Financial Management I Assignment

Question 1: Present Value of Coca-Cola’s $1,000 IOU

Coca-Cola promised to pay $1,000 at the end of 10 years. If the market interest rate is 8.53%, the
present value (PV) can be calculated using the formula:
FV
PV =
( 1+r )n
Where:
 FV =1 , 000 (Future Value)
 r =0.0853 (Market interest rate)
 n=10 (Number of years)
Step-by-Step Solution:
1 , 000
1. Substitute the values into the formula: PV =
( 1+0.0853 )10
2. Calculate the base of the exponent: 1+0.0853=1.0853
3. Raise the base to the power of 10: ( 1.0853 )10=2.2746
1 , 000
4. Divide the future value by the result: PV = PV ≈ 439.45
2.2746
Interpretation:
The present value represents the amount you should pay today to receive $1,000 in 10 years,
assuming an annual market interest rate of 8.53%. This value reflects the time value of money,
where future cash flows are discounted to their value today.
Answer: You should be prepared to pay $439.45 for the IOU today.

Question 2: Monthly Payment on a $100,000 Mortgage

If you take out a 100 , 000 fifteen− yearmortgageataninterestrateof 1PMT$) can be calculated
using the loan payment formula:
n
P ⋅r ⋅ ( 1+r )
PMT = n
( 1+r ) −1
Where:
 P=100 , 000 (Principal loan amount)
 r =0.01 (Monthly interest rate)
 n=180 (15 years × 12 months)
Step-by-Step Solution:
180
100 ,000 ⋅0.01 ⋅ ( 1+0.01 )
1. Substitute the values into the formula: PMT = 180
( 1+0.01 ) −1
2.Calculate the base of the exponent: 1+0.01=1.01
3.Raise the base to the power of 180: ( 1.01 )180 ≈ 6.7275
4.Calculate the numerator: 100 , 000 ⋅0.01 ⋅6.7275=6 ,727.5
5.Calculate the denominator: 6.7275−1=5.7275
6 ,727.5
6. Divide the numerator by the denominator: PMT = PMT ≈ 1 , 131.08
5.7275
Components of the First Payment:
 Interest: 0.01 ×100 , 000=1, 000
 Amortization: 1 ,131.08−1 , 000=131.08
Interpretation:
The monthly payment ensures that the loan is fully repaid, including interest, over 15 years. The
first payment's breakdown shows a higher interest portion, which decreases over time as the loan
balance reduces.
Answer: Monthly payment = 1 ,131.08∗¿ , with∗¿1,000 interest and $131.08 amortization in
the first payment.

Question 3: Future Value with Simple and Compound Interest

You deposit 1 , 000inabankaccount .Thebankpays 4 FV$) under both simple and compound
interest scenarios.
a) Simple Interest:
The formula is: FV =P ⋅ ( 1+r ⋅n ) Where:
 P=1 , 000 (Principal)
 r =0.04 (Annual interest rate)
 n=10 (Number of years)
Step-by-Step Solution:
1. Substitute the values: FV =1 , 000 ⋅ ( 1+ 0.04 ⋅10 )
2. Simplify the calculation: FV =1 , 000 ⋅ ( 1+ 0.4 ) FV =1 , 000 ⋅1.4 FV =1 , 400
b) Compound Interest:
The formula is: FV =P ⋅ ( 1+r )n Step-by-Step Solution:

1. Substitute the values: FV =1 , 000 ⋅ ( 1+ 0.04 )10

2. Calculate the base: 1+0.04=1.04
3. Raise the base to the power of 10: ( 1.04 )10 ≈ 1.4802
 4. Multiply by the principal: FV =1 , 000 ⋅1.4802 FV ≈ 1 , 480.20
c) Interest on Interest:
“ InterestonInterest ”=CompoundInterest−SimpleInterest
“ InterestonInterest ”=1 , 480.20−1 , 400 “ InterestonInterest ” ≈ 80.20
Interpretation:
Simple interest grows linearly, while compound interest grows exponentially due to interest-on-
interest effects. This makes compound interest a more effective investment over long periods.
Answer:
 Future Value with Simple Interest: $1,400
 Future Value with Compound Interest: $1,480.20
 Interest on Interest: $80.20

Question 4: Present Value to Meet Savings Goal

You will require 700∈5 years . Ifyouearn 6 PV$) formula:
FV
PV =
( 1+r )n
Where:
 FV =700 (Future Value)
 r =0.06 (Interest rate)
 n=5 (Number of years)
Step-by-Step Solution:
700
1. Substitute the values: PV =
( 1+0.06 )5
2. Calculate the base of the exponent: 1+0.06=1.06
3. Raise the base to the power of 5: ( 1.06 )5 ≈ 1.3382
700
4. Divide the future value by the result: PV = PV ≈ 523.09
1.3382
Interpretation:
The present value reflects the amount you need to invest today at 6% interest to accumulate $700
in 5 years. This calculation highlights the importance of saving early to achieve financial goals.
Answer: You need to invest $523.09 today.

