Question

In: Finance

            You need the following information for #7 and #8. Assume that today is July 26,...

            You need the following information for #7 and #8.

Assume that today is July 26, 2018. Assume that you expect the following cash flows of REL, INC.

                                                                        CASH FLOWS

7/26/18                        7/26/19                     7/26/20                           7/26/21            7/26/22           

                                    $10                               $0                               $15                $15     

Assume that you will buy one share today (7/26/18) and sell your one share two years from today (7/26/20).

7)   How much will you pay today for a share of stock? Also assume that a fair rate of return for an investment of like risk is 10%.

  1. $36.36
  2. $33.06
  3. $20.36
  4. $28.63
  5. $30.61

8) How much do you expect to sell your one share for on 7/26/20? Assume that these are all of the cash flows that REL will produce. Also assume that a fair rate of return for an investment of like risk is 10%.

  1. $27
  2. $25
  3. $24
  4. $30
  5. $26     

Solutions

Expert Solution

Solution:

7) The answer is e. 30.61

A share of REL, INC is to be valued based on the present values of its future cash flows. The fair rate of return for an investment of like risk is 10%. So we nedd to divide each cash flow by this discounting rate (1+0.10)n (where n is the point in time) to arrive at the present values of the cash flows:

Discounting each cash flow by fair return rate 10% and adding the up we get the value of a share

= [$10 (1+0.10)1] + [$0 (1+0.10)2 ] + [$15   (1+0.10)3] + [$15 (1+0.10)4]

= [$10 1.101] + [$0 1.102 ] + [$15 1.103] + [$15 1.104]

= 9.0909 + 0 + 11.2697 + 10.2452

= 30.6058

= $30.61 (rounded up to 2 decimals)

8) The answer is e. $26

We are selling one share for on 7/26/20 on which date the future cash flows are $15 and $15

Discounting these cash flows to their present value on 7/26/20 and adding up the expected sale price is:

= [$15 1.101] + [$15 1.102 ]

= 13.6364 + 12.3967

= 26.0331

= $26 (rounding to nearest dollar)

jeff jeffy answered 1 year ago
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