3. Time Value of Money Assume that ten years from now, you will need $10,000 and that your bank compounds interest at a 4 percent annual rate. A. How much do you need to deposit today in order to have a balance of $10,000 in 10 years? Explain and show your work. B. Suppose instead that you want to make equal payments in years 1 through 9 to accumulate $10,000 in year 10, how large must each of the 9 payments be? Explain. C. If your (very reliable) uncle were to offer to make the payments found in part (B) for you or to give you $7,000 one year from now, which would you choose? Explain. (Even if you could not solve for the answer in part B, please explain what criterion you would use to make the choice.)4. Capital Asset Pricing Model 4. Capital Asset Pricing Model In parts (A), (B), and (C) below assume that the risk-free interest rate is 3 percent and the market risk premium is 7 percent. A. Dorothy Inc. is considering a project that will generate after-tax annual cash flows of $600,000 for 6 years. The beta of the project is 1.0, and the investment cost for the project is $2,700,000. Should the firm undertake the project? Explain. B. Wicked Witch of the West Inc. is considering a project that will generate after tax cash flows of $600,000 for 10 years. The beta of its project is 1.2, and the investment cost for the project is $3,400,000. Should the firm undertake the project? C. Draw a graph of the SML and locate the projects (A) and (B) on the graph. 5. Effective Annual Yield (EAY) and Effective Annual Rate (EAR) A. You plan to invest $1,000 for one year and you have the opportunity to invest it at a 12 percent APR, compounded monthly. Alternatively, you could invest the funds at an annual rate of 12.3 percent compounded semiannually. What is the EAY of each alternative? (Hint: You need to carry your answer to at least the fourth decimal place.) Which investment should be chosen?
3. Time Value of Money Assume that ten years from now, you will need $10,000 and that your bank compounds interest at a 4 percent annual rate. A. How much do you need to deposit today in order to have a balance of $10,000 in 10 years? Explain and show your work. B. Suppose instead that you want to make equal payments in years 1 through 9 to accumulate $10,000 in year 10, how large must each of the 9 payments be? Explain. C. If your (very reliable) uncle were to offer to make the payments found in part (B) for you or to give you $7,000 one year from now, which would you choose? Explain. (Even if you could not solve for the answer in part B, please explain what criterion you would use to make the choice.)4. Capital Asset Pricing Model 4. Capital Asset Pricing Model In parts (A), (B), and (C) below assume that the risk-free interest rate is 3 percent and the market risk premium is 7 percent. A. Dorothy Inc. is considering a project that will generate after-tax annual cash flows of $600,000 for 6 years. The beta of the project is 1.0, and the investment cost for the project is $2,700,000. Should the firm undertake the project? Explain. B. Wicked Witch of the West Inc. is considering a project that will generate after tax cash flows of $600,000 for 10 years. The beta of its project is 1.2, and the investment cost for the project is $3,400,000. Should the firm undertake the project? C. Draw a graph of the SML and locate the projects (A) and (B) on the graph. 5. Effective Annual Yield (EAY) and Effective Annual Rate (EAR) A. You plan to invest $1,000 for one year and you have the opportunity to invest it at a 12 percent APR, compounded monthly. Alternatively, you could invest the funds at an annual rate of 12.3 percent compounded semiannually. What is the EAY of each alternative? (Hint: You need to carry your answer to at least the fourth decimal place.) Which investment should be chosen?
Chapter4: Time Value Of Money
Section: Chapter Questions
Problem 2STP
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Transcribed Image Text:3. Time Value of Money
Assume that ten years from now, you will need $10,000 and that your bank compounds
interest at a 4 percent annual rate.
A. How much do you need to deposit today in order to have a balance of $10,000 in
10 years? Explain and show your work.
B. Suppose instead that you want to make equal payments in years 1 through 9 to
accumulate $10,000 in year 10, how large must each of the 9 payments be?
Explain.
C. If your (very reliable) uncle were to offer to make the payments found in part (B)
for you or to give you $7,000 one year from now, which would you choose?
Explain. (Even if you could not solve for the answer in part B, please explain
what criterion you would use to make the choice.)4. Capital Asset Pricing Model
4. Capital Asset Pricing Model
In parts (A), (B), and (C) below assume that the risk-free interest rate is 3 percent and the market
risk premium is 7 percent.
A. Dorothy Inc. is considering a project that will generate after-tax annual cash flows of
$600,000 for 6 years. The beta of the project is 1.0, and the investment cost for the project is
$2,700,000. Should the firm undertake the project? Explain.
B. Wicked Witch of the West Inc. is considering a project that will generate after tax cash flows
of $600,000 for 10 years. The beta of its project is 1.2, and the investment cost for the project is
$3,400,000. Should the firm undertake the project?
C. Draw a graph of the SML and locate the projects (A) and (B) on the graph.
5. Effective Annual Yield (EAY) and Effective Annual Rate (EAR)
A. You plan to invest $1,000 for one year and you have the opportunity to invest it at a
12 percent APR, compounded monthly. Alternatively, you could invest the funds at an
annual rate of 12.3 percent compounded semiannually. What is the EAY of each
alternative? (Hint: You need to carry your answer to at least the fourth decimal place.)
Which investment should be chosen?
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