Exam (elaborations)
CHAPTER 8 ASE-STYLE REVIEW QUESTIONS WITH CORRECT ANSWERS.
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CHAPTER 8 ASE-STYLE REVIEW QUESTIONS WITH CORRECT ANSWERS.
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FIN 307 MIDTERM 2 STUDY GUIDEQUESTIONS ANSWERED
CORRECTLY ,GRADED A+
Future vvValue vv- vvAnswer vvThe vvvalue vvon vva vvfuture vvdate vvof vvan vvinvestment vv
made vvtoday
Future vvValue vvExample vv- vvAnswer vvExample: vvinvest vv$100 vvtoday
• vvFuture vvvalue vvat vv5% vvinterest vvis vv$105 vvone vvyear vvfrom vv
now.
• vv$100 vvyields vv$5 vvin vva vvyear, vvwhich vvis vvwhy vvthe vvinterest vv
rate vvis vvalso vvcalled vvyield.
-The vvyield vvis vvthe vvsame vvas vvfinding vvthe vvcost vvof vva vvsimple vvloan vvof vv$100
vvfor vva vvyear vvat vv5% vvinterest
-The vvhigher vvthe vvinterest vvrate vvor vvamount vvinvested, vvthe vvhigher vvthe vvfuture
vvvalue
Future vvValue vvFormula vv- vvAnswer vvFV=PV*(1+i)
Compound vvInterest vv- vvAnswer vvInterest vvpaid vvon vvinterest
Present vvValue vv- vvAnswer vvCurrent vvvalue vvof vva vvfuture vvpayment vv
*amount vvthat vvmust vvbe vvinvested vvtoday vvin vvorder vvto vvobtain vva vvspecific vvamount
vvon vva vvgiven vvfuture vvdate.
PV vvFormula vv- vvAnswer vvFV/(1+i)^n
-i vvis vva vvdiscount vvrate vvbecause vvit vvreduces vvfuture vvvalues
Present vvValue vvincreases vvwhen: vv- vvAnswer vv1. vvthe vvfuture vvpayment vvFV vvis
vvhigher;
2. vvthe vvtime vvuntil vvpayment vvn vvgets vvshorter;
3. vvthe vvinterest vvrate vvi vvis vvlower
Finding vvAnnual vvGrowth vvRates
• vvSuppose: vvinvestment vvgrows vv0.5% vvper vvmonth
,• vvWhat vvis vvthe vvcompound vvannual vvrate? vv- vvAnswer vvFV=100*(1.005)^12=106.17
-Compound vvANNUAL vvrate= vv6.17%
Finding vvAnnual vvPercentage vvChanges: vv
Compute vvthe vvaverage vvannual vvgrowth vvrate vvwhen vv
we vvknow vvthe vvtotal vvgrowth vvrate vvof vvan vvinvestment vv
lasting vvn vvyears.
• vvAn vvinvestment vvhas vvincreased vv20 vvpercent vvover vv
5 vvyears: vvfrom vv100 vvto vv120. vv- vvAnswer vv120=100*(1+i)^5
(120/100)^1/5=1+i
1.0371= vv1+i
I=.0371=3.71% vv(annual vvpercentage vvrate)
Internal vvRate vvof vvReturn vv- vvAnswer vvThe vvinterest vvrate vvi vvthat vvequates vvthe
vvpresent vvvalue vvof vvan vv
investment vvwith vvits vvcost
If vvyou vvborrow vv$1 vvmillion vvat vvinterest vvR, vvis vvthe vvrevenue vvenough vvto vvmake
vvthe vvpayments?
The vvinternal vvrate vvof vvreturn vvof vvthe vvcompany vvdetermines vv
whether vvor vvnot vvthe vvinvestment vvmake vvsense.
IRR vvEx
You vvrun vva vvbook vvcompany vvand vvyou vvare vv
considering vvpurchasing vva vvnew vvmachine.
