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Chapter 4: Q14BP (page 282)
Question: Phil Goode will receive $175,000 in 50 years. His friends are very jealous of him. If the funds are discounted back at a rate of 14 percent, what is the present value of his future 鈥減ot of gold鈥�?
The present value is $249.92.
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Home Security Systems is analyzing the purchase of manufacturing equipment that will cost \(50,000. The annual cash inflows for the next three years will be:
Year | Cash flow |
1 | \)25,000 |
2 | 23,000 |
3 | 18,000 |
a. Determine the internal rate of return.
b. With a cost of capital of 18 percent, should the machine be purchased?
The Suboptimal Glass Company uses a process of capital rationing in its decision making. The firm鈥檚 cost of capital is 10 percent. It will only invest \(77,000 this year. It has determined the internal rate of return for each of the following projects:
Project | Project size | Internal rate of return |
A | \)10,500 | 21% |
B | 30,500 | 22 |
C | 25,500 | 18 |
D | 10,500 | 13 |
E | 10,500 | 20 |
F | 20,500 | 11 |
G | 10,500 | 16 |
a. Select the projects that the firm should accept.
b. If Projects A and B are mutually exclusive, how would that affect your overall answer? That is, which projects would you accept in spending the $77,000?
Question:Surgical Supplies Corporation paid a dividend of $1.12 per share over the last 12 months. The dividend is expected to grow at a rate of 2.5 percent over the next three years (supernormal growth). It will then grow at a normal, constant rate of 7 percent for the foreseeable future. The required rate of return is 12 percent (this will also serve as the discount rate).
a. Compute the anticipated value of the dividends for the next three years (D1, D2, and D3).
b. Discount each of these dividends back to the present at a discount rate of 12 percent and then sum them.
c. Compute the price of the stock at the end of the third year (P3).
P3 = D4/ (Ke - g)
d. After you have computed P3, discount it back to the present at a discount rate of 12 percent for three years.
e. Add together the answers in part b and part d to get the current value of the stock. (This answer represents the present value of the first three periods of dividends plus the present value of the price of the stock after three periods.)
If, as an investor, you had a choice of daily, monthly, or quarterly compounding, which would you choose? Why?
Katie Pairy Fruits Inc. has a \(1,000 20-year bond outstanding with a nominal yield of 15 percent (coupon equals 15% x \)1,000 5 \(150 per year). Assume that the current market required interest rate on similar bonds is now only 12 percent.
a. Compute the current price of the bond.
b. Find the present value of 3 percent x \)1,000 (or \(30) for 20 years at 12 percent. The \)30 is assumed to be an annual payment. Add this valueto $1,000.
c. Explain why the answers in parts a and b are basically the same. (There is a slight difference due to rounding in the tables.)
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