BUSI 320 Comprehensive Problem 3

Use what you have learned about the time value of money to analyze each of the following decisions:

Decision #1:   Which set of Cash Flows is worth more now?

Assume that your grandmother wants to give you generous gift. She wants you to choose which one of the following sets of cash flows you would like to receive:

Option A: Receive a one-time gift of $10,000 today.

Option B: Receive a $1400 gift each year for the next 10 years. The first $1400 would received 1 year from today.   

Option C: Wait exactly 10 years from today and then receive a one-time gift of $17,000.

Compute the Present Value of each of these options if you expect the interest rate to be 2% annually for the next 10 years.    Which of these options does financial theory suggest you should choose?

       Option A would be worth $__________ today.

Option B would be worth $__________ today.

       Option C would be worth $___________today.

       Financial theory supports choosing Option _______

Compute the Present Value of each of these options if you expect the interest rate to be 5% annually for the next 10 years. Which of these options does financial theory suggest you should choose?

       Option A would be worth $__________ today.

       Option B would be worth $__________today.

       Option C would be worth $__________today.

      Financial theory supports choosing Option ______

Compute the Present Value of each of these options if you expect to be able to earn 8% annually for the next 10 years. Which of these options does financial theory suggest you should choose?

      Option A would be worth $__________today.

       Option B would be worth $__________today

       Option C would be worth $_________ today.

       Financial theory supports choosing Option _______

Decision #2: Planning for Retirement

Erich and Mallory are 22, newly married, and ready to embark on the journey of life.   They both plan to retire 45 years from today. Because their budget seems tight right now, they had been thinking that they would wait at least 10 years and then start investing $2400 per year to prepare for retirement. Mallory just told Erich, though, that she had heard that they would actually have more money the day they retire if they put $2400 per year away for the next 10 years - and then simply let that money sit for the next 35 years without any additional payments – then they would have MORE when they retired than if they waited 10 years to start investing for retirement and then made yearly payments for 35 years (as they originally planned to do).   Please help Erich and Mallory make an informed decision:   

Assume that all payments are made at the END a year (or month), and that the rate of return on all yearly investments will be 7.5% annually.

(Please do NOT ROUND when entering “Rates” for any of the questions below)

a) How much money will Erich and Mallory have in 45 years if they do nothing for the next 10 years, then put $2400 per year away for the remaining 35 years?

b1) How much money will Erich and Mallory have in 10 years if they put $2400 per year away for the next 10 years?

b2) How much will the amount you just computed grow to if it remains invested for the remaining 35 years, but without any additional yearly deposits being made?

c) How much money will Erich and Mallory have in 45 years if they put $2400 per year away for each of the next 45 years?

d) How much money will Erich and Mallory have in 45 years if they put away $200 per MONTH at the end of each month for the next 45 years? (Remember to adjust 7.5% annual rate to a Rate per month! (do NOT round!)

e) If Erich and Mallory wait 25 years (after the kids are raised!) before they put anything away for retirement, how much will they have to put away at the end of each year for 20 years in order to have $800,000 saved up on the first day of their retirement 45 years from today?

Question 2

Kenny is planning for retirement in 20 years. Currently, he has $300,000 in a savings account and $600,000 in a mutual fund. Moreover, he plans to add to his savings by depositing $3,000 per month in his savings account at the beginning of each month for the next twenty years until retirement. The savings account will return 5% APR compounded monthly and the investment in the mutual fund will return 8% compounded annually.

(a) How much money will Kenny have at retirement 20 years later? (b)





(c)
Kenny expects to live for 20 years after he retires and at retirement he will deposit all of his savings in a bank account paying 2% APR compounded monthly. If he wants to withdraw an equal sum of money at the end of each month from the bank account for financing his daily expenses after retirement, how much can he withdraw each time?

If the yield to maturity of a bond is higher than its coupon rate, the par value of the bond should be higher than its price, resulting in a discount bond. Conversely, if the yield to maturity of a bond is lower than its coupon rate, the par value of the bond should be lower than its price, resulting in a premium bond. Critically discuss this phenomenon. (word limit: 150 words)

Geary Machine Shop is considering a 4-year project to improve its production efficiency. Buying a new machine press for $510,621 is estimated to result in $161,346 in annual pretax cost savings. The press falls in the MACRS five-year class (Refer to the MACRS table on page 277), and it will have a salvage value at the end of the project of $119,530. The press also requires an initial investment in spare parts inventory of $57,367, along with an additional $8,489 in inventory for each succeeding year of the project. If the shop's tax rate is 0.35 and its discount rate is 0.1, what is the total cash flow in year 4? (Do not round your intermediate calculations.)

(Make sure you enter the number with the appropriate +/- sign)

Dog Up! Franks is looking at a new sausage system with an installed cost of $662,692. This cost will be depreciated straight-line to 23,962 over the project's 7-year life, at the end of which the sausage system can be scrapped for $95,309. The sausage system will save the firm $222,899 per year in pretax operating costs, and the system requires an initial investment in net working capital of $51,567. If the tax rate is 0.37 and the discount rate is 0.09, what is the total cash flow in year 7? (Make sure you enter the number with the appropriate +/- sign)

A firm is must choose to buy the GSU-3300 or the UGA-3000. Both machines make the firm’s production process more efficient which in turn increases incremental cash flows. The GSU-3300 produces incremental cash flows of $24,453.00 per year for 8 years and costs $100,693.00. The UGA-3000 produces incremental cash flows of $28,659.00 per year for 9 years and cost $125,955.00. The firm’s WACC is 9.72%. What is the equivalent annual annuity of the GSU-3300? Assume that there are no taxes.

