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fundamentals of corporate finance

Questions and Answers of Fundamentals Of Corporate Finance

*24. You have some extra cash this month and you are considering putting it toward your car loan. Your interest rate is 7%, your loan payments are $600 per month, and you have 36 months left on your
23. You are thinking about leasing a car. The purchase price of the car is $30,000. The residual value (the amount you could pay to keep the car at the end of the lease) is$15,000 at the end of 36
22. You have just purchased a car and taken out a $50,000 loan. The loan has a five-year term with monthly payments and an APR of 6%.a. How much will you pay in interest, and how much will you pay in
*21. You have just sold your house for $1,000,000 in cash. Your mortgage was originally a 30-year mortgage with monthly payments and an initial balance of $800,000. The mortgage is currently exactly
20. You have decided to refinance your mortgage. You plan to borrow whatever is outstanding on your current mortgage. The current monthly payment is $2356 and you have made every payment on time. The
*19. You are buying a house and the mortgage company offers to let you pay a “point”(1% of the total amount of the loan) to reduce your APR from 6.5% to 6.25% on your$400,000, 30-year mortgage
*18. Consider the loan from the previous question: a 60-month, $20,000 car loan with a 6% APR, compounded monthly. Assume that right after you make your 50th payment, the balance on the loan is
17. You have just taken out a $20,000 car loan with a 6% APR, compounded monthly. The loan is for five years. When you make your first payment in one month, how much of the payment will go toward the
16. Ironwood Bank is offering a 30-year mortgage with an APR of 6.00% based on monthly compounding. If you plan to borrow $160,000, what will be your monthly payment?
15. Assume you graduate from college with $30,000 in student loans. If your interest rate is fixed at 4.66% APR with monthly compounding and you will repay the loans over a 10-year period, what will
14. Suppose Capital One is advertising a 60-month, 5.99% APR motorcycle loan. If you need to borrow $8000 to purchase your dream Harley-Davidson, what will your monthly payment be?
13. You make monthly payments on your car loan. It has a quoted APR of 5% (monthly compounding). What percentage of the outstanding principal do you pay in interest each month?
12. You have been accepted into college. The college guarantees that your tuition will not increase for the four years you attend. The first $10,000 tuition payment is due in six months. After that,
11. A payday loan is structured to obscure the true interest rate you are paying. For example, in Washington, you pay a $30 “fee” for a two-week $200 payday loan (when you repay the loan, you pay
10. Suppose the interest rate is 8% APR with monthly compounding. What is the present value of an annuity that pays $100 every six months for five years?
9. Your bank account pays interest with an EAR of 5%. What is the APR quote for this account based on semiannual compounding? What is the APR with monthly compounding?
8. You have found three investment choices for a one-year deposit: 10% APR compounded monthly, 10% APR compounded annually, and 9% APR compounded daily.Compute the EAR for each investment choice.
*7. You have been offered a job with an unusual bonus structure. As long as you stay with the firm, you will get an extra $70,000 every seven years, starting seven years from now. What is the present
6. Which do you prefer: a bank account that pays 5% per year (EAR) for three years ora. an account that pays 2.5% every six months for three years?b. an account that pays 7.5% every 18 months for
5. An online bank is offering to pay 0.25% interest per month on deposits. Your local bank offers to pay 0.75% interest quarterly (every 3 months). Which is the higher interest rate?
4. You are considering two ways of financing a spring break vacation. You could put it on your credit card, at 15% APR, compounded monthly, or borrow the money from your parents, who want an 8%
4 The Opportunity Cost of Capital• An investor’s opportunity cost of capital (or simply, the cost of capital) is the best available expected return offered in the market on an investment of
3. You are looking to buy a car and you have been offered a loan with an APR of 6%, compounded monthly.a. What is the true monthly rate of interest?b. What is the EAR?Problems• The shape of the
2. Your bank is offering you an account that will pay 20% interest in total for a two-year deposit. Determine the equivalent discount rate for a period length ofa. six months.b. one year.c. one month.
1. You are considering a car loan with a stated APR of 6% based on monthly compounding.What is the effective annual rate of this loan?
9. What do we mean when we refer to the “opportunity cost” of capital?
8. In the early 1980s, inflation was in the double-digits and the yield curve sloped sharply downward. What did the yield curve say about investors’ expectations about future inflation rates?
7. Can the nominal interest rate available to an investor be negative? (Hint: Consider the interest rate earned from saving cash “under the mattress.”) Can the real interest rate be negative?
