Exam 7: Time Value of Money Basics and Applications

If we are simply interested in determining whether the market as a whole,such as the S&P 500,is over- or undervalued,then the perpetual constant growth model is reasonable.

Derek owns a perpetuity contract that promises to pay him $1,000 per year in end-of the-year cash flows with the first cash flow beginning one year from today.Derek perceives some risk with the promised cash flows and has discounted them at an annual rate of 10.00% to determine the present value of the contract.Derek has offered to sell a portion of the contract to his brother Cam.The agreement is that Derek will keep the first 25 cash flows and that Cam will keep the remaining cash flows beginning with the first cash flow 26 years from today.What is the present value of the original contract? What is the present value of the first 25 cash flows? What is the present value of the cash flows received in year 26 and beyond? If Derek makes the deal as described and charges Cam $1,000 for the year 26 and beyond cash flows,which brother is getting a better deal? Please provide dollar values for each of these questions.

Your parents paid $1,000 for a college fund bond when you were born.Today is your 20^th birthday and you are ready to cash the bond which has grown to a value of $3,361.85.What was the average annual rate of return on your college fund bond?

The next dividend payment (one year from now)by Bacon Signs Inc.,will be $2.50 per share.The dividends are anticipated to maintain a 2% growth rate,forever.If the required rate of return for Bacon Signs Inc.is 11%,what is the current price per share:

What is the present value of $3,500 received 3 years from today if the prevailing interest rate is 6.10%?

You have two contracts available to you: ONE is a perpetuity with cash flows of $500 per year,with the first cash flow beginning today.TWO is a perpetuity with cash flows of $500 per year,with the first cash flow beginning one year from today.Which has a greater present value if the required rate of return is 5%?

Your plans for the future have finally materialized because you have won the lottery.Congratulations! The lottery marketing material says you have won $20,000,000 but a more careful examination of the terms and conditions means that you have won twenty $1,000,000 beginning-of-the-year cash flows with the first cash flow today.Further,the lottery contract says that instead of waiting for so many years to collect your winnings,you could accept a lump sum check today in the amount of $12,000,000.If you determine that the appropriate interest rate to compare these two alternatives is 6%,which alternative is preferred? To answer this question,solve for the present value of each alternative and make your decision based strictly on the values.You may ignore taxes in your decision

Perpetuities last "forever" but annuities have a finite life.

Johnson Signs Inc.has been able to increase dividends at the rate of 2% per year since the company first started paying dividends in 1957.Johnson has developed a new production technique and can sell their signs at a premium price for the next three years.This immediate revenue boost will allow Johnson to increase dividends at a rate of 12% per year next year,then 10% the following year,and 8% the next year.After that,they intend to revert to their previous slow but steady increase in annual dividends.If current dividends are $2.45 per share and Johnson investors require an annual rate of return of 11%,what is the current price per share for the company's stock?

If a bond is selling for its face value,which of the following statements is true?

Autorola plans to invest money today at an interest rate of 6% compounded annually to have $40,000 available for the purchase of a car four years from now.How much does the firm need to invest today?

The interest rate used to discount bond cash flows to determine the bond price is known as the:

Explain the rationale for why anyone would choose to buy a zero coupon bond that pays no interest prior to maturity and pays only the face value of the bond at maturity.

Five years ago Fairfield Farms Inc.issued 20 year semi-annual coupon bonds with a 9% annual coupon rate and a $1,000 face value.If the bonds currently carry a yield to maturity of 6%,what is the current price of a bond?

Your friend has agreed to lend you $5,000 today if you will repay him $5,061.36 in three months.What annual interest rate is your friend charging you for this loan?

If you were able to invest $2,500 at a rate of 6.40% for six months,how much money would you have at the end of that period?

What is the future value of a series of $5,000 end-of-the-year cash flows to be received forever if the required rate of return is 6.00% per year and the first cash flow is one year from today?