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Practice Your FV and PV Skills

1. You just turned 35 and have been saving for an around-the-world vacation. You want to
take the trip to celebrate your 40th birthday. You have set aside, as of today, $15,000 for
such a trip. You expect the trip will cost $25,000. The financial instruments you have
invested the $15,000 in have been earning, on average, about 8%. (You may ignore
income taxes.)

a. Will you have enough money in that vacation account on your 40th birthday to take
the trip? What will be the surplus, or shortfall, in that account when you turn 40?
(Hint: Exhibit 1 will be useful in answering this question.)

Money Target: $25,000

Present Value: $15,000

Interest rate 8% for 5 years.

Future Value = PV amount x (Annual interes rates)time = $15,000 x (1.08)5 = $22039.92

The money i have in 5 years to with the target: $22039.92 - $25,000 = - $2960.079

In conclusion i have a shortfall about $2960.079 to catch up.

b. If you had to, you could further fund the trip by making, starting today, five annual
$500 contributions to the account. If you adhered to such a plan, how much will be in
the account on your 40th birthday? (Hint: Exhibit 3 and the answer to part (a) above
will both be useful in answering this question.)

Money Target: $25,000

Present Value: $15,000

Futher fund five annual $500 contributions to the account

Interest rate 8% for 5 years.

Future Value = PV amount x (Annual interes rates for single lump )time + Anual contribution x (Annual
interes rates for series invested money)time

= $15,000 x (1.08)5 + $500 x 6.336 = $22039.92 + $3168 = $ 25207.92

The money i have in 5 years to with the target = $ 25207.92- $25,000 = $207.9212

In conclusion i have a surpluss about $207.9212


2. Your company has been offered a contract for the development and delivery of a solarpowered military
troop transport vehicle. The request for proposal provides all the
necessary technical specifications and it also stipulates that two working, economically
feasible prototypes must be delivered in four years, at which time you will receive your
only customer paymenta single and final payment of $50 million. Assume a
reinvestment interest rate of 18% for all the monies received over the next four years.
(You may ignore income taxes.)

a. What lump-sum dollar amount would you be willing to accept today instead of the
$50 million in four years? (Hint: Exhibit 2 will be useful in answering this question.)

Final Payment: $ 50,000,000

Interest rate 18% for 4 years.

Present value factors = 0.5158

Present Value = Present value factors x Future value amount = 0.5158 * $50,000,000

= $25,789,443.76

Lump-sum dollar amount i would be willing to accept today is = $25,789,443.76

b.. Alternatively, what four yearly receipts, starting a year from now, would you be
willing to accept? (Hint: Exhibit 4 and the answer to part (a) above will both be
useful in answering this question.)

present value factor for annual saving = 2.690

Four yearly receipts = = Present value factors x Future value amount for anual savings

= $25,789,443.76 / 2.690 x = $ 9,587,153.813

3. The aged but centrally located golf course you manage does not have an in-ground
automated water sprinkling system. Instead, to properly water the course, sprinklers and
hoses must be repeatedly set, moved, and put away by some of the grounds crewa
tedious and laborious task. If over the next 12 years you project annual savings of about
$40,000 from having an automated system, what is the maximum price you would be
willing to pay today for an installed, automated golf course sprinkler system? (Assume an
interest rate of 6%, and you may ignore income taxes.)

Future value annual savings: $40,000

Interest rate for 12 years is 6%; present value factor for annual saving = 8.384

Present value = Present value factors x Future value amount for anual savings = 8.384 x $40,000

= $ 335,360
a. Redo your calculation using a 10-year time period and $48,000 in annual savings.

Future value annual savings: $48,000

Interest rate for 10 years is 6%; present value factor for annual saving = 7.360

Present value = Present value factors x Future value amount for anual savings = 7.360x $48,000

= $ 353,280

b. Redo your initial calculation one more time using $50,000 in annual savings for the
first six years and $30,000 in annual savings for the next six years.

Future value annual savings for the first six years $50,000 and and $30,000 in annual savings for the next
six years.

