 83 N ”F. if there is more than one project to take, how should the financial manager choose among them? ' 8. What is the relation between arbitrage and the Law of One Price? indicates problems available in Msz’nanceLab. An asterisk (*) indicates problems with a higher level ofdifficulry. Cost-Benefit Analysis Honda Motor Company is considering offering a $2000 rebate on its minivan, lowering the vehicle’s price from $30,000 to $28,000. The marketing group estimates that this rebate will increase sales over the next year from 40,000 to 55,000 vehicles. Suppose Honda’s profit margin with the rebate is $6000 per vehicle. If the change in sales is the only consequence of this decision, what are its costs and benefits? Is it a good idea? You are an international shrimp trader. A food producer in the Czech Republic offers to pay you 2 million Czech koruna today in exchange for a year's supply of frozen shrimp. Your Thai supplier will provide you with the same supply for 3 million Thai baht today. If the current competitive market exchange rates are 25.50 koruna per dollar and 41.25 baht per dollar, what is the value of this deal? Suppose your employer offers you a choice between a $5000 bonus and 100 shares of the company’s stock. Whichever one you choose will be awarded today. The stock is currently trading for $63 per share. 3.. Suppose that if you receive the stock bonus, you are free to trade it. Which form of the bonus should you choose? What is its value? b. Suppose that if you receive the stock bonus, you are required to hold it for at least one year. What can you say about the value of the stock bonus now? What will your decision depend on? Valuation Principle Bubba is a shrimp farmer. In an ironic twist, Bubba is allergic to shellfish, so he cannot eat any shrimp. Each day he has a one-ton supply of shrimp. The market price of shrimp is $10,000 per ton. a. What is the value of a ton of shrimp to him? b. Would this value change if he Were not allergic to shrimp? Why or why not? Brett has almond orchards, but he is sick of almonds and prefers to eat walnuts instead. The owner of the walnut orchard next door has offered to swap this year’s crop with him in an even exchange. Assume he produces 1000 tons of almonds and his neighbor produces 800 tons of walnuts. If the market price of almonds is $100 per ton and the market price of walnuts is $1.10 per ton: a. Should he make the exchange? b. Does it matter whether he prefers almonds or walnuts? Why or why not? Interest Rates and the Time Value of Money You have $100 and a bank is offering 5% interest on deposits. If you deposit the money in the bank, how much will you have in one year? Par! 2 interest Rates and Valuing Cash Flows interest per one year. If ead? :1 one year? 7 Suppose the interest rate is 4%. ' . a. Having $200 today is equivalent to having-nth b. Having $200 in one year is equivalent to havm c. Which would you prefer, $200 today or $200 depend on when you need the money? Why or . . (3111‘ answer The NPV Decision Rule Your storage firm has been offered $100,000 in on year. Assume your costs are $95,000, payable irnr'n di' 8%. Should you take the contract? ' a government n today and n. 1n one year upon $5 million in one year. The government will payy the building’s completion. Suppose the interest rate- a. What is the NPV of this opportunity? 1). How can your firm turn this NPV into cash today ' Your firm has identified three potential investment-pro _ cash flows are shown here: ' ' Project Cash Flow Today ($) WWW %m__mrum~.wmwhw Your computer manufacturing firm must purchase 10.000 keyboards from a sup— l plier. .One supplier demands a payment of $100,000 today- Elli-$595.10 per keyboard ' payable in one year. Another supplier will charge $21 1361‘ keYb.03¥d; 21180 payable in one year. The interest rate is 6%. ‘ " H ' I I I a. What is the difference in their offers in terms of dollars today3'lfllhich offer should your firm take? ' ' 13— Suppose your firm does not want to Spend cash today. How can it take the first offer and not spend $100,000 of its own cash today? { [:hapter 4 NPV and the Time Value of Money 121 1 . Why is a cash flow in the future worth less than the same amount today? \1 2. What is compound interest? M 3. What is the intuition behind the geometric growth in interest? 4. What is a discount rate? \ 5. What is the intuition behind the fact that the present value of a stream of cash flOWs is just the sum of the present values of each individual cash flow? \l 6. What must be true about the cash flow stream in order for us to be able to use the shortcut formulas? 7. What is the difference between an annuity and a perpetuity? 