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Unformatted text preview: CHAPTER 6 DISCOUNTED CASH FLOW VALUATION Solutions to Questions and Problems NOTE: All end of chapter problems were solved using a spreadsheet. Many problems require multiple steps. Due to space and readability constraints, when these intermediate steps are included in this solutions manual, rounding may appear to have occurred. However, the final answer for each problem is found without rounding during any step in the problem. Basic 1. To solve this problem, we must find the PV of each cash flow and add them. To find the PV of a lump sum, we use: PV = FV / (1 + r) t [email protected]% = $950 / 1.10 + $1,040 / 1.10 2 + $1,130 / 1.10 3 + $1,075 / 1.10 4 = $3,306.37 [email protected]% = $950 / 1.18 + $1,040 / 1.18 2 + $1,130 / 1.18 3 + $1,075 / 1.18 4 = $2,794.22 [email protected]% = $950 / 1.24 + $1,040 / 1.24 2 + $1,130 / 1.24 3 + $1,075 / 1.24 4 = $2,489.88 2. To find the PVA, we use the equation: PVA = C ({1 – [1/(1 + r) ] t } / r ) At a 5 percent interest rate: [email protected]%: PVA = $6,000{[1 – (1/1.05) 9 ] / .05 } = $42,646.93 [email protected]%: PVA = $8,000{[1 – (1/1.05) 6 ] / .05 } = $40,605.54 And at a 15 percent interest rate: [email protected]%: PVA = $6,000{[1 – (1/1.15) 9 ] / .15 } = $28,629.50 [email protected]%: PVA = $8,000{[1 – (1/1.15) 6 ] / .15 } = $30,275.86 Notice that the PV of cash flow X has a greater PV at a 5 percent interest rate, but a lower PV at a 15 percent interest rate. The reason is that X has greater total cash flows. At a lower interest rate, the total cash flow is more important since the cost of waiting (the interest rate) is not as great. At a higher interest rate, Y is more valuable since it has larger cash flows. At the higher interest rate, these bigger cash flows early are more important since the cost of waiting (the interest rate) is so much greater. 3. To solve this problem, we must find the FV of each cash flow and add them. To find the FV of a lump sum, we use: FV = PV(1 + r) t [email protected]% = $940(1.08) 3 + $1,090(1.08) 2 + $1,340(1.08) + $1,405 = $5,307.71 [email protected]% = $940(1.11) 3 + $1,090(1.11) 2 + $1,340(1.11) + $1,405 = $5,520.96 [email protected]% = $940(1.24) 3 + $1,090(1.24) 2 + $1,340(1.24) + $1,405 = $6,534.81 Notice we are finding the value at Year 4, the cash flow at Year 4 is simply added to the FV of the other cash flows. In other words, we do not need to compound this cash flow. 4. To find the PVA, we use the equation: PVA = C ({1 – [1/(1 + r) ] t } / r ) [email protected] yrs: PVA = $5,300{[1 – (1/1.07) 15 ] / .07} = $48,271.94 [email protected] yrs: PVA = $5,300{[1 – (1/1.07) 40 ] / .07} = $70,658.06 [email protected] yrs: PVA = $5,300{[1 – (1/1.07) 75 ] / .07} = $75,240.70 To find the PV of a perpetuity, we use the equation: PV = C / r PV = $5,300 / .07 = $75,714.29 Notice that as the length of the annuity payments increases, the present value of the annuity approaches the present value of the perpetuity. The present value of the 75 year annuity and the present value of the perpetuity imply that the value today of all perpetuity payments beyond 75 years is only $473.59....
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This note was uploaded on 06/16/2011 for the course FIN 521 taught by Professor Varney during the Spring '11 term at Andrew Jackson.
 Spring '11
 VARNEY
 Finance, Valuation

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