2.99 See Answer

Question: An insurance company is offering a new


An insurance company is offering a new policy to its customers. Typically, the policy is bought by a parent or grandparent for a child at the child’s birth. The details of the policy are as follows: The purchaser (say, the parent) makes the following six payments to the insurance company:

First birthday: …………….……………..$ 900
Second birthday: ………………………..$ 900
Third birthday: …………………………..$1,000
Fourth birthday: ……………….………$1,000
Fifth birthday: ……………….………….$1,100
Sixth birthday: ……………….…………$1,100

After the child’s sixth birthday, no more payments are made. When the child reaches age 65, he or she receives $500,000. If the relevant interest rate is 12 percent for the first six years and 8 percent for all subsequent years, is the policy worth buying?



> You want to borrow $73,000 from your local bank to buy a new sailboat. You can afford to make monthly payments of $1,450, but no more. Assuming monthly compounding, what is the highest rate you can afford on a 60-month APR loan?

> Could a company’s cash flow to stockholders be negative in a given year? Explain how this might come about. What about cash flow to creditors?

> You’re prepared to make monthly payments of $340, beginning at the end of this month, into an account that pays 6 percent interest compounded monthly. How many payments will you have made when your account balance reaches $20,000?

> What is the relationship between the value of an annuity and the level of interest rates? Suppose you just bought a 15-year annuity of $9,000 per year at the current interest rate of 10 percent per year. What happens to the value of your investment if in

> Your job pays you only once a year for all the work you did over the previous 12 months. Today, December 31, you just received your salary of $50,000 and you plan to spend all of it. However, you want to start saving for retirement beginning next year. Y

> You have just won the lottery and will receive $1,000,000 in one year. You will receive payments for 30 years, which will increase 5 percent per year. If the appropriate discount rate is 8 percent, what is the present value of your winnings?

> You’ve just joined the investment banking firm of Dewey, Cheatum, and Howe. They’ve offered you two different salary arrangements. You can have $95,000 per year for the next two years, or you can have $70,000 per year for the next two years, along with a

> You want to be a millionaire when you retire in 40 years. How much do you have to save each month if you can earn a 12 percent annual return? How much do you have to save if you wait 10 years before you begin your deposits? 20 years?

> You have an investment that will pay you 1.17 percent per month. How much will you have per dollar invested in one year? In two years?

> You are planning to save for retirement over the next 30 years. To do this, you will invest $700 a month in a stock account and $300 a month in a bond account. The return of the stock account is expected to be 11 percent, and the bond account will pay 6

> You receive a credit card application from Shady Banks Savings and Loan offering an introductory rate of 1.5 percent per year, compounded monthly for the first six months, increasing thereafter to 18 percent compounded monthly. Assuming you transfer the

> You are looking at an investment that has an effective annual rate of 17 percent. What is the effective semiannual return? The effective quarterly return? The effective monthly return?

> Suppose a company’s operating cash flow has been negative for several years running. Is this necessarily a good sign or a bad sign?

> What is the primary disadvantage of the corporate form of organization? Name at least two advantages of corporate organization.

> First Simple Bank pays 7 percent simple interest on its investment accounts. If First Complex Bank pays interest on its accounts compounded annually, what rate should the bank set if it wants to match First Simple Bank over an investment horizon of 10 ye

> If the appropriate discount rate for the following cash flows is 11 percent compounded quarterly, what is the present value of the cash flows? Year Cash …………….………………Flow 1………………………………………….……….$ 725 2………………………………………….…..…….980 3………………………………………………….…….0 4

> In the previous problem, suppose you make $3,600 annual deposits into the same retirement account. How large will your account balance be in 30 years? Data from previous problem: You are planning to make monthly deposits of $300 into a retirement accoun

> You are planning to make monthly deposits of $300 into a retirement account that pays 10 percent interest compounded monthly. If your first deposit will be made one month from now, how large will your retirement account be in 30 years?

> Live Forever Life Insurance Co. is selling a perpetuity contract that pays $1,800 monthly. The contract currently sells for $95,000. What is the monthly return on this investment vehicle? What is the APR? The effective annual return?

> Friendly’s Quick Loans, Inc., offers you “three for four or 1 knock on your door.” This means you get $3 today and repay $4 when you get your paycheck in one week (or else). What’s the effective annual return Friendly’s earns on this lending business? If

> One of your customers is delinquent on his accounts payable balance. You’ve mutually agreed to a repayment schedule of $500 per month. You will charge 1.3 percent per month interest on the overdue balance. If the current balance is $18,000, how long will

> You want to buy a new sports coupe for $68,500, and the finance office at the dealership has quoted you a 6.9 percent APR loan for 60 months to buy the car. What will your monthly payments be? What is the effective annual rate on this loan?

