Part 4 Ch 03

Part 4 Ch 03 - CHAPTER 3 INTEGRATIVE PROBLEM 3-33 ASSUME...

Info icon This preview shows pages 1–5. Sign up to view the full content.

View Full Document Right Arrow Icon
CHAPTER 3 INTEGRATIVE PROBLEM ANSWER : Discuss basic time value concepts, terminology, and solution methods. A cash flow time line is a graphical representation that is used to show the timing of cash flows. The tick marks represent end of periods (often years), so time 0 is today; time 1 is the end of the first year, or 1 year from today; and so on. LUMP-SUM AMOUNT—a single flow; for example, a $100 inflow in Year 2: 0 1 2 3 Year 100 Cash flow ANNUITY—a series of equal cash flows occurring over equal intervals: 0 1 2 3 Year 100 100 100 Cash flow UNEVEN CASH FLOW STREAM—an irregular series of cash flows that do not constitute an annuity: 0 1 2 3 Year -50 100 75 50 Cash flow CF = -50 represents a cash outflow rather than a receipt or inflow. 44 3-33 ASSUME THAT YOU ARE NEARING GRADUATION AND THAT YOU HAVE APPLIED FOR A JOB WITH A LOCAL BANK. AS PART OF THE BANK'S EVALUATION PROCESS, YOU HAVE BEEN ASKED TO TAKE AN EXAMINATION THAT COVERS SEVERAL FINANCIAL ANALYSIS TECHNIQUES. THE FIRST SECTION OF THE TEST ADDRESSES TIME VALUE OF MONEY ANALYSIS. SEE HOW YOU WOULD DO BY ANSWERING THE FOLLOWING QUESTIONS: A. DRAW CASH FLOW TIME LINES FOR (1) A $100 LUMP SUM CASH FLOW AT THE END OF YEAR 2, (2) AN ORDINARY ANNUITY OF $100 PER YEAR FOR THREE YEARS, AND (3) AN UNEVEN CASH FLOW STREAM OF -$50, $100, $75, AND $50 AT THE END OF YEARS 0 THROUGH 3. k% k% k%
Image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
B. (1) WHAT IS THE FUTURE VALUE OF AN INITIAL $100 AFTER THREE YEARS IF IT IS INVESTED IN AN ACCOUNT PAYING 10 PERCENT ANNUAL INTEREST? ANSWER : Show dollars corresponding to question mark, calculated as follows: 0 1 2 3 100 FV = ? After 1 year: FV 1 = PV + INT 1 = PV + PV(k) = PV(1 + k) = $100(1.10) = $110.00. Similarly: FV 2 = FV 1 + INT 2 = FV 1 + FV 1 (k) = FV 1 (1 + k) = $110(1.10) = $121.00 = PV(1 + k)(1 + k) = PV(1 + k) 2 . FV 3 = FV 2 + INT 3 = FV 2 + FV 2 (k) = FV 2 (1 + k) = $121(1.10) = $133.10 = PV(1 + k) 2 (1 + k) = PV(1 + k) 3 In general, we see that: FV n = PV(1 + i) n , so FV 3 = $100(1.10) 3 = $100(1.3310) = $133.10. Note that this equation has four variables: FV n , PV, k, and n. Here we know all except FV n , so we solve for FV n . However, often, we will solve for one of the other three variables. By far, the easiest way to work all time value problems is with a financial calculator. Just plug in any three of the four values and find the fourth. Finding future values (moving to the right along the time line) is called compounding . Note we generally find FV using one of these methods: (1) Numerical approach use a regular calculator: FV 3 = $100(1.10) 3 = $133.10. (2) Financial calculator: This is especially efficient for more complex problems, including exam problems. Input the following values: N = 3, I = 10, PV = -100, and PMT = 0; compute FV = $133.10. (3) Spreadsheet: Set up your spreadsheet and use the FV financial function similar to the following: 45 10%
Image of page 2
Step 1: Set up the spreadsheet: Step 2: Select FV in the financial function category: Step 3: Input the cell locations of the data: Step 4: Press OK to display the solution: B. (2) WHAT IS THE PRESENT VALUE OF $100 TO BE RECEIVED IN 3 YEARS IF THE APPROPRIATE INTEREST RATE IS 10 PERCENT?
Image of page 3

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
ANSWER : Finding present values, or discounting (moving to the left along the time line), is the reverse of compounding, and the basic present value equation is the reciprocal of the compounding
Image of page 4
Image of page 5
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern