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Mba800 HW3

This document contains homework problems related to time value of money and interest rates. Problem 1 asks about calculating the net present value of an investment that pays returns over 7 years at a 9% discount rate. Problem 2 asks to calculate the present value of an investment paying $680 per month for 15 years plus a $28,000 lump sum at the end, discounted at 5.25%. Problem 3 asks about calculating the time for an initial $5,000 investment growing at 4% interest to reach $7,500, both with and without $50 monthly contributions. Problem 4 involves calculating the net present value of an investment paying irregular cash flows over 5 years at an 18% required rate of return. Problem 5 asks about forecasting

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281 views2 pages

Mba800 HW3

This document contains homework problems related to time value of money and interest rates. Problem 1 asks about calculating the net present value of an investment that pays returns over 7 years at a 9% discount rate. Problem 2 asks to calculate the present value of an investment paying $680 per month for 15 years plus a $28,000 lump sum at the end, discounted at 5.25%. Problem 3 asks about calculating the time for an initial $5,000 investment growing at 4% interest to reach $7,500, both with and without $50 monthly contributions. Problem 4 involves calculating the net present value of an investment paying irregular cash flows over 5 years at an 18% required rate of return. Problem 5 asks about forecasting

Uploaded by

Chandresh Zinzuwadia
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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MBA 800 Homework #3

Time Value of Money and Interest Rates


Dr. Stanley D. Longhofer
1) Walt is evaluating an investment that will provide the following returns at the end of
each of the following years: year 1, $12,500; year 2, $10,000; year 3, $7,500; year 4,
$5,000; year 5, $2,500; year 6, $0; and year 7, $12,500. Walt believes that he should
earn an annual rate of 9 percent on this investment. How much should he pay for this
investment?
Year

Return

Rate 9%

12500

10000

NPV(r,CF0, L1,L2)

7500

PV = $ 37,680.95

5000

2500

12500

2) Consider an investment that will pay $680 per month for the next 15 years and will be
worth $28,000 at the end of that time. How much is this investment worth to you
today at a 5.25 percent discount rate?
FV = $28000
I = 5.25%

PV = $98,266.75 using calculator

N = 15 years
PMT = 680
P/Y = 12
3) Suppose you deposit $5,000 into an account earning 4 percent interest, compounded
monthly.
a) How many years will it take for your account to be worth $7,500?
PV = $5000

N=?

FV = $7500

N = 121.8434 months

I = 4%
Compounded Monthly
b) Suppose in addition to the initial $5,000 deposit, you will make monthly
contributions of $50. How many years will it take for the account to grow to
$7,500 in this case?
PMT = 50, PpY = 12 Therefore, N = 35.394 Months

4) Consider an investment that will pay you $2,000 per month for each of the next 2
years, and then $5,000 per month in the following 3 years.
a) If your required rate of return on this investment is 18 percent per year, what is
the most you would be willing to pay for it?
NOTE: Your cash flow worksheet does NOT incorporate the P/Y setting. Thus, you
must use periodic interest rates when calculating the NPV with irregular cash
flows.
$2000 / month for 2 years
$5000/ month for 3 years

PV = 10,490.60

I = 18 % I/month = 18/12 = 1.5%


b) Suppose you can purchase this investment for $150,000. What is its net present
value? Should you purchase this investment?
NPV = PV Cost = 10490.6 150000 = - 139509.4 NO PURCHASE
5) The yield on 1-year Treasury securities is 6%, 2-year securities yield 6.2%, and 3year securities yield 6.3%. There is no maturity risk premium. Using the pure
expectations theory, forecast the yields on the following securities:
a) A 1-year Treasury security, 1 year from now.
(1+r1)=1.06, Therefore r1 = 6%
b) A 2-year Treasury security, 1 year from now.
6%
6) Explain briefly what it means when we say that we have an inverted yield curve.
What does this imply about investors expectations regarding future interest rates?
Inverted yield curve is when the long term interest rate is lower than the short term
interest rate. Therefore, investors would expect future interest rates to drop and hence
they would prefer to borrow on a short-term basis and then re-borrow when the rates
have dropped. Inverted yield curve is considered as a sign of slow economy.
7) Problem 5-27 from the text: Can the nominal interest rate available to an investor be
significantly negative? (Hint: consider the interest rate earned from saving cash
under the mattress.) Can the real interest rate be negative? Explain.
Nominal Interest rates are the rates quoted by banks or financial institution. These rates
cannot be negative because even if you just put money under a mattress, you will earn
0%.
Real interest rate is basically the nominal interest rate less the rate of inflation. This can
be negative if the rate of inflation is higher than the nominal interest rate.

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