Fundamentals of Finance, Fall 2011 Instructor: Dr.

Sorin Tuluca

Mitulkumar Patankar Student ID: 1021790

Case Study 1 Discounted Cash Flow Analysis

Davis, Michaels and Company
1. Consider a 1-Year $10,000 CD A. The future value of a $10,000 CD that has a maturity of 1 year at maturity with 10% interest is $11,000. Financial Calculator Inputs: $ -10,000=PV, 1=N, I=10, FV=? ($11,000) B. The future value of a 1-year, $10,000 CD after one year at an interest rate of 5.0% is $10,500. Financial Calculator Inputs: $-10,000=PV, 1=N, 5=I, FV=? ($10,500) The future value of a 1-year, $10,000 CD after one year at an interest rate of 15.0% is $11,500. Financial Calculator Inputs: $-10,000=PV, 1=N, 15=I, FV=? ($11,500) C. The effective annual rate of First National Banks CD offering a 10% nominal interest rate compounded semiannually is 10.25%. Calculations: (1+.10/2)^2 -1 =.1025 The future value of a $10,000 dollar CD compounded semiannually for one year at The First National Bank is $11,025 Calculations: FV=$10,000(1.1025) FV=$11,025, or Financial Calculator Inputs: $ -10,000=PV, 1=N, 10.25=I, FV=? ($11,025) D. Using a 360 day bankers year, the Effective Annual Rate of Pacific Trusts 10% interest CD compounded daily is 10.52% Calculations: (1+.10/365)^365 1 =.1052 The future value of Pacific Trusts $10,000 CD with an effective annual rate Of 10.52% after one year is $11,052. Financial Calculator Inputs: $ -10,000=PV, 1=N, 10.52=I, FV=? ($11,052) E. First National Bank would have to offer a nominal rate of 10.26% on its Semiannually compounded CD to be competitive with Pacific Trusts daily compounding CD. Calculations: $10,000(1+X/2)^2 = $11,052FV of Pacific Trusts CD (1+X/2)^2 = 1.052 (Take square root of both sides of equation) (1+X/2) =1 .0513 X/2 = 1.0513 - 1 X/2=.0513 X = 0.513 (*2) X=.1026

Fundamentals of Finance, Fall 2011 Instructor: Dr. Sorin Tuluca

Mitulkumar Patankar Student ID: 1021790

Considering a 5-Year CD, rework parts a-d of question 1 A. The value at maturity of a $10,000 CD with a 10% interest rate is $16,105.10 Inputs: $-10,000=PV, 5=N, 10=I, FV-? ($16,105.10) B. The future value of a 5-year, $10,000 CD after five years at an interest rate of 5.0% is $12,762.82. Financial Calculator Inputs: $-10,000=PV, 5=N, 5=I, FV=? ($12,762.82) The future value of a 5-year, $10,000 CD after five years at an interest rate of 15.0% is $20,133.57. Financial Calculator Inputs: $-10,000=PV, 5-N, 15=I, FV=? ($20,113.57) C. The effective annual rate of First National Banks CD offering a 10% nominal interest rate compounded semiannually is 10.25%. Calculations: (1+.10/2)^2 -1 =.1025 The future value of a $10,000 dollar CD compounded semiannually for five years at The First National Bank is $16,288.95 Calculations: FV=$10,000(1.1025)^5 FV=$16,288.95, or Financial Calculator Inputs: $-10,000=PV, 5=N, 10.25=I,FV=? ($16,288.95) D. Using a 360 day bankers year, the Effective Annual Rate of Pacific Trusts 10% interest CD compounded daily is 10.52% Calculations: (1+.10/365)^365 1 =.1052 The future value of Pacific Trusts $10,000 CD with an effective annual rate Of 10.52% after five years is $16,489.38. Financial Calculator Inputs: $-10,000=PV, 5=N, 10.52=I, FV=? ($16,489.38)