> Big Dom’s Pawn Shop charges an interest rate of 30 percent per month on loans to its customers. Like all lenders, Big Dom must report an APR to consumers. What rate should the shop report? What is the effective annual rate?

> An investment will pay you $58,000 in seven years. If the appropriate discount rate is 10 percent compounded daily, what is the present value?

> Suppose a company’s cash flow from assets is negative for a particular period. Is this necessarily a good sign or a bad sign?

> Gold Door Credit Bank is offering 9.3 percent compounded daily on its savings accounts. If you deposit $4,500 today, how much will you have in the account in 5 years? In 10 years? In 20 years?

> What is the future value of $2,100 in 17 years assuming an interest rate of 8.4 percent compounded semiannually?

> Barcain Credit Corp. wants to earn an effective annual return on its consumer loans of 16 percent per year. The bank uses daily compounding on its loans. What interest rate is the bank required by law to report to potential borrowers? Explain why this ra

> First National Bank charges 14.2 percent compounded monthly on its business loans. First United Bank charges 14.5 percent compounded semiannually. As a potential borrower, which bank would you go to for a new loan?

> Find the APR, or stated rate, in each of the following cases: Stated Rate (APR) Number of Times Compounded Effective Rate (EAR) Semiannually 8.6% Monthly 19.8 Weekly 9.4 Infinite 16.5

> Find the EAR in each of the following cases: Stated Rate (APR) Number of Times Compounded Effective Rate (EAR) 8% Quarterly 16 Monthly 12 Daily 15 Infinite

> In the previous problem, suppose a sales associate told you the policy costs $375,000. At what interest rate would this be a fair deal?

> Dinero Bank offers you a $50,000, seven-year term loan at 7.5 percent annual interest. What will your annual loan payment be?

> You want to have $90,000 in your savings account 10 years from now, and you’re prepared to make equal annual deposits into the account at the end of each year. If the account pays 6.8 percent interest, what amount must you deposit each year?

> If you deposit $4,000 at the end of each of the next 20 years into an account paying 11.2 percent interest, how much money will you have in the account in 20 years? How much will you have if you make deposits for 40 years?

> What does liquidity measure? Explain the trade-off a firm faces between high liquidity and low liquidity levels.

> If you put up $34,000 today in exchange for a 7.65 percent, 15-year annuity, what will the annual cash flow be?

> An investment offers $5,300 per year for 15 years, with the first payment occurring one year from now. If the required return is 7 percent, what is the value of the investment? What would the value be if the payments occurred for 40 years? For 75 years?

> Paradise, Inc., has identified an investment project with the following cash flows. If the discount rate is 8 percent, what is the future value of these cash flows in year 4? What is the future value at a discount rate of 11 percent? At 24 percent? Year

> Investment X offers to pay you $6,000 per year for nine years, whereas Investment Y offers to pay you $8,000 per year for six years. Which of these cash flow streams has the higher present value if the discount rate is 5 percent? If the discount rate is

> Seaborn Co. has identified an investment project with the following cash flows. If the discount rate is 10 percent, what is the present value of these cash flows? What is the present value at 18 percent? At 24 percent? Year ………….………………Cash Flow 1…………………

> Earlier, we discussed the Rule of 72, a useful approximation for many interest rates and periods for the time it takes a lump sum to double in value. For a 10 percent interest rate, show that the “Rule of 73” is slightly better. For what rate is the Rule

> You have 40 years left until retirement and want to retire with $2 million. Your salary is paid annually, and you will receive $40,000 at the end of the current year. Your salary will increase at 3 percent per year, and you can earn an 11 percent return

> As discussed in the text, an annuity due is identical to an ordinary annuity except that the periodic payments occur at the beginning of each period and not at the end of the period. Show that the relationship between the value of an ordinary annuity and

> What is the value of an investment that pays $15,000 every other year forever, if the first payment occurs one year from today and the discount rate is 10 percent compounded daily? What is the value today if the first payment occurs four years from today

> Your financial planner offers you two different investment plans. Plan X is a $20,000 annual perpetuity. Plan Y is a 20-year, $28,000 annual annuity. Both plans will make their fi rst payment one year from today. At what discount rate would you be indiff

> Companies often try to keep accounting earnings growing at a relatively steady pace, thereby avoiding large swings in earnings from period to period. They also try to meet earnings targets. To do so, they use a variety of tactics. The simplest way is to

