Finance

Review

[NOTE: As discussed, please get a financial calculator (e.g.,HP). Please practice to use financial calculator to do the following calculation questions quickly!]

1. A cash-strapped young professional offers to buy your car with four, equal annual payments of $3,000, beginning two years from today. As another choice, you also consider collecting one-time $9,000 cash from car buyers on the transaction date. If you can invest your money at 10% interest rate, should you accept the young professional’s offer or stick to the $9,000 cash payment plan?

Ans: Option A(Installment) PV of Cash Inflows: 8645 Option B PV: 9000. Option B selected for higher cash inflow.

2.

1. A perpetuity of Tk.5,000 per year beginning at the end of year 1. Assume a 15% interest rate. What is its present value? Ans: 33,333
2. A perpetuity of Tk.5,000 per year beginning after 4 years (at the end of 4th year). Assume a 15% interest rate. What is its present value? Ans: 21,917
3. A perpetuity of Tk.5,000 per year beginning right now (t = 0). Assume a 15% interest rate. What is its present value?  Ans: 38,333

3. You believe you will need to have saved Tk.1,000,000 by the time you retire in 40 years in order to live comfortably.  In order to meet your retirement goal, how much must you save each year before you retire (i.e., over the next 40 years)? Assume the interest rate will be averagely 6% per year over the period.

Ans: 6462

4.  [Bond price changes over time]

If you purchase a three-year, 9% coupon bond for Tk.950, how much could it be sold for two years later if interest rates have remained stable? 

Ans: 981.60

5.   [Bond price changes over time]  

 Beximco Pharma has a bond with Tk.1000 face value and a coupon rate of 8%, and Beximco has another bond with Tk.1000 face value and a coupon rate of 12%. Both bonds pay coupon payment on January 1st in each year. Both bonds have 10-year maturities from today (January 2, 2015) and both sell at a yield to maturity of 10%. Suppose their yields to maturity next year are still 10%.

Now, suppose you purchase two bonds today (January 2, 2015) and hold both bonds for 1 year (until January 1, 2016).

1. What is the rate of return on each bond?  [Rate or Return (RoR) = (Coupon income + Bond price changes)/initial investment in the bond.]

Ans: 10% and 10% (Both Same)

(2) Does the higher coupon bond provide a higher rate of return?    

6. There is a real estate business project. Suppose you purchase a land for $50,000 now and invest $300,000 now for construction. During the next 3 years from now, you can rent out this building and receive an annual rent of $16,000 at the end of each year. At the end of the 3rd year, you can sell the building for $450,000.  Suppose the opportunity cost of capital (r) is 7%, will you make the investment?