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Tute 1

- The document provides answers to questions about corporate finance concepts including the importance of integrating different finance functions and managing risk and ethics. - It also includes examples of calculating future and present values using the time value of money, including compound interest calculations over multiple time periods. - Questions involve scenarios like investment amounts needed for a child's college education and loans to purchase property where excess payments are used to pay down principal.

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Rony Rahman
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138 views4 pages

Tute 1

- The document provides answers to questions about corporate finance concepts including the importance of integrating different finance functions and managing risk and ethics. - It also includes examples of calculating future and present values using the time value of money, including compound interest calculations over multiple time periods. - Questions involve scenarios like investment amounts needed for a child's college education and loans to purchase property where excess payments are used to pay down principal.

Uploaded by

Rony Rahman
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 PDF, TXT or read online on Scribd
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Tutorial 1

Chapter 1 Scope of corporate finance


Q1-1. Why must a financial manager have an integrated understanding of the five basic finance
functions? Why has the risk-management function become more important in recent years?
Why is the corporate governance function considered a finance function?
A1-1. A financial manager needs to know all five basic finance areas because they all impact his
or her job. While the managers primary responsibilities may be in raising money or choosing investment projects, the manager also needs to know about capital markets and
debt/equity optimal levels, be able to manage risks of the business and governance of the
corporation. Corporate governance is a function because a manager wants to act in the best
interest of its shareholders. New methods of managing risk have been developed in recent
years, and a manager must be aware of these in order to maximize shareholder value.
Q1-7. Are ethics critical to the financial managers goal of maximizing shareholder wealth? How
are the two related? Is establishing corporate ethics policies and requiring employee compliance enough to ensure ethical behavior by employees?
A1-7. Ethics are critical to stockholder wealth maximization. Unethical behavior can have severe
financial consequences to a company. For example, Arthur Anderson was unable to continue in its role as a corporate accountant for Enron and its other clients because of the fallout
from Enrons collapse. For many businesses, reputation is critical to conducting business.
A firm with a reputation for shady dealing will lose value relative to its ethical competitors.

Chapter 3 The Time Value of Money

P3-1.

You have $1,500 to invest today at 7% interest compounded annually.


a. How much will you have accumulated in the account at the end of the following number of years?
1. three years
2. six years
3. nine years
b. Use your findings in part (a) to calculate the amount of interest earned in
1. years 1 to 3
2. years 4 to 6
3. years 7 to 9
c. Compare and contrast your findings in part (b). Explain why the amount of interest
earned increases in each succeeding 3-year period.

A3-1. Future Value: FVn = PV (1 + r)n or FVn = PV (FVFr%,n)


a. 1. FV3
FV3
FV3

= PV (1.07)3
= $1,500 (1.22504)
= $1,837.57

b. 1. Interest earned = FV3 PV


Interest earned = $1,837.57
-1,500.00
$ 337.57

2. FV6
FV6
FV6

= PV (1.07)6
= $1,500 (1.50073)
= $2,251.10

2. Interest earned = FV6 FV3


Interest earned = $2,251.10
-1,837.57
$ 413.53

3. FV9
FV9
FV9

= PV (1.07)9
= $1,500 (1.83846)
= $2,757.69

3. Interest earned = FV9 FV6


Interest earned = $2,757.69
-2,251.10
$ 506.59

c. The fact that the longer the investment period the larger the total amount of interest collected is not unexpected and is due to the greater length of time that the principal sum
of $1,500 is invested. The most significant point is that the incremental interest earned
per 3 year period increases with each subsequent 3-year period. The total interest for
the first 3 years is $337.57, however, for the second 3 years (from year 3 to 6) the additional interest earned is $413.93. For the third 3-year period the incremental interest is
$506.19. This increasing change in interest earned is due to compounding, the earning
of interest on pervious interest earned. The greater the previous interest earned the
greater the impact of compounding.