Question 5: Present Value of a 3-Year Annuity

The annuity pays 100 annuallyfor 3 years , withan 8PV$) of this annuity, we use the formula:
 (
PV =PMT ⋅ 1−
1
( 1+r )n )
/r

Where:
 PMT =100 (Annual payment)
 r =0.08 (Discount rate)
 n=3 (Number of years)
Step-by-Step Solution:

1. Substitute the values into the formula: PV =100 ⋅ 1−( 1

)
( 1+ 0.08 )3
/0.08

2. Calculate the base of the exponent: 1+0.08=1.08

3. Raise the base to the power of 3: ( 1.08 )3 ≈ 1.2597
1
4. Calculate the fraction: ≈ 0.7938
1.2597
5. Subtract from 1: 1−0.7938=0.2062
6. Multiply by the payment and divide by the discount rate: PV =100 ⋅0.2062/0.08
PV ≈ 257.71
Interpretation:
The present value of the annuity represents the value of receiving $100 annually for 3 years,
discounted at 8% per year. This value highlights the diminishing worth of future payments as
they are discounted to their value today.
Answer: The present value of the annuity is $257.71.

Question 6: Loan Repayment with Equal Annual Installments

You borrow $1,000 and agree to repay the loan in five equal annual payments at an interest rate
of 12%. To find the annual payment (), we use the loan payment formula:
Where:
(Loan amount)
(Annual interest rate)
(Number of payments)
Step-by-Step Solution:
Substitute the values into the formula:
Calculate the base of the exponent:
Raise the base to the power of 5:
Calculate the numerator:
Calculate the denominator:
Divide the numerator by the denominator:
Interpretation:
The annual payment ensures that the loan is fully repaid over 5 years, including both principal
and interest. The constant payments simplify budgeting and provide clarity on debt obligations.
Answer: The annual payment is $277.49.

Question 7: Present Value of Lottery Winnings

You just won a lottery of 40 million , whichpays2 million annually for 20 years. The discount rate
is 10%, and the first payment comes in 1 year. To calculate the present value ( PV ) of the
winnings, we use the formula for the present value of an annuity:

PV =PMT ⋅ 1−
( 1
)
( 1+r )n
/r

Where:
 PMT =2 , 000 , 000 (Annual payment)
 r =0.10 (Discount rate)
 n=20 (Number of years)
Step-by-Step Solution:

(
1. Substitute the values into the formula: PV =2 , 000 , 000 ⋅ 1−
1
)
( 1+0.10 )20
/0.10

2. Calculate the base of the exponent: 1+0.10=1.10

3. Raise the base to the power of 20: ( 1.10 )20 ≈ 6.7275
1
4. Calculate the fraction: ≈ 0.1486
6.7275
5. Subtract from 1: 1−0.1486=0.8514
6. Multiply by the payment and divide by the discount rate: PV =2 , 000 , 000 ⋅0.8514 /0.10
PV ≈ 17 ,028 , 000
Interpretation:
The present value of the lottery winnings reflects the amount you would accept today in a lump
sum to forego the annual payments over 20 years, discounted at 10%.
Answer: The present value of the winnings is $17,028,000.

Question 8: Monthly Interest Rate on a Loan

You borrowed 100 , 000 tobuyacondoandwillrepaytheloaninequalmonthlypaymentsof 804.62 over
30 years. To find the monthly interest rate (r ), we use the loan payment formula:
 n
P ⋅r ⋅ ( 1+r )
PMT = n
( 1+r ) −1
Where:
 P=100 , 000 (Loan amount)
 PMT =804.62 (Monthly payment)
 n=360 (30 years × 12 months)
Step-by-Step Solution:
1. Substitute the known values into the formula and solve iteratively:
100 , 000 ⋅r ⋅ ( 1+r )360
804.62= 360
( 1+r ) −1
2. Using trial and error or a financial calculator:
o r ≈ 0.0065
o Equivalent to 0.65% monthly interest rate.
Interpretation:
This monthly interest rate represents the cost of borrowing on a monthly basis, compounded over
the life of the loan.
Answer: The monthly interest rate is 0.65%.

