Question

In: Finance

Your friend, Mike Szyslak wants be a millionaire, and he found several ways applicable. But he...

Your friend, Mike Szyslak wants be a millionaire, and he found several ways applicable. But he is still hesitating among the various options and comes to you for financial advice. Using algebra, TVM tables, financial calculator, or Excel to solve these problems, and present a report to explain the concept of Time Value of Money.

Option 4: He sets aside $50,000 into a saving account now, and will deposit $50,000 into the account at the beginning of each year for next 10 years. If the market rate is 10%, Will he become a millionaire in 10 years?

Option 5: Mike considers to buy 1,000 bonds. The bond is semi-annual coupon bond with 10-year maturity, $1,000 par value bond with a 10 percent annual coupon, and 10 percent annual required rate of return? How much does it cost now if he wants to receive all the coupon payments and par values during the 10-year period? What would be the value of the bond if, just after it had been issued, the expected inflation rate rose by 3 percentage points, causing Mike to require a 13 percent return? What would happen to the bonds' value if inflation fell, and required rate of return declined to 7 percent?

Which of the options would you recommend that Mike choose? Why?

Expert Solution

Part A) If Mike follows option 4 then yes, he will become a millionaire:

He would receive $1,006.245.48 after 10 years.

Part B)

Cost to buy the bonds:

Therefore, to buy 1000 such bonds, total cost would be 1000 * $1,000 = $1,000,000.

==> In case the inflation rises and the required rate of return becomes 13%. The value of the bond would fall to $834.72 per bond:

==> In case the inflation goes down and the required rate of return becomes 7%. The value of the bond would go up to $1,213.19 per bond:

==> Time value of money states that it is beneficial to receive a sum of money now rather than getting the same amount of money later in the future as the recipient misses out on the opportunity cost of investing that money and earning interest.

Based on the data calculated, Mike should go with Option 4 as that way he is not blocking the entire amount in the beginning and also is eliminating the risk of fluctuation in the value of bonds due to systematic and various external factors. And option 4 would also fulfill his wish of becoming a millionaire.

jeff jeffy answered 2 years ago

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