P3-11. Robert Williams is considering an offer to sell his medical practice, allowing him to retire
five years early. He has been offered $500,000 for his practice and can invest this amount
in an account earning 10 % per year. If the practice is expected to generate the following
cash flows, should Robert accept this offer and retire now?
End of Year
1
2
3
4
5

Cash Flow
$150,000
150,000
125,000
125,000
100,000

A3-11. FV on original retirement date if early retirement is chosen:


$500,000 (1.10)5 = $805,255
FV on retirement date if early retirement is not chosen:
$150,000 (1.10)4 =

$219,615

199,650

151,250

$150,000 (1.10) =
$125,000 (1.10) =

$125,000 (1.10)1 =
0

$100,000 (1.10) =

137,500
100,000
$808,015

Robert Williams should not retire early because the future value of his cash flows at the
end of five years would be about $3,000 less than if he continued working..
P3-19. Melissa Gould wants to invest today in order to assure adequate funds for her sons college
education. She estimates that her son will need $20,000 in 18 years; $25,000 in 19 years;
$30,000 in 20 years; and $40,000 in 21 years. How much does Melissa have to invest in a
fund today if the fund earns the following interest rate?
a. 6 % per year with annual compounding
b. 6 % per year with quarterly compounding
c. 6 % per year with monthly compounding
A3-19. a. Amount required today with annual compounding (rate = .06; # periods = 1 n)
$20,000 (1.06)-18 = $ 7,007
25,000 (1.06)-19 =
8,263
-20
30,000 (1.06)
=
9,354
40,000 (1.06)-21 = 11,766
Total = $36,390

b. Amount required today with quarterly compounding (rate = .06/4 = .015; # periods = 4
n)
$20,000 (1.015)-72 = $ 6,847
25,000 (1.015)-76 =
8,063
-80
30,000 (1.015) =
9,117
40,000 (1.015)-84 = 11,453
Total = $35,480
c. Amount required today with monthly compounding (rate= .06/12 = .005; # periods =
12 n):

$20,000 (1.005)-216 = $ 6,810


25,000 (1.005)-228 =
8,018
-240
30,000 (1.005) =
9,063
40,000 (1.005)-252 = 11,382
Total = $35,273

P3-23. Consumer Insurance, Inc. sells extended warranties on appliances that provide coverage
after the manufacturers' warranties expire. An analyst for the company forecasts that the
company will have to pay warranty claims of $5 million per year for three years, with the
first costs expected to occur four years from today. The company wants to set aside a lump

sum today to cover these costs, and money invested today will earn 10%. How much does
the firm need to invest now?
A3-23. PV of deferred annuity* = $5,000,000 [1-(1.10)-3 ] (1.10)-3 = $9,342,044
.10
* Note the present value of the three deposits is measured at the beginning of year 4, i.e.,
the end of year 3.

P3-39. You are planning to purchase a building for $40,000, and you have $10,000 to apply as a
down payment. You may borrow the remainder under the following terms: a 10-year loan
with semiannual repayments and a stated interest rate of 6 %. You intend to make $6,000
payments, applying the excess over your required payment to the reduction of the principal
balance.
a. Given these terms, how long (in years) will it take you to fully repay your loan?
b. What will be your total interest cost?
c. What would your interest cost be if you made no prepayments and repaid your loan by
strictly adhering to the terms of the loan?

A3-39. a. Required Payment:


PMT =

Period
1
2
3
4
5
6

$30,000
= $30,000
= $2,016.47
-2 x 10
-20
[ 1 (1 + {.06/2}
] 1 (1.03)
.06 /2
.03

Beginning
Balance
$30,000.00
24,900.00
19,647.00
14,236.41
8,663.50
2,923.41

Amortization Schedule
Interest
Payment (.03 Principal) Principal Prepay
$2,016.47
$ 900.00
$1,116.47 $3,983.53
2,016.47
747.00
1,269.47 3,983.53
2,016.47
589.41
1,427.06 3,983.53
2,016.47
427.09
1,589.38 3,983.53
2,016.47
259.91
1,756.56 3,983.53
2,016.47
87.70
1,928.77
994.64
$3,011.11

The loan will be paid off in 6 periods or 3 years.

b. Total interest cost = $3,011.11


c. Total interest cost with no prepayments:
20 $2,016.47 $30,000 = $10,329.40

Ending
Balance
$24,900.00
19,647.00
14,236.41
8,663.50
2,923.41
0

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