Question

In: Finance

The PVAF (present value annuity factor) is: A) it is always at time zero B) {[(1+(r/m)mt...

The PVAF (present value annuity factor) is:

A) it is always at time zero

B) {[(1+(r/m)mt – 1]/(r/m)}

C) (1 + r/m)n=m*t

D) 1 / (1 + r/m)n=m*t

E) {[1 -1/(1+r/m)mt]/(r/m)}

If the US T-Bill rate is 1.7%, the US expected inflation rate is 0.6%, the real rate of interest for Brazil is 2.2%, the default risk premium for Amazon is 0.9%, the maturity premium for Amazon debt is 1.2%, and the liquidity premium is 0.4%, then what is the expected interest rate (cost of capital) Amazon will have to pay to borrow?

Solutions

Expert Solution

Answer 1) Option E) {[1 -1/(1+r/m)mt]/(r/m)}

The present value of annuity factor is used to calculate the present value of future dollar cash flow. This concept is based on the time value of money.

The formula for calculating PVAF is {[1 -1/(1+r/m)mt]/(r/m)}

where r is the rate of interest

m is the method of compounding (if monthly m=12, quarterly m =4, semi annually m =2, annually m =1)

t is the total time peiod.

option a) is incorrect because PVAF can be calucalted for any time period.

Option b,c,d are incorrect due to the wrong formula for discounting and computing the present value.

Answer 2)

Expected Interest Rate (Cost of Capital) = Real Risk Free Rate + Inflation Premium + Default Premium + Maturity Premium + Liquidity premium

= 2.2% + .6% + .9% + 1.2% + .4%

= 5.3%


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