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CHAPTER 5
DISCOUNTED CASH FLOW VALUATION
Answers to Concepts Review and Critical Thinking Questions
1.
Assuming positive cash flows and a positive interest rate, both the present and the future value will
rise.
2.
Assuming positive cash flows and a positive interest rate, the present value will fall, and the future
value will rise.
3.
It’s deceptive, but very common. The deception is particularly irritating given that such lotteries are
usually government sponsored!
4.
The most important consideration is the interest rate the lottery uses to calculate the lump sum
option. If you can earn an interest rate that is higher than you are being offered, you can create larger
annuity payments. Of course, taxes are also a consideration, as well as how badly you really need $5
million today.
5.
If the total amount of money is fixed, you want as much as possible as soon as possible. The team
(or, more accurately, the team owner) wants just the opposite.
6.
The better deal is the one with equal installments.
7.
Yes, they should. APRs generally don’t provide the relevant rate. The only advantage is that they are
easier to compute, but, with modern computing equipment, that advantage is not very important.
8.
A freshman does. The reason is that the freshman gets to use the money for much longer before
interest starts to accrue.
9.
The subsidy is the present value (on the day the loan is made) of the interest that would have accrued
up until the time it actually begins to accrue.
10.
The problem is that the subsidy makes it easier to repay the loan, not obtain it. However, the ability
to repay the loan depends on future employment, not current need. For example, consider a student
who is currently needy, but is preparing for a career in a highpaying area (such as corporate
finance!). Should this student receive the subsidy? How about a student who is currently not needy,
but is preparing for a relatively lowpaying job (such as becoming a college professor)?
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View Full Document Solutions to Questions and Problems
NOTE: All endofchapter 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 + $730 / 1.10
2
+ $1,420 / 1.10
3
+ $1,780 / 1.10
4
= $3,749.57
[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:
[email protected]%:
PVA = $4,300{[1 – (1/1.06)
9
] / .06 } = $29,247.28
[email protected]%:
PVA = $6,100{[1 – (1/1.06)
5
] / .06 } = $25,695.42
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This note was uploaded on 01/29/2012 for the course FIN 301 taught by Professor Ouyang during the Winter '08 term at Drexel.
 Winter '08
 OUYANG
 Finance, Future Value, Interest, Interest Rate, Valuation

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