-Machine vvcosts vv$1 vvmillion vv(which vvyou vvmust vvborrow)
-Machine vvcan vvproduce vv3,000 vvbooks vvper vvyear.
-You vvsell vvthe vvbooks vvfor vv$50, vvgenerating vv$150,000 vvin vv
revenue vvper vvyear.
-Assume: vvmachine vvis vvthe vvonly vvinput; vvthe vvrevenue vvis vv
sure; vvthere vvis vvno vvmaintenance; vvmachine vvlasts vv10 vv
years. vv- vvAnswer vv-Revenue vvstream: vv$150,000 vva vvyear vvfor vv10 vvyears.
-Cost vvstream: vvspend vv$1 vvmillion vvtoday vvand vvrepay vvthe vvloan vvwith vvfixed
vvpayments vvfor vv10 vvyears vv(with vvsome vvamortization vvschedule)
The vvloan vvamount vvmust vvequal vvthe vvpresent vvvalue vv
of vvthe vvsum vvof vvthe vvfixed vvpayments
1,000,000= vvFixed vvPMT/(1+R)^1+Fixed vvPMT/(1+R)^2....+Fixed vvPMT/(1+R)^10
, Bond vv- vvAnswer vva vvpromise vvto vvmake vva vvseries vvof vvpayments vvon vvspecific
vvfuture vvdates.
Bonds vvcreate vvobligations, vvand vvare vvtherefore vv
thought vvof vvas vvlegal vvcontracts vvthat:
-Require vvthe vvborrower vvto vvmake vvpayments vvto vvthe vv
lender, vvand
-Specify vvwhat vvhappens vvif vvthe vvborrower vvfails vvto vvdo vv
so.
Coupon vvBond vv- vvAnswer vvMost vvcommon vvtype vvof vvbond
• vvIssuer vv(=borrower) vvmust vvmake vvannual vvpayments, vvcalled vvcoupon vvpayments.
-Pays vvannual vvinterest vvi vvc(= vvcoupon vvrate)
• vvPayments vvstop vvand vvloan vvis vvrepaid vvon vvthe vvmaturity vvdate vvn vv(= vvterm vvto
vvmaturity).
-Final vvpayment vv= vvprincipal vv(= vvface vvvalue= vvpar vvvalue vvof vvthe vvbond
4 vvKey vvElements vvin vva vvBond vv- vvAnswer vv1. vvMaturity vv
2. vvFace vvValue vv
3. vvCoupon vvRate vv
4. vvPrice
Maturity vv- vvAnswer vvthe vvnumber vvn vvof vvperiods vvuntil vvthe vvloan vvis vvrepaid
Face vvValue vv- vvAnswer vvhow vvmuch vvthe vvcontract vvis vvworth vvat vvmaturity
Coupon vvRate vv- vvAnswer vvinterest vvpayments; vvcoupon vvpayment vvis vvC= vvic×F
Price vv- vvAnswer vvthe vvvalue vvof vvthe vvloan, vvon vvthe vvmarket
Valuing vvthe vvPrincipal vv- vvAnswer vvIf vva vvbond vvhas vva vvface vvvalue vvF=$100 vvand
vvits vv
maturity vvdate vvis vvn vvyears vvin vvthe vvfuture, vvthen vvthe vv
present vvvalue vvof vvthe vvprincipal vvis:
Pbp=F/(1+i)^n= vv100/(1+i)^n
• vvThe vvhigher vvis vvn, vvthe vvlower vvis vvthe vvprincipal's vv
present vvvalue.
Valuing vvthe vvCoupon vvPayments vv- vvAnswer vvThe vvpresent vvvalue vvexpression
vvgives vvus vva vvgeneral vvformula vvfor vvthe vvseries vvof vvyearly vvcoupon vvpayments
vvmade vvover vvn vvyears.
-Pcp= vvC/(1+i)^1+C/(1+i)^2+.....+C/(1+i)^n
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