Question 9: Total Debt Ratio of a Firm

A firm has the following data:
 Long-term debt-equity ratio = 0.4
 Shareholders’ equity = $1,000,000
 Current assets = $200,000
 Current ratio = 2.0
 Current liabilities = Notes payable
Step-by-Step Solution:
1. Calculate total long-term debt: “ Long−termDebt ”=0.4 ⋅1 ,000 ,000=400 , 000
2. Calculate current liabilities using the current ratio:
“ CurrentAssets ” 200 , 000
“ CurrentLiabilities ”= “ CurrentLiabilities ”= =100 , 000
“ CurrentRatio ” 2
3. Calculate total debt: “ TotalDebt ”=“ Long−termDebt ”+ “CurrentLiabilities ”
“ TotalDebt ”=400 , 000+100 , 000=500 ,000
4. Calculate total assets: “ TotalAssets ”=“ Shareholders ’ Equity ”+“ TotalDebt ”
“ TotalAssets ”=1 ,000 , 000+500 ,000=1 ,500 , 000
“TotalDebt ”
5. Calculate total debt ratio: “ TotalDebtRatio ”=
“TotalAssets ”
500 , 000
“ TotalDebtRatio ”= =0.3333
1 , 500 ,000
Interpretation:
The total debt ratio indicates the proportion of the firm’s assets financed by debt, which in this
case is approximately 33.33%.
Answer: The total debt ratio is 33.33%.

Would you like me to proceed with the next set of questions in this detailed style? Let me know!

Question 10: Price of a Bond with Current Yield and Coupon Rate
A bond with:
 Par value: $1,000
 Current yield: 7.5%
 Coupon rate: 8%
The price of the bond ( P) is calculated using the relationship between current yield and the
coupon payment:
Annual Coupon Payment
Current Yield =
Price
Annual Coupon Payment
Rearranging for price: P=
Current Yield
Step-by-Step Solution:
1. Calculate the annual coupon payment:
Annual Coupon Payment=Par Value× Coupon Rate
Annual Coupon Payment=1 , 000 ×0.08=80
80
2. Substitute into the formula for price: P=
0.075
3. Perform the calculation: P=1 , 066.67

Interpretation:
The price of the bond reflects the relationship between its coupon payment and the current yield
demanded by investors. A higher price indicates that the bond’s coupon rate exceeds the market-
required yield.
Answer: The bond’s price is $1,066.67.

Question 11: Value of a Bond After 1 Year

A bond with a par value of $1,000 and a 6% coupon rate has:
 3 years to maturity initially, selling at $1,010.77
  After 1 year, 2 years to maturity, with a required return of 7%
Step-by-Step Solution:
1. Calculate the present value of the remaining coupon payments:

o Annual coupon payment = 1 , 000× 0.06=60

o Using the present value of an annuity formula:

PV ( coupons )=PMT ⋅ 1−
1
(
(1+r )n
/r Where:
)
 PMT =60, r =0.07, n=2

Substitute values: PV ( coupons )=60⋅ 1− ( 1

( 1+0.07 )2)/0.07

(
PV ( coupons )=60⋅ 1−
1
1.1449 )
/0.07 PV ( coupons )=60⋅ ( 1−0.8734 ) /0.07
PV ( coupons )=60⋅ 0.1266/0.07 PV ( coupons ) ≈ 108.45

2. Calculate the present value of the par value (face value):

Par Value 1 ,000 1 ,000
PV ( face )= n
PV ( face )= 2 PV ( face ) = PV ( face ) ≈ 873.44
( 1+r ) ( 1+ 0.07 ) 1.1449

3. Add the present values of the coupons and the face value:
PV ( total )=PV ( coupons )+ PV ( face ) PV ( total )=108.45+ 873.44 PV ( total ) ≈ 981.89

Interpretation:
The value of the bond reflects the discounted cash flows of the remaining coupon payments and
the face value, adjusted for the required return of 7%.
Answer: The value of the bond is $981.89.

Question 12: Price of Preferred Stock

Favored stock pays a dividend of 2.40 pershareannually . Itsdividendyieldis 8P$) is calculated as:
Dividend
P=
Dividend Yield
Step-by-Step Solution:
2.40
1. Substitute the values: P=
0.08
2. Perform the calculation: P=30
Interpretation:
The price of the preferred stock reflects the perpetual dividend payment discounted at the
dividend yield rate.
Answer: The price of the stock is $30.00.

Question 13: Price of Preferred Stock with Annual Dividend

Preferred Products issues preferred stock with an annual dividend of
7 , paidinperpetuity .Thediscountrateis 12P$) is:
Dividend
P=
Discount Rate
Step-by-Step Solution:
7
1. Substitute the values: P=
0.12
2. Perform the calculation: P=58.33
Interpretation:
This price reflects the perpetuity value of a constant dividend payment discounted at the required
rate of return.
Answer: The price of the preferred stock is $58.33.