6. How do changes in inflation expectations impact interest rates?
5. What mistake do you make when you discount real cash flows with nominal discount rates?
4. Why aren’t the payments for a 15-year mortgage twice the payments for a 30-year mortgage at the same rate?
3. Why is it so important to match the frequency of the interest rate to the frequency of the cash flows?
2. Why is the EAR for 6% APR, with semiannual compounding, higher than 6%?
1. Explain how an interest rate is just a price.
• See the link between interest rates in the market and a firm’s opportunity cost of capital
• Know how inflation, expectations, and risk combine to determine interest rates
• Use quoted rates to calculate loan payments and balances
• Understand the different ways interest rates are quoted
Assume that today is August 5, 2015. Natasha Kingery is 30 years old and has a Bachelor of Science degree in computer science. She is currently employed as a Tier 2 field service representative for a
48. You have just deposited $1000 in an unusual bank account that pays interest biannually(once every 2 years). If the 2-year interest rate is 8% (total interest over 2 years is 8%, not 8% per year),
47. You intend to endow a scholarship that pays $5000 every 6 months, starting 6 months from now. If the appropriate discount rate is 2% per 6-month period, how much money will you have to donate
46. You have just entered college and have decided to pay for your living expenses using a credit card that has no minimum monthly payment. You intend to charge $1000 per month on the card for the
45. You are looking to buy a car and can afford to pay $200 per month. If the interest rate on a car loan is 0.75% per month for a 60-month loan, what is the most expensive car you can afford to buy?
44. Your firm spends $5000 every month on printing and mailing costs, sending statements to customers. If the interest rate is 0.5% per month, what is the present value of eliminating this cost by
43. Suppose you currently have $5000 in your savings account, and your bank pays interest at a rate of 0.5% per month. If you make no further deposits or withdrawals, how much will you have in the
*42. You have just turned 22 years old, received your bachelor’s degree, and accepted your first job. Now you must decide how much money to put into your retirement plan. The plan works as follows:
*41. You are thinking of making an investment in a new factory. The factory will generate revenues of $1 million per year for as long as you maintain it. You expect that the maintenance costs will
40. A local bank is running the following advertisement: “For just $1000 we will pay you$100 forever!” The fine print says that for a $1000 deposit, the bank will pay $100 every year in
39. You receive a $10,000 check from your grandparents for graduation. You decide to save it toward a down payment on a house. You invest it earning 10% per year and you think you will need to have
*38. You are saving for retirement. To live comfortably, you decide you will need to save$2 million by the time you are 65. Today is your 22nd birthday, and you decide, starting today and continuing
*37. You would like to buy the house and take the mortgage described in Problem 35.You can afford to pay only $23,500 per year. The bank agrees to allow you to pay this amount each year, yet still
*36. You are thinking about buying a piece of art that costs $50,000. The art dealer is proposing the following deal: He will lend you the money, and you will repay the loan by making the same
35. You are thinking of purchasing a house. The house costs $350,000. You have $50,000 in cash that you can use as a down payment on the house, but you need to borrow the rest of the purchase price.
34. You have decided to buy a perpetual bond. The bond makes one payment at the end of every year forever and has an interest rate of 5%. If the bond initially costs $1000, what is the payment every
33. You have an investment opportunity that requires an initial investment of $5000 today and will pay $6000 in one year. What is the rate of return of this opportunity?
32. You have an investment account that started with $1000 10 years ago and which now has grown to $5000.a. What annual rate of return have you earned (you have made no additional contributions to
31. You are thinking about buying a savings bond. The bond costs $50 today and will mature in 10 years with a value of $100. What annual interest rate will the bond earn?
