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Chapter 4: Q1DQ (page 319)
How is the valuation of any financial asset related to future cash flows?
Valuation of financial assets depends upon valuing the present value of future cash flows from the financial asset.
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Assume a \(40,000 investment and the following cash flows for two alternatives:
Year | Investment X | Investment Y |
1 | \)6,000 | $15,000 |
2 | 8,000 | 20,000 |
3 | 9,000 | 10,000 |
4 | 17,000 | -- |
5 | 20,000 | -- |
Which of the alternatives would you select under the payback method?
Question:Ecology Labs Inc. will pay a dividend of \(6.40 per share in the next 12 months (D1). The required rate of return (Ke) is 14 percent and the constant growth rate is 5 percent.
a. Compute P0. (For parts b, c, and d in this problem, all variables remain the same except the one specifically changed. Each question is independent of the others.)
b. Assume Ke, the required rate of return, goes up to 18 percent. What will be the new value of P0?
c. Assume the growth rate (g) goes up to 9 percent. What will be the new value of P0? Ke goes back to its original value of 14 percent.
d. Assume D1 is \)7.00. What will be the new value of P0? Assume Ke is at its original value of 14 percent and g goes back to its original value of 5 percent.
Cal Lury owes $10,000 now. A lender will carry the debt for five more years at 10 percent interest. That is, in this particular case, the amount owed will go up by10 percent per year for five years. The lender then will require that Cal pay off the loan over the next 12 years at 11 percent interest. What will his annual payment be?
What are the three factors that influence the required rate of return by investors?
Question: Betty Bronson has just retired after 25 years with the electric company. Her total pension funds have an accumulated value of $180,000, and her life expectancy is 15 more years. Her pension fund manager assumes he can earn a 9 percent return on her assets. What will be her yearly annuity for the next 15 years?
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