Question 4

a. Differentiate between the concepts of discounting and compounding as they relate to cash flow valuations. ( 1 mark)

b. What are the differences among a lump sum, annuity, perpetuity and a growing annuity? Show by way of formulae and example, how the present values and future values of each of the different cash flows listed above can be computed. (4 marks)

c. Illustrate which formulas or a combination of formulas can be used to determine the following: (1) amount loan to be amortized over a period of time, given a loan amount and applicable interest rate, (2) bonds valuation and stock valuation. (4 marks)

d. What is meant by effective annual rate (EAR) and how do they differ from Annual percentage rates (APR). Explain the differences with the help of an example. (2 marks)

e. Why are stocks valued as perpetuities and bonds as annuities? (2 marks)

f. Explain the capital budgeting process and explain four (4) of the tools that are used for screening capital projects. (2 marks)