8. What is an internal rate of return? All problems in this chapter are available in MyFinanceLab. An asterisk (*) indicates problems with a higher level of difficulty. The Timeline 1. You have just taken out a five—year loan from a bank to buy an engagement ring. The ring costs $5000. You plan to put down $1000 and borrow $4000. You will need to make annual payments of $1000 at the end of each year. Show the timeline of the loan from your perspective. How would the timeline differ if you created it from the bank’s perspective? ‘ \1 2. You currently have a one-year-old loan outstanding on your car. You make monthly payments of $300. You have just made a payment. The loan has four years to go (i.e., it had an original term of five years). Show the timeline from your perspective. How would the timeline differ if you created it from the bank’s perspective? Valuing Cash Flows \l 3. Calculate the future value of $2000 in a. 5 years at an interest rate of 5% per year. b. 10 years at an interest rate of 5% per year. c. 5 years at an interest rate of 10% per year. d. Why is the amount of interest earned in part (a) less than half the amount of interest earned in part (b)? 4. What is the present value of $10,000 received a. 12 years from today when the interest rate is 4% per year? I). 20 years from today when the interest rate is 8% per year? c. 6 years from today when the interest rate is 2% per year? 5. Your brother has offered to give you either $5000 today or $10,000 in 10 years. If the interest rate is 7% per year, which option is preferable? \: 3. Your cousin is currently 12 years old. She will be going to college in six years. Your aunt and uncle would like to have $100,000 in a savings account to fund her education at that time. If the account promises to pay a fixed interest rate of 4% per “322 \i [email protected] You have a loan outstanding. It requireslnialnn f’art 2 Interest Rates and Valuing Cash Flows year, how much money do they need to put into the account today to ensure that they will have $100,000 in six years? ”is .3 _... “ i 0‘ ‘ =. MM" '3’. Your mom is thinking of retiring. Her retirement plan will pay her either $250,000 immediately on retirement or $350,000 five years after the date of her retirement. Which alternative should she choose if the interest rate is a. 0% per year? b. 8% per year? c. 20% per year? (Egg! 8. Your grandfather put some money in an account for you on the day you were born. You are now 18 years old and are allowed to withdraw the money for the first time. The account currently has $3996 in it and pays arr-8% interest rate. a. How much money would be in the account if you left the money there until your twenty—fifth birthday? ' ' ' - b. What if you left the money until your Sixty-fifth birthday? c. How much money did your grandfather originally put in the account? Valuing a Stream of flash Flaws @331, 9. You have just received a windfall from an investment you made in a friend’s “-31 business. She will be paying you $10,000 at thejen'di of this year, $20,000 at the end of the following year, and $30,000 at the end ofth " fter that (three years from today). The interest rate is 3.5% per year. " ' '. a. What is the present value of your win‘dfal b. What is the future value of your windfall _ payment)? " '. " ears (on the date of the last annual payments of $1000 fered to allow you to skip ge payment at the end of iliihe loan is 5%, what final different to the two forms “NJ each at the end of the next three years.__You” ahk making the next two payments in lieu of the loan’s term in three years. If the interest at payment will the bank require you to makes of payment? I ' '- ‘i ”i . You are wondering whether it is worth i _ cost of going to college for four years; in However, you feel that if you get a colle'g ,_ ._ wages from graduation onward will be$3 0 college. If your discount rate is 9%, Whip" geYou figure that the total £955 is $40,000 per year. en; value of your lifetime ‘ an if you did not go to of go g to college? jfifgj 12. You have been offered a unique investinérif' :35 you will receive $500 one year from 110., ten years from now. ' ' :.. hvest $10,000 today, rpm now, and $10 000 J V % per year? Should you take the opportunity? -' b. What is the NPV of the opportunity 95 per year? Should you take it now? ligéi i3. Marian Plunket owns her own husifles. .. ‘4‘?" undertakes the investment, it Will 1?? $4 years. The opportunity requires 83.1.91? investment at the end of the 539011 opportunity if the interest rate is 2_ investment. If she _h of the next three 00 Plus an additional 3 the NPV of this he it? Mentor ll NPV and the Time Value of Money 123 Perpetuitiee, Annuities, and Other Special Cases 14. ' 20. *22. [123‘ Your friend majoring in mechanical engineering has invented a money machine. The main drawback of the machine is that it is slow. It takes one year to manufacture $100. However, once built, the machine will last forever and will require no maintenance. The machine can be built immediately, but it will cost $1000 to build. Your friend wants to know if she should invest the money to construct it: If the interest rate is 9.5% per year, what should your friend do? . How would your answer to Problem 14 change if the machine takes one year to build? The British government has a consol bond outstanding paying £100 per year forever. Assume the current interest rate is 4% per year. a. What is the value of the bond immediately after a payment is made? b. What is the value of the bond immediately before a payment is made? . What is the present value of $1000 paid at the end