It is estimated that in 5 years the total cost for one year of college will be $20,000 $12,418.43 must be invested today in a CD paying 10% annual interest rate in order to accumulate the needed $20,000 for college in five years. Financial Calculator Inputs: $20,000=FV, 5=N, 10=I, PV=? ($-12418.43) B. If only $10,000 is invested today for 5 years, an interest rate of 14.87% is required to reach the goal of $20,000 in 5 years for college tuition. Financial Calculator Inputs: $-10,000=PV, 5=N, $20,000=FV, I=? (14.8698) C. If only $10,000 is invested, the First National Bank must offer a stated rate of 14.35% on its semiannually compounded CD to accumulate the required $20,000 in 5 years. Financial Calculator Inputs: $-10,000=PV, $20,000=FV, 10=N, 2=P/YR, I=? (14.3547)
A. 2

Fundamentals of Finance, Fall 2011 Instructor: Dr. Sorin Tuluca

Mitulkumar Patankar Student ID: 1021790

Now considering a second alternative with 5 annual payments of $2,000 each. The payments are assumed made at the end of each year.
A.

B.

C.

D.

E.

F.

The type of annuity in which payments are made at the end of each year is referred to as an Ordinary Annuity (Annuity in Arrears) The future value of the annuity with payments of $2,000 each year at the end of 5 years is $12,210.20 with an interest rate of 10% compounded annually. Financial Calculator Inputs: $ -2,000=PMT, 5=N, 10=I, FV=? ($12,210.20) The future value of an annuity with yearly payments of $2,000 for five years deposited at the First National Bank which offers semiannual compounding of a nominal 10% interest rate is $12,271.11. Calculations: EAR= (1=.10/2)^2 -1 =10.25% Financial Calculator Inputs: 10.25=I, $2,000=PMT, 5=N, $0=PV, FV=? ($12,271.1147) Under 10% annual compounding of interest for 5 years, an annuity would require five equal payments of $3,275.95 in order to accumulate $20,000 after 5 years. Financial Calculator Inputs: $20,000=FV, 10=I, 5=N, $0=PV, PMT=? ($-3,275.95) A lump sum of $7,581.57 would be required if deposited today to compound to the equivalent of $12,210.20 in five years assuming an annual interest rate of 10% Financial Calculator Inputs: $12,210.20 (from part B)=FV, 10=I, 5=N, PV=? ($-7,581.57) Assuming payments are constant at $1,000 each and are made every six months for a total of 10 payments, the future value of this annuity will be $12,577.89 assuming an interest rate of 10% compounded semiannually at the First National Bank. Calculations: Interest = (10/2) =5 $1,000*{[(1.05^10)-1]/.05} = $12,577.89

5. Now Assume payments are made at the beginning of each period. There are 5 annual payments of $2,000 each. The type of annuity in which payments are made at the beginning of each period is known as an Annuity Due (Annuity in Advance) B. The future value of an Annuity Due of payments of $2,000 for 5 years paying interest of 10% annually is $13,431.22 Financial Calculator Inputs: BEGIN, 10=I, $-2000=PMT, 5=N, $0=PV, FV=? ($13,431.22) C. The future value of an Annuity Due with payments of $2,000 invested for five years at the First National Bank at 10% interest compounded semiannually is $13,528.90
A.

Fundamentals of Finance, Fall 2011 Instructor: Dr. Sorin Tuluca

Mitulkumar Patankar Student ID: 1021790

Calculations: EAR= (1+.10/2)^2 1 =.1025 Financial Calculator Inputs: BEGIN, 10.25=I, 5=N, $ -2000=PMT, $0=PV, FV=? ($13,528.90) D. At an interest rate of 10% under annual compounding for 5 years, a payment of $2,978.14 each year for 5 years is needed to accumulate $20,000. Financial Calculator Inputs: BEGIN, PV=$0, FV=$20,000, 10=I, 5=N, PMT=? ($-2,978.13) E. A lump sum of $8,339.73 would need to be deposited today to accumulate $13,431.22 after 5 years at 10% interest compounded annually. Financial Calculator Inputs: BEGIN, 5=N, 10=I, $13,431.22=FV, PV=? ($-8339.73) F. Assuming payments into an annuity at the First National Bank are a constant $1,000 made at the beginning of each period every six months at an interest rate of 10% compounded semiannually, the future value of the annuity is $13,206.79. Financial Calculator Inputs: BEGIN, $-1000=PMT, 5=I, 10=N, FV=? ($13,206.7872)

6. Based on the following schedule of payments: End of Year 0 1 2 3 4 5

A.