> A financial planning service offers a college savings program. The plan calls for you to make six annual payments of $9,000 each, with the first payment occurring today, your child’s 12th birthday. Beginning on your child’s 18th birthday, the plan will p

> You have just arranged for a $750,000 mortgage to finance the purchase of a large tract of land. The mortgage has an 8.1 percent APR, and it calls for monthly payments over the next 30 years. However, the loan has an eight-year balloon payment, meaning t

> Your Christmas ski vacation was great, but it unfortunately ran a bit over budget. All is not lost: You just received an offer in the mail to transfer your $10,000 balance from your current credit card, which charges an annual rate of 19.8 percent, to a

> This is a classic retirement problem. A time line will help in solving it. Your friend is celebrating her 35th birthday today and wants to start saving for her anticipated retirement at age 65. She wants to be able to withdraw $105,000 from her savings a

> This problem illustrates a deceptive way of quoting interest rates called add-on interest. Imagine that you see an advertisement for Crazy Judy’s Stereo City that reads something like this: “$1,000 Instant Credit! 14% Simple Interest! Three Years to Pay!

> Two banks in the area offer 30-year, $240,000 mortgages at 6.8 percent and charge a $2,300 loan application fee. However, the application fee charged by Insecurity Bank and Trust is refundable if the loan application is denied, whereas that charged by I.

> The interest rate on a one-year loan is quoted as 11 percent plus two points (see the previous problem). What is the EAR? Is your answer affected by the loan amount? Previous problem: You are looking at a one-year loan of $10,000. The interest rate is qu

> You are looking at a one-year loan of $10,000. The interest rate is quoted as 8 percent plus three points. A point on a loan is simply 1 percent (one percentage point) of the loan amount. Quotes similar to this one are common with home mortgages. The int

> Ben Bates graduated from college six years ago with a finance undergraduate degree. Although he is satisfied with his current job, his goal is to become an investment banker. He feels that an MBA degree would allow him to achieve this goal. After examini

> Could a company’s change in NWC be negative in a given year? Explain how this might come about. What about net capital spending?

> On subsidized Stafford loans, a common source of financial aid for college students, interest does not begin to accrue until repayment begins. Who receives a bigger subsidy, a freshman or a senior? Explain. In words, how would you go about valuing the su

> A viatical settlement is a lump sum of money given to a terminally ill individual in exchange for his life insurance policy. When the insured person dies, the purchaser receives the payout from the life insurance policy. What factors determine the value

> Eligibility for a subsidized Stafford loan is based on current financial need. However, both subsidized and unsubsidized Stafford loans are repaid out of future income. Given this, do you see a possible objection to having two types?

> As you increase the length of time involved, what happens to the present value of an annuity? What happens to the future value?

> There are four pieces to an annuity present value. What are they?

> Should lending laws be changed to require lenders to report EARs instead of APRs? Why or why not?

> If you were an athlete negotiating a contract, would you want a big signing bonus payable immediately and smaller payments in the future, or vice versa? How about looking at it from the team’s perspective?

> What do you think about the Tri-State Megabucks lottery discussed in the chapter advertising a $500,000 prize when the lump sum option is $250,000? Is it deceptive advertising?

> Imprudential, Inc. has an unfunded pension liability of $650 million that must be paid in 20 years. To assess the value of the firm’s stock, financial analysts want to discount this liability back to the present. If the relevant discount rate is 7.4 perc

> For each of the following, compute the present value: Present Value Years Interest Rate Future Value 6 7% $ 15,451 7 13 51,557 23 14 886,073 18 550,164

> Critics have charged that compensation to top managers in the United States is simply too high and should be cut back. For example, focusing on large corporations, Ray Irani of Occidental Petroleum has been one of the best-compensated CEOs in the United

> For each of the following, compute the future value: Present Value Years Interest Rate Future Value $ 2,250 11 10% 8,752 7 8 76,355 14 17 183,796 8 7

> You are scheduled to receive $20,000 in two years. When you receive it, you will invest it for six more years at 8.4 percent per year. How much will you have in eight years?

> You have just made your first $4,000 contribution to your retirement account. Assuming you earn an 11 percent rate of return and make no additional contributions, what will your account be worth when you retire in 45 years? What if you wait 10 years befo

> Suppose you are still committed to owning a $170,000 Ferrari (see Problem 9). If you believe your mutual fund can achieve a 12 percent annual rate of return and you want to buy the car in 9 years on the day you turn 30, how much must you invest today?

> Your coin collection contains fifty 1952 silver dollars. If your grandparents purchased them for their face value when they were new, how much will your collection be worth when you retire in 2057, assuming they appreciate at a 4.5 percent annual rate?