Interest rate for 12 years is 6%; present value factor for annual saving = 8.384

Interest rate for first six years is 6%; present value factor for annual saving = 4.917

Interest rate for 12 years 7 - 12 is 6%; present value factor for annual saving = 8.384 - 4.917 = 3.467

Present value = (Present value factors x Future value amount for anual savings)first six years + (Present
value factors x Future value amount for anual savings)next six years

= ($50,000 x 4.917) +( $30,000 x 3.467) = $245850 + $104010

= $349,860

4. The cafeteria you operate has a regular clientele for all three meals, seven days a week.
You want to expand your product line beyond what you are currently able to offer. To do
so requires the purchase of some additional specialty equipment costing $45,000, but you
project a resultant increase in sales (after deducting the cost of sales) of about $8,000 per
year for each of the next eight years with this new equipment. Assuming a required rate
of return (i.e., a hurdle rate) of 8%, should you pursue this opportunity? Why or why not?
Do the analysis under two conditions:

a. You are part of an income-tax-exempt enterprise.

Answer

Equipment cost $45,000

Future value increase in sales per year: $8,000

Interest rate for 8 years is 8%; present value factor for annual saving = 5.747

Present value = Present value factors x Future value amount for anual savings = 5.747 x $8,000

= $ 45,976
Profit for purchase of some additional specialty equipment = $45,976 - $45,000

= $976

We can pusue this opportunity because ig gives profit. But the profit is quite little which is $976.

b. The enterprise you are part of is subject to 40% corporate income tax rate, and the straight-line,
depreciable life of the equipment you are contemplating purchasing is five years.

Equipment cost $45,000

Future value increase in sales per year: $8,000

Interest rate for 8 years is 8%; present value factor for annual saving = 5.747

Because the life of the machine is 5 years so the future value search for the first 5 years, present value
factor for annual saving is 3.993

Present value for the first 5 years = Present value factors x Future value amount for anual savings

= 3.993x $8,000 = $ 31,944

Income tax for the 5 years = $ 31,944 * 40% = $12,777.6

Profit/Loss for purchase of some additional specialty equipment = $31,944- $45,000 - $12,777.6

= -$25,833.6

For this condition the firm should not pusue this opportunity because it just give a lot of cost and big
amount loss of money.

5. You are contemplating the purchase of a one-half interest in a corporate airplane to


facilitate the expansion of your business into two new geographic areas. The acquisition
would eliminate about $220,000 in estimated annual expenditures for commercial flights,
mileage reimbursements, rental cars, and hotels for each of the next 10 years. The total
purchase price for the half-share is $6 million, plus associated annual operating costs of
$100,000. Assume the plane can be fully depreciated on a straight-line basis for tax
purposes over 10 years. The companys weighted average cost of capital (commonly
referred to as WACC) is 8%, and its corporate tax rate is 40%. Does this endeavor
present a positive or negative net present value (NPV)? If positive, how much value is
being created for the company through the purchase of this asset? If negative, what
additional annual cash flows would be needed for the NPV to equal zero? To what
phenomena might those additional positive cash flows be ascribable?

Purchase price for the half-share = $6,000,000

Estimated annual expenditures for the next 10 years = $220,000


Annual operating costs of $100,000.

Interest rate for 10 years is 8%; present value factor for annual saving = 6.710

Present value for annual expenditures for the next 10 years = Present value factors x Future value
amount for anual savings = 6.710 x $220,000

= $1,476,200

Present value for annual operating costs for the next 10 years = Present value factors x Future value
amount for anual savings = 6.710 x $100,000

= $ 671,000

Saving from the a acquisition = $1,476,200 - $ 671,000 - $6,000,000

= -$5,194,800

There are no information about the income from the investment so the income needed to reach an NPV
zero is $5,194,800

6. The final tally is in: This years operating costs were down $100,000, a decrease directly
attributable to the $520,000 investment in the automated materials handling system put in place at the
beginning of the year. If this level of annual savings continues for five more
years, resulting in six total years of annual savings, what compounded annual rate of
return will that represent? If these annual savings continue for nine more years, what
compounded annual rate of return will that represent? (You may ignore income taxes.)

Answer:

Future value of decreasing operating costs this year $100,000 (annual savings) for 6 years

Investment cost = $520,000

Present value factors)( Annual rate of return) in 6 years = (asked)

To return the $520,000 investment, future value of annual savings need to be calculated

Present value annual savings = Present value factors x Future value amount for anual savings

= X $100,000 = $100,000

To return the investment :

Present value annual savings = Investment cost = $520,000

$520,000 = $100,000
= 5,2

From the Present Value Factors for a series of amounts n Years in the future, for the present value factors
of approximatetly 5,2 in 6 years time so the annual rate of return is 4%