of each of the next 100 years if the interest rate is 7% per year? . When you purchased your car, you took out a five-year annual-payment loan with an interest rate of 6% per year. The annual payment on the car is $5000. You have just made a payment and have now decided to pay the loan off by repaying the outstanding balance. What is the payoff amount if a. you have owned the car for one year (so there are four years left on the loan)? b. you have owned the car for four years (so there is one year left on the loan)? . Your grandmother has been putting $1000 into a savings account on every birthday since your first (that is, when you turned one). The account pays an interest rate of 3%. How much money will be in the account on your eighteenth birthday immediately after your grandmother makes the deposit on that birthday? Assume that your parents wanted to have $160,000 saved for college by your eigh- teenth birthday and they started saving on your first birthday. If they saved the same amount each year on your birthday and earned 8% per year on their investments, a. how much would they have to save each year to reach their goal? b. if they think you will take five years instead of four to graduate and decide to have $200,000 saved just in case, how much more would they have to save each year to reach their new goal? . A rich relative has bequeathed you a growing perpetuity. The first payment will occur in a year and will be $1000. Each year after that, you will receive a payment on the anniversary of the last payment that is 8% larger than the last payment. This pattern of payments will go on forever. If the interest rate is 12% per year, a. what is today's value of the bequest? b. what is the value of the bequest immediately after the first payment is made? You are thinking of building a new machine that will save you $1000 in the first year. The machine will then begin to wear out so that the savings decline at a rate of 2% per year forever. What is the present value of the savings if the interest rate is 5% per year? ‘5 You work for a pharmaceutical company that has developed a new drhg. The patent on the drug will last 17 years. You expect that the drug’s profits will be $2 million in its first year and that this amount will grow at a rate of 5% per year for the next 17 years. Once the patent expires, other pharmaceutical companies will be able to produce the same drug and competition will likely drive profits to zero. What is the present value of the new drug if the interest rate is 10% per year? Week 2 Page I of 4 The Valuation Principle: The Foundation of Financial Decision Making/NPV and ime Value of Money - Discussion Wk 2 Under doc sharing tab is a grading rubric that shows how the threaded discussions for this class will be graded. To receive the maximum points for this exercise you are going to have to participate in the discussion on multiple occasions throughout the week. You must develop your own response as well as respond to the responses of at least 2 of your fellow students. Once you understand the concept and can solve the problem, heip your fellow students who may be having difficulty. FIN 100 Week 2 discussion I know that it may not seem possible looking at the situation over the last 2 years but, there have been numerous studies that show that the US stock market has had an average return of 12% over the past 60 years. Assume that you start putting $100/mo into the stock market today and that you earned the average return stated above and continue until your retirement age of 65, how much would you have when you retire? Now calculate what you would have had at age 65 if you had started this investment strategy at age 18. Whiie each of you will have different numbers for the first situation, you should all have the same number for the second situation and should be abie to discuss how the element of time effect’s your outcomes. ifiRespond @Expand All Print View Responses E Response A @ Q Discussion Wk2 [email protected] 9 I RE. Discussion Wk2 RE: DIscussmn EL>Wk2 E} RE: Discussion Wk2 E} E RE: Discussion Wk2 @ E Week2Discussmn @ E RE: WeekZDIscussmn E} I RE. WeekZDiscussion @ I RE: WeekZDiscussion RE: Week2 E} I DIscussmn E} I RE: Week2Discussion E) I RE: WeekZDiscussion E} I RE: WeekZDIscussmn http://threadcontent.nextecollege.com/(NEXTUCfl b80691))/Main/CourseMode/Thread/Li... RE: Discussion Wk2 ANNA CHRISTIAN JEANETTE COOPER 9 I RE. WeekZDIscussmn E} I RE: Week2Discussion >>Show Options Author AN NA CHRISTIAN ADRIAN NA ALEMAN N EKITA BARRETT Professor Leonard ANNA CHRISTIAN ADRIANNA ALEMAN DONNA AUGUSTONO ADRIANNA ALEMAN NEKITA BARRETT Professor Leona rd ADRIANNA ALEMAN JOHN INYANG SHALITA SMITH AMANDA LEIBFRIED Date/Time* 7/7/2010 7:17:43 AM 7/7/2010 5: 41: 50 PM 7/7/2010 8:40:07 PM 7/10/2010 5:50:47 PM . 7/8/2010 8- 26 47 AM 7/11/2010 8' 07' 37 PM I” 7/7/2010 5:34:23 PM H 7/7/2010 6' 35. 36 PM 7/7/2010 10: 35: 46 PM7 7/9/2010 4:02: 31 PM 7/10/2010 5:51:53 PM 7/8/2010 8. 28” 05AM 7/9/2010" 3' 58' 30 PM 7/8/2010 1:36: 16 PM - 7/9/2010 4' 15. 51 PM 7/11/2010 3. 35: 11 PM 7/15/2010 ...
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