Financial Modeling Exam 1 Practice Questions and Solutions
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Course
Financial Modelling
Institution
Financial Modelling
1. Explain the differences between Excel functions PMT, IPMT, and PPMT. What type of cash-flow stream is each of these based on? When should each of these be used? Which vary with time in your amortization schedule? Why? Each of these is for use with an annuity, or annuity-type cash flow (constant ...
Financial Modeling Exam 1 Practice
Questions and Solutions
1. Explain the differences between Excel functions PMT, IPMT, and PPMT. What type
of cash-flow stream is each of these based on? When should each of these be used?
Which vary with time in your amortization schedule? Why? ✅Each of these is for use
with an annuity, or annuity-type cash flow (constant cash flows over a set period of time
at regular intervals). PMT calculates the total payment, which is the same for every
period. IMPT calculates the interest payment for each period, which will differ as the
remaining balance on the loan changes over time. PPMT calculates the principal
payment for each period, which will also change over time. These change over time
because the interest goes down as the balance of the loan goes down, so more of the
total payment goes to principal, and less goes to interest. PMT should be used to
calculate the overall payment for every period, while IPMT and PPMT should be used
for each period individually (because they change each period).
1. What type of cash flow stream does Excel's PV and NPV functions not handle well?
✅These functions do not handle perpetuities (cash flow streams that continue forever)
very well. They only handle cash flow streams with finite cash flows. (They also do not
handle cash flow streams that do not occur at regular intervals. For example, if you got
one cash flow in a year, another in 18 months, and a third at 36 months. You can make
this work in those formulas, but they will not deal with it themselves. We only talked
about part of this in class, which is these functions can only do calculations for finite
cash flow streams that occur in regular intervals).
In class, we tied our dividend forecast to sales. Why is this a bad assumption in reality?
In your answer, explain this both from a mechanical perspective, and from the
perspective of how this differs from what companies actually do. What would be a more
reasonable assumption? ✅There are two problems with this assumption. First, it's not
what firms actually do. Most firms try to keep dividends constant, or want dividends to
grow at a constant rate. (So they really would have a separate plan for dividends, and
change on things to make this work, like issuing new debt or equity if needed). Second,
sales do not really translate directly to cash, and we need cash to pay dividends. A
better assumption would be to tie dividends to something closer to cash, like net
income. (You could also make an argument for basing dividends on cash flow from
operations and investing, since this tells you how much cash flow you have before
financing. Or you could assume that the firm will keep dividends constant, or that
dividends will grow at a constant rate.)
Extra principal pay ✅Present Value of the difference between what you will owe minue
what you want to owe.
Use an annuity formula over that time period
How does Excel treat a PMT function ✅Excel treats this as if you're the borrower.
Therefore FV is negative because it is an extra payment the borrower is making
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