Tut01q - July 2009 Strictly for course AB102 internal...

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July 2009 Strictly for course AB102 internal circulation only. Nanyang Business School AB102 Financial Management Tutorial 1: Introduction, Time Value of Money (Common Questions) 1) (1-13) The president of Southern Semiconductor Corporation (SSC) made this statement in the company’s annual report: “SSC’s primary goal is to increase the value of our common stockholders’ equity.” Later in the report, the following announcements were made: a) The company contributed $1.5 million to the symphony orchestra in Birmingham, Alabama, its headquarters city. b) The company is spending $500 million to open a new plant and expand operations in China. No profits will be produced by the Chinese operation for 4 years, so earnings will be depressed during this period versus what they would have been had the decision not been made to expand in that market. c) The company holds about half of its assets in the form of U.S. Treasury bonds, and it keeps these funds available for use in emergencies. In the future, though, SSC plans to shift its emergency funds from Treasury bonds to common stocks. Discuss how SSC’s stockholders might view each of these actions, and how they might affect the stock price. 2) (2-41k) Effective versus nominal interest rates . Five banks offer nominal rates of 6 percent on deposits, but A pays interest annually, B pays semiannually, C quarterly, D monthly, and E daily. a) What effective annual rate does each bank pay? If you deposited $5,000 in each bank today, how much would you have at the end of 1 year? 2 years? b) If the banks were all insured by the government (the FDIC) and thus equally risky, would they be equally able to attract funds? If not, and the TVM were the only consideration, what nominal rate would cause all the banks to provide the same effective annual rate as Bank A? c) Suppose you don’t have the $5,000 but need it at the end of 1 year. You plan to make a series of deposits, annually for A, semiannually for B, quarterly for C, monthly for D, and daily for E, with payments beginning today. How large must the payments be to each bank? d) Even if the 5 banks provided the same effective annual rate, would a rational investor be indifferent between the banks? 3) (2-39) Required annuity payments . Your father is now 50 years old and will retire in 10 years. He expects to live for 25 years after he retires, until he is 85. He wants a fixed retirement income that has the same purchasing power at the time he retires as $40,000 has today. (The real value of his retirement income will decline annually after he retires). His retirement income will begin the day he retires , 10 years from today; and he will then receive 24 additional annual payments. Annual inflation is expected to be 5 percent. He currently has $100,000 saved, and he expects to earn 8 percent annually on his savings.
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