Payment $2,000 $2,000 $0 $1,500 $2,500 $4,000

The value of the payment stream at the end of year 5 assuming the payments are made with an interest rate of 10% compounded annually is $14,714.22. Financial Calculator Inputs: $2,000=CF0, $2,000=CF1,$0=CF2, $1,500=CF3,$2,500=CF4, $4,000=CF5, 10=I, NPV=? ($-9136.37) $-9136.37=PV, 10=I, 5=N, FV=? ($14,714.22) B. A payment of $5,282.05 would be needed to accumulate $20,000 in 5 years based on the cash flow stream given above at 10% interest. Calculations: 20,000-14,714.22 (future value) = $5,285.78 (additional needed in 5 years @10%). Financial Calculator Inputs: $5,285.78=FV, 5=N, 10=I, PV=? ($3,282.05) Calculations: $2,000(pmt at time 0) + $3,282.05(PV of addition needed)= $5,282.05 Financial Calculator Check: $5,282.05=CF0, $2,000=CF1, $0=CF2, $1,500=CF3, $2,500=CF4, $4,000=CF5, 10=I, NPV=?($12,418.42) $-12,418.42=PV, 10=I, 5=N, FV=? ($20,000)
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Fundamentals of Finance, Fall 2011 Instructor: Dr. Sorin Tuluca

Mitulkumar Patankar Student ID: 1021790

7. Consider Bay City Savings Bank, which pays 10% interest compounded continuously. A. The effective annual rate of Bay City Savings Banks 10% interest rate compounded continuously is 10.52% Calculations: (e^.10) 1= .1052 0r Effective interest rate calculator inputs: Nominal Interest rate = 10, Number of compounding periods per year n =1, continuous compounding n = infinitive, press calculate = (Effective interest rate r = 10.517092 %) B. The future value of a lump sum of $10,000 after 5 years with 10% Continuously compounded is $16,487.21 Calculations [$10,000 (e^.1*5)]= $16,487.21 C. The future value of a five year ordinary annuity with payments of $2,000 each at an interest rate of 10% compounded continuously is $12,337.23 Calculations [ (e^.1)-1]= .1052 Financial Calculator Inputs: 10.52=I, -2000=PMT, 5=N, 0=PV FV=? ($12,337.23) 8. The client is also considering borrowing the $20,000 for his daughters first year of college and repaying the loan over a four-year period. Assuming that he can borrow the funds at a 10% interest rate, what amount of interest and principle will be paid at the end of each year? If the client borrows the funds for his daughters college tuition for the first year and planning on repaying the loan over a four year period with a 10% annual interest rate, the client must make yearly payments of $6,309.42 (with the exemption of $.02 in year four due to rounding.) During year 1, the amount of interest paid is $2,000 while the principle repaid is $4,309.42. During year 2, the amount of interest to be repaid is $15,609.06 while the principle being repaid is $4,740.36. Year 3 will find $1,095.02 worth of interest being paid and the repayment of $5,214.40 of principle. Finally in year 4 the amount of interest to be paid is $573.58 and the amount of principle paid is $5735.83. Financial Calculator Inputs: $20,000=PV, 0=FV, 10=I, 4=N, PMT=? ($-6,309.42), then press amortization, P1 =1 and P2 = 1, then P1 =2 and P2 =2 etcand Calculate the Principle and Interest amount for each period. LOAN AMORTIZATION TABLE: Principle Beginning Year $20,000.00 $15,690.58 $10,950.22 Interest Payment Principle at Expense Year End $2,000.00 $6,309.42 $15,690.58 $1,569.06 $6,309.42 $10,950.22 $1,095.02 $6,309.42 $5,735.82
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Year 1 Year 2 Year 3

Fundamentals of Finance, Fall 2011 Instructor: Dr. Sorin Tuluca

Mitulkumar Patankar Student ID: 1021790

Year 4

$5,735.82

$573.58

$6,309.40

$0.00