30. A rich aunt has promised you $5000 one year from today. In addition, each year after that, she has promised you a payment (on the anniversary of the last payment) that is 3% larger than the last
29. You work for a pharmaceutical company that has developed a new drug. The patent on the drug will last 17 years. You expect that the drug’s profits will be $2 million in its first year and that
28. When Alfred Nobel died, he left the majority of his estate to fund five prizes, each to be awarded annually in perpetuity starting one year after he died (the sixth one, in economics, was added
*27. You are thinking of building a new machine that will save you $1000 in the first year.The machine will then begin to wear out so that the savings decline at a rate of 2% per year forever. What
26. A rich relative has bequeathed you a growing perpetuity. The first payment will occur in a year and will be $1000. Each year after that, you will receive a payment on the anniversary of the last
*25. You are trying to decide how much to save for retirement. Assume you plan to save$5000 per year with the first investment made one year from now. You think you can earn 10% per year on your
23. Assume that Social Security promises you $40,000 per year starting when you retire 45 years from today (the first $40,000 will be paid 45 years from now). If your discount rate is 7%, compounded
22. You figure that the total cost of college will be $100,000 per year 18 years from today.If your discount rate is 8% compounded annually, what is the present value today of four years of college
*21. When you purchased your car, you took out a five-year annual-payment loan with an interest rate of 6% per year. The annual payment on the car is $5000. You have just made a payment and have now
20. Assume that your parents wanted to have $160,000 saved for college by your 18th birthday and they started saving on your first birthday. They saved the same amount each year on your birthday and
19. Your grandmother has been putting $1000 into a savings account on every birthday since your first (that is, when you turned one). The account pays an interest rate of 3%. How much money will be
18. What is the present value of $1000 paid at the end of each of the next 100 years if the interest rate is 7% per year?
17. If you still donate the $100,000 from Problem 16 today, but ask the college to delay the scholarship payment so that the first scholarship payment is made 10 years from today, then how large will
16. You have $100,000 to donate to your college. You want to endow a perpetual scholarship that makes its first payment in 1 year. If the college’s discount rate is 4%, how large will the annual
15. You are offered the right to receive $1000 per year forever, starting in one year. If your discount rate is 5%, what is this offer worth to you?
14. The British government has a consol bond outstanding paying £100 per year forever.Assume the current interest rate is 4% per year.a. What is the value of the bond immediately after a payment is
13. How would your answer to Problem 12 change if you endow it now, but it makes the first award to a student 10 years from today?
12. You want to endow a scholarship that will pay $10,000 per year forever, starting one year from now. If the school’s endowment discount rate is 7%, what amount must you donate to endow the
11. Assume you can earn 9% per year on your investments.a. If you invest $100,000 for retirement at age 30, how much will you have 35 years later for retirement?b. If you wait until age 40 to invest
10. You have a loan outstanding. It requires making three annual payments of $1000 each at the end of the next three years. Your bank has offered to allow you to skip making the next two payments in
9. Suppose you receive $100 at the end of each year for the next three years.a. If the interest rate is 8%, what is the present value of these cash flows?b. What is the future value in three years of
8. You have just received a windfall from an investment you made in a friend’s business.She will be paying you $10,000 at the end of this year, $20,000 at the end of next year, and $30,000 at the
7. You plan to deposit $500 in a bank account now and $300 at the end of one year. If the account earns 3% interest per year, what will the balance be in the account right after you make the second
6. You currently have a one-year-old loan outstanding on your car. You make monthly payments of $300. You have just made a payment. The loan has four years to go(i.e., it had an original term of five
5. You have just taken out a five-year loan from a bank to buy an engagement ring. The ring costs $5000. You plan to put down $1000 and borrow $4000. You will need to make annual payments of $1000 at
8. In what types of situations would it be useful to solve for the number of periods or the rate of return?
7. What must be true about the growth rate in order for a growing perpetuity to have a finite value?
6. What are some examples of annuities?
5. How can a perpetuity have a finite value?
4. What are some examples of perpetuities?
3. What is the difference between an annuity and a perpetuity?
2. What must be true about a cash flow stream in order for us to be able to use the shortcut formulas?
1. What is the intuition behind the fact that the present value of a stream of cash flows is just the sum of the present values of each individual cash flow?
• Value cash flow streams with non-annual payments
• Compute the number of periods, cash flow, or rate of return of a loan or investment
• Value both perpetuities and annuities when the cash flows grow at a constant rate
• Value a common set of regular cash flows called an annuity
• Value a perpetual series of regular cash flows called a perpetuity
• Value a series of many cash flows
*30. Your grandfather put some money in an account for you on the day you were born.You are now 18 years old and are allowed to withdraw the money for the first time.The account currently has $3996
29. You are planning to invest $5000 in an account earning 9% per year for retirement.a. If you put the $5000 in an account at age 23, and withdraw it 42 years later, how much will you have?b. If you
28. You just won a prize that comes with two payout choices. The first option is to get$100,000 right now and nothing hereafter. The second option is to get $94,000 right now and $10,000 three years
27. Your mom is thinking of retiring. Her retirement plan will pay her either $250,000 immediately on retirement or $350,000 five years after the date of her retirement.Which alternative should she

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