> You have just received notification that you have won the $1 million first prize in the Centennial Lottery. However, the prize will be awarded on your 100th birthday (assuming you’re around to collect), 80 years from now. What is the present value of you

> In January 2007, the average house price in the United States was $314,600. In January 2000, the average price was $200,300. What was the annual increase in selling price?

> At 7 percent interest, how long does it take to double your money? To quadruple it?

> Assume the total cost of a college education will be $290,000 when your child enters college in 18 years. You presently have $55,000 to invest. What annual rate of interest must you earn on your investment to cover the cost of your child’s college educat

> Solve for the unknown number of years in each of the following: Present Value Years Interest Rate Future Value $ 560 9% $ 1,284 810 10 4,341 18,400 17 364,518 21,500 15 173,439

> Corporate ownership varies around the world. Historically individuals have owned the majority of shares in public corporations in the United States. In Germany and Japan, however, banks, other large financial institutions, and other companies own most of

> Solve for the unknown interest rate in each of the following: Present Value Years Interest Rate Future Value $ 240 2 297 360 10 1,080 39,000 15 185,382 38,261 30 531,618

> You expect to receive $10,000 at graduation in two years. You plan on investing it at 11 percent until you have $75,000. How long will you wait from now?

> Referring to the TMCC security we discussed at the very beginning of the chapter: a. Based on the $24,099 price, what rate was TMCC paying to borrow money? b. Suppose that, on March 28, 2020, this security’s price is $38,260. If an investor had purchased

> Although appealing to more refined tastes, art as a collectible has not always performed so profitably. During 2003, Sotheby’s sold the Edgar Degas bronze sculpture Petite Danseuse de Quatorze Ans at auction for a price of $10,311,500. Unfortunately for

> In 2008, a gold Morgan dollar minted in 1895 sold for $43,125. For this to have been true, what rate of return did this coin return for the lucky numismatist?

> In 1895, the first U.S. Open Golf Championship was held. The winner’s prize money was $150. In 2007, the winner’s check was $1,260,000. What was the percentage increase per year in the winner’s check over this period? If the winner’s prize increases at t

> You’re trying to save to buy a new $170,000 Ferrari. You have $40,000 today that can be invested at your bank. The bank pays 5.3 percent annual interest on its accounts. How long will it be before you have enough to buy the car?

> What is compounding? What is discounting?

> The basic present value equation has four parts. What are they?

> Take a look back at Example 5.7. Is it deceptive advertising? Is it unethical to advertise a future value like this without a disclaimer? To answer the next five questions, refer to the TMCC security we discussed to open the chapter.

> Why might the revenue and cost figures shown on a standard income statement not be representative of the actual cash inflows and outflows that occurred during a period?

> What happens to a future value if you increase the rate r ? What happens to a present value?

> The most recent financial statements for Live Co. are shown here: Assets and costs are proportional to sales. Debt and equity are not. The company maintains a constant 30 percent dividend payout ratio. No external equity financing is possible. What is

> The most recent financial statements for Summer Tyme, Inc., are shown here: Assets, costs, and current liabilities are proportional to sales. Long-term debt and equity are not. The company maintains a constant 40 percent dividend payout ratio. As with

> The most recent financial statements for GPS, Inc., are shown here: Assets and costs are proportional to sales. Debt and equity are not. A dividend of $1,400 was paid, and the company wishes to maintain a constant payout ratio. Next yearâ€&#

> The most recent financial statements for Zoso, Inc., are shown here (assuming no income taxes): Assets and costs are proportional to sales. Debt and equity are not. No dividends are paid. Next year’s sales are projected to be $7,434.

> In the previous question, assume Phillips pays out half of net income in the form of a cash dividend. Costs and assets vary with sales, but debt and equity do not. Prepare the pro forma statements and determine the external financing needed. Income S

> Consider the following simplified financial statements for the Phillips Corporation (assuming no income taxes): Phillips has predicted a sales increase of 15 percent. It has predicted that every item on the balance sheet will increase by 15 percent as

> In the chapter, we discussed the two versions of the sustainable growth rate formula. Derive the formula ROE × b from the formula given in the chapter, where ROE is based on beginning of period equity. Also, derive the formula ROA × b from the internal g

> Based on the result in Problem 31, show that the internal and sustainable growth rates are as given in the chapter.

> Define the following: S=Previous year’s sales A=Total assets D=Total debt E=Total equity g=Projected growth in sales PM=Profit margin b=Retention (plowback) ratio Show that EFN can be written as follows: EFN=−PM(S)b + (A − PM(S)b)×g

2.99

See Answer