Question 14: Discount Rate for a Stock

A stock sells for 40 . Thenextdividendwillbe 4 per share. The rate of return on reinvested funds is
15%, and the company reinvests 40% of earnings. Calculate the discount rate (r ).
Step-by-Step Solution:
1. Use the Gordon Growth Model: r =Dividend Yield + g Where:
o g=extReinvestmentRate × extReturnonReinvestment
2. Calculate the growth rate: g = 0.40 \times 0.15 = 0.06 \text{ or 6%}
D1
3. Calculate the dividend yield: Dividend Yield= \text{Dividend Yield} = \frac{4}{40}
P0
= 0.10 \text{ or 10%}
4. Add the components: r = 0.10 + 0.06 = 0.16 \text{ or 16%}
Interpretation:
The discount rate reflects the required return for the stock based on its dividend yield and growth
rate.
Answer: The discount rate is 16%.

Question 15: Stock Price with Multiple Dividends

A stock is expected to pay dividends of 1.00 ,1.25, and 1.50 inthenext 3 years . Thestockwillsellfor
20 at the end of Year 3. The discount rate is 10%. Calculate the stock price today.
Step-by-Step Solution:
1. Use the present value formula for each dividend and the terminal
D1 D2 D 3+ P3
value: P0= + + Where:
( 1+r ) ( 1+r ) ( 1+r )3
1 2

o D1=1.00 , D2=1.25 , D3=1.50 , P3=20

o r =0.10
2. Calculate each term:
1.00 1.00
o First dividend: = =0.9091
( 1+ 0.10 ) 1.10
1

1.25 1.25
o Second dividend: = =1.0331
( 1+ 0.10 ) 1.21
2

1.50+20 21.50
o Third dividend and terminal price: = =16.1510
( 1+ 0.10 )3 1.331
3. Sum the present values: P0=0.9091+ 1.0331+ 16.1510 P0 ≈ 18.0932

Interpretation:
The stock price reflects the present value of expected future cash flows, including dividends and
the terminal sale price.
Answer: The stock price is $18.09.

Question 16: Stock Price with Constant Growth

Fincorp will pay a year-end dividend of $4.80 per share, expected to grow at 4% indefinitely.
The discount rate is 12%. Calculate the stock price.
Step-by-Step Solution:
D1
1. Use the Gordon Growth Model: P0= Where:
r −g
o D1=4.80, r =0.12, g=0.04
4.80 4.80
2. Substitute the values: P0= P 0= P =60
0.12−0.04 0.08 0

Interpretation:
The stock price reflects the value of perpetual dividend payments growing at a constant rate.
Answer: The stock price is $60.00.
Question 17: Present Value of Dividends
Grandiose Growth has a dividend growth rate of 20%, a discount rate of 10%, and an end-of-year
dividend of $2 per share. Calculate the present value of dividends for Years 1, 2, and 3.
Step-by-Step Solution:
Dt
1. Use the present value formula for each dividend: PV = Where:
( 1+r )t

o D1=2.00 , D2=2.00 × 1.20=2.40 , D3=2.40 × 1.20=2.88

o r =0.10
2. Calculate each term:
2.00 2.00
o Year 1: = =1.8182
( 1+ 0.10 ) 1.10
1

2.40 2.40
o Year 2: = =1.9835
( 1+ 0.10 ) 1.21
2

2.88 2.88
o Year 3: = =2.1635
( 1+ 0.10 ) 3
1.331
3. Sum the present values: PV =1.8182+1.9835+2.1635 PV ≈ 5.9652

Interpretation:
The present value represents the discounted value of dividends for the first three years.
Answer: The present value of dividends is $5.97.

Question 18: Total Rate of Return on a Stock

A stock is selling today for 40 pershare . Attheendoftheyear ,itpaysadividendof 2 per share and
sells for $44. Calculate the total rate of return, dividend yield, and capital gains yield.
Step-by-Step Solution:
Dividend+Price Change
1. Total Rate of Return: Total Rate of Return=
Initial Price
2+ ( 44−40 )
Substitute the values: Total Rate of Return= \text{Total Rate of
40
Return} = \frac{2 + 4}{40} = \frac{6}{40} = 0.15 \text{ or 15%}
Dividend
2. Dividend Yield: Dividend Yield= Substitute the values: \
Initial Price
text{Dividend Yield} = \frac{2}{40} = 0.05 \text{ or 5%}
Price Change
3. Capital Gains Yield: Capital Gains Yield= Substitute the
Initial Price
values: \text{Capital Gains Yield} = \frac{44 - 40}{40} = \frac{4}
{40} = 0.10 \text{ or 10%}
Interpretation:
The total rate of return combines the stock’s dividend income and capital appreciation, reflecting
the overall profitability of the investment.
Answer:
 Total Rate of Return: 15%
 Dividend Yield: 5%
 Capital Gains Yield: 10%