Please round to 2 decimal places

With the growing popularity of casual surf print clothing, two recent MBA graduates decided to broaden this casual surf concept to encompass a “surf lifestyle for the home.” With limited capital, they decided to focus on surf print table and floor lamps to accent people’s homes. They projected unit sales of these lamps to be 8,700 in the first year, with growth of 5 percent each year for the next five years. Production of these lamps will require $52,000 in net working capital to start. The net working capital will be recovered at the end of the project. Total fixed costs are $112,000 per year, variable production costs are $25 per unit, and the units are priced at $55 each. The equipment needed to begin production will cost $192,000. The equipment will be depreciated using the straight-line method over a five-year life and is not expected to have a salvage value. The effective tax rate is 34 percent and the required rate of return is 30 percent.

What is the NPV of this project?

1. You own a portfolio of two stocks, O and Q. Stock O is valued at $4,000 and has an expected return of 10.5 percent. Stock Q has an expected return of 18.7 percent. What is the expected return on the portfolio if the portfolio total value is $5,000?

   		11.73 percent
   		10.92 percent
   		12.14 percent
   		13.03 percent

1. Cornel Co. has a beat of 1.4. If the risk-free rate is 3% and the market return is 12%, what is its cost of equity assume CAPM?

   		18.0%
   		16.5%
   		15.6%
   		17.6%

If the current one year spot rate is 1.45% and the current two year spot rate is 1.78%, what is the one year forward rate at the end of one year, assuming semi-annual compounding of spot rates and forward rates?

What is the price of the stock of company ABC is you know this will last for 10 years and will pay dividends for 8 years beginning at the end of year 3. The dividend will be a flat $1 pero year. The discount rate is 10%

Question 3

a. A 10-year 5% coupon bond has a yield of 8% and a duration of 7.85 years. If the bond yield increases by 60 basis points, what is the percentage change in the bond price?

b. Alpha Insurance Company is obligated to make payments of $2 million, $3 million, and $4 million at the end of the next three years, respectively. The market interest rate is 8% per annum.

i. Determine the duration of the company’s payment obligations.

ii. Suppose the company’s payment obligations are fully funded and immunized using both 6-month zero coupon bonds and perpetuities. Determine how much of each of these bonds the company will hold in the portfolio.

I want to ask B2 ii

The Clark Corporation desires to expand. It is considering a cash purchase of Kent Enterprises for $3.3 million. Kent has a $840,000 tax loss carryforward that could be used immediately by the Clark Corporation, which is paying taxes at the rate of 40 percent. Kent will provide $440,000 per year in cash flow (aftertax income plus depreciation) for the next 16 years. The discount rate is 13 percent. Use Appendix D as an approximate answer, but calculate your final answer using the formula and financial calculator methods.

a. Compute the net present value. (Negative amount should be indicated by a minus sign. Do not round intermediate calculations. Round your final answer to 2 decimal places.)

b. Should the merger be undertaken?

• No

• Yes

The Wall Street Journal reported the following spot and forward rates for the Swiss franc ($/SF).

a. Was the Swiss franc selling at a discount or premium in the forward market?

• Discount

• Premium

b. What was the 30-day forward premium (or discount) percentage? (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)

c. What was the 90-day forward premium (or discount) percentage? (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)

d. Suppose you executed a 90-day forward contract to exchange 140,000 Swiss francs into U.S. dollars. How many dollars would you get 90 days hence?

e. Assume a Swiss bank entered into a 180-day forward contract with Bankers Trust to buy $140,000. How many francs will the Swiss bank deliver in six months to get the U.S. dollars? (Round your answer to 2 decimal places.)

Parramore Corp has $12 million of sales, $3 million of inventories, $4 million of receivables, and $2 million of payables. Its cost of goods sold is 75% of sales, and it finances working capital with bank loans at an 6% rate. Assume 365 days in year for your calculations. Do not round intermediate steps.

What is Parramore's cash conversion cycle (CCC)? Do not round intermediate calculations. Round your answer to two decimal places. = days

If Parramore could lower its inventories and receivables by 12% each and increase its payables by 12%, all without affecting sales or cost of goods sold, what would be the new CCC? Do not round intermediate calculations. Round your answer to two decimal places.= days

How much cash would be freed up, if Parramore could lower its inventories and receivables by 12% each and increase its payables by 12%, all without affecting sales or cost of goods sold? Do not round intermediate calculations. Round your answer to the nearest cent. Write out your answer completely. For Example, 13.2 million should be entered as 13,200,000.= $

By how much would pretax profits change, if Parramore could lower its inventories and receivables by 12% each and increase its payables by 12%, all without affecting sales or cost of goods sold? Do not round intermediate calculations. Round your answer to the nearest cent. Write out your answer completely. For Example, 13.2 million should be entered as 13,200,000.= $

General Meters is considering two mergers. The first is with Firm A in its own volatile industry, the auto speedometer industry, while the second is a merger with Firm B in an industry that moves in the opposite direction (and will tend to level out performance due to negative correlation).

a. Compute the mean, standard deviation, and coefficient of variation for both investments. (Do not round intermediate calculations. Enter your answers in millions. Round "Coefficient of variation" to 3 decimal places and "Standard deviation" to 2 decimal places.)
  

b. Assuming investors are risk-averse, which alternative can be expected to bring the higher valuation?
  

• Merger A

• Merger B