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Tut_Ch_5_Part_1

# Tut_Ch_5_Part_1 - TUTORIAL 1 BAC1644 Ch 5 Part 1 To solve...

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TUTORIAL BAC1644 Ch 5 Part 1 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 / 1.12 + \$730 / 1.12 2 + \$1,420 / 1.12 3 + \$1,780 / 1.12 4 = \$3,572.12 [email protected]% = \$950 / 1.18 + \$730 / 1.18 2 + \$1,420 / 1.18 3 + \$1,780 / 1.18 4 = \$3,111.72 [email protected]% = \$950 / 1.24 + \$730 / 1.24 2 + \$1,420 / 1.24 3 + \$1,780 / 1.24 4 = \$2,738.56 2. To find the PVA, we use the equation: PVA = C ({1 – [1/(1 + r ) t ]} / r ) At a 6 percent interest rate: PVA = \$4,400{[1 – (1/1.06) 9 ] / .06 } = \$29,927.45 PVA = \$6,100{[1 – (1/1.06) 5 ] / .06 } = \$25,695.42 And at a 22 percent interest rate: PVA = \$4,400{[1 – (1/1.22) 9 ] / .22 } = \$16,659.65 [email protected]%: PVA = \$6,100{[1 – (1/1.22) 5 ] / .22 } = \$17,468.20 Notice that the PV of Investment X has a greater PV at a 6 percent interest rate, but a lower PV at a 22 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 annual payments. At a higher interest rate, getting these payments early are more important since the cost of waiting (the interest rate) is so much greater.

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