Question 19: Average Accounting Return (AAR)

You are evaluating a 3-year project with the following:
 Projected net income: 2 , 000 ( Year 1 ) ,4,000 (Year 2), $6,000 (Year 3)
 Initial cost: $12,000, depreciated straight-line to zero over 3 years
Step-by-Step Solution:
Total Net Income
1. Calculate Average Net Income: Average Net Income=
Number of Years
2 , 000+4 ,000+ 6 , 000 12 ,000
Average Net Income= Average Net Income= =4 ,000
3 3
2. Calculate Average Investment:
Initial Cost+ Ending Book Value
Average Investment= Since the project is
2
12 , 000+0
depreciated to zero: Average Investment= =6 , 000
2
Average Net Income
3. Calculate AAR: AAR= Substitute the values: \
Average Investment
text{AAR} = \frac{4,000}{6,000} = 0.6667 \text{ or 66.67%}

Interpretation:
The AAR provides a simple measure of profitability based on accounting figures, useful for
comparing projects.
Answer: The Average Accounting Return is 66.67%.

Question 20: Payback Period

An investment project provides cash inflows of
300 peryearfor 8 years. Calculatethepaybackperiodforinitialcostsof 1,400, 1 ,750 ,∧¿2,500.
Step-by-Step Solution:
1. Initial Cost = $1,400:
 o Annual cash inflow = $300
Initial Cost 1 , 400
o Payback period = Payback Period= ≈ 4.67 years
Annual Cash Inflow 300
1 ,750
2. Initial Cost = $1,750: Payback Period= ≈ 5.83 years
300
2 ,500
3. Initial Cost = $2,500: Payback Period= ≈ 8.33 years
300
Interpretation:
The payback period measures how long it takes for the project to recover its initial investment
from cash inflows.
Answer:
 Payback Period for $1,400: 4.67 years
 Payback Period for $1,750: 5.83 years
 Payback Period for $2,500: 8.33 years

Question 21: Discounted Payback Period

An investment project has annual cash inflows of 7 , 000 ,7,500, 8 , 000 ,∧¿8,500, with a discount
rate of 15%. Calculate the discounted payback period for initial costs of 8 , 000 ,13,000, and
$18,000.
Step-by-Step Solution:
Cash Inflow
1. Discount the Cash Flows: Discounted Cash Flow= Where
( 1+r )t
r =0.15:
7 , 000 7 ,000
o Year 1: = ≈ 6 , 086.96
( 1+ 0.15 ) 1
1.15
7 , 500 7 ,500
o Year 2: = ≈ 5 ,671.14
( 1+ 0.15 ) 2
1.3225
8 , 000 8 ,000
o Year 3: = ≈ 5 ,259.97
( 1+ 0.15 ) 1.5209
3

8 , 500 8 , 500
o Year 4: = ≈ 4 , 858.82
( 1+ 0.15 ) 1.7490
4

2. Calculate Cumulative Discounted Cash Flows:

o Year 1: 6 , 086.96
o Year 2: 6 , 086.96+5 , 671.14=11, 758.10
o Year 3: 11, 758.10+5 , 259.97=17 ,018.07
o Year 4: 17 , 018.07+ 4 , 858.82=21 , 876.89
3. Determine Payback Periods:
 o For 8 , 000 :Thecumulativediscountedcashflowexceeds 8,000 during Year 2.
8 , 000−6 , 086.96
 Payback period = 1+ Payback Period ≈1.34 years
5 , 671.14
o For 13 , 000 :Thecumulativediscountedcashflowexceeds13,000 during Year 3.
13 ,000−11, 758.10
 Payback period = 2+ Payback Period ≈ 2.24 years
5 , 259.97
o For 18 , 000 :Thecumulativediscountedcashflowexceeds18,000 during Year 4.
18 , 000−17 , 018.07
 Payback period = 3+ Payback Period ≈3.20 years
4 , 858.82
Interpretation:
The discounted payback period accounts for the time value of money, providing a more accurate
measure of investment recovery.
Answer:
 For $8,000: 1.34 years
 For $13,000: 2.24 years
 For $18,000: 3.20 years