Caity and Peter are best friends who are concerned about saving for their future, so they have

decided to both open a bank account each and start saving. They have decided to retire in 40

years. Once they have retired, they will each need $100,000 per year for 20 years. After 20

years, they will enter a retirement home together for the remainder of their lives. As soon as

they enter the retirement home, they will need to make a single payment of $350,000 each

(this occurs exactly a year after the last $100,000 cash flow).

Given they want to have exactly the same amount in their bank accounts at retirement, and

that interest will be fixed at 10 % p.a. compounded quarterly for their entire lives, how

much do Caity and Peter have to deposit monthly into their savings accounts? In addition to

this, you are given the following information:

The first withdrawal of $100,000 is at t=41;

Peter expects to receive an inheritance of $65,000 at t=15, which he will deposit

into his savings accounts;

Caity is expecting to get cash bonuses of $4,000 every year for 10 years, with the

first bonus occurring at t=1 (which will all be invested into her savings account);

and,

All payments are made at the end of the year.

Question 2 (26 marks)

Welq Co, manufacturers of home furnishings, are considering a new product line that

produces decorative garden accessories. Given the complexities around determining the

viability of a new product line, they have called you, their trusted financial advisor, to

recommend whether to proceed with the project. If Welq goes ahead with the project, they

will need to lease a new warehouse facility for $40,000 a year, which is tax deductible the

year after the lease payment is made. In addition, Welq will have to renovate the warehouse,

at a cost of $60,000, which for tax purposes, they will tax immediately. Machinery to produce

the garden accessories will cost $350,000 which includes installation costs of $50,000. This

machinery will be depreciated straight line on an annual basis over the entire useful life of 5

years, to a salvage value of zero.

The project will generate quarterly pretax revenues and pretax expenses of $53,000 and

$35,000, respectively. The respective tax implications will also occur at this time. Welq

believes they will sell the machine for $13,000 at the end of the useful life.

In addition, you have been given the following information:

The corporate tax rate is 30%;

The project is in an industry which is 100% more risky than the industry in

which the firm currently operates;

The firm currently has a beta of 0.8;

The market risk premium is 1% every quarter; and,

The expected return on the market is 2% every quarter.

Assuming that the initial investment is made today and cash flows are received or paid as

stated in the question, do you recommend that Welq Co proceed with the project? Why or

why not?