Principles of Finance Essay Sample

Part I: This portion of the assignments tests your ability to cipher present value.

A. Suppose your bank history will be deserving $ 15. 000. 00 in one twelvemonth. The involvement rate ( price reduction rate ) that the bank pays is 7 % . What is the present value of your bank history today? What would the present value of the history be if the price reduction rate is merely 4 % ? Solution:

Formula for Present Value:
PV = FV n { [ 1/ ( 1 + I ) N }
Where PV = the present value of the future amount of money
FV n = the future value of the investing at the terminal of n old ages
n = the figure of old ages until the payment ( or watercourse ) will be received
I = the one-year price reduction or involvement rate in the job:

FV n = $ 15. 000
n = 1 twelvemonth
I = 7 %
PV = $ 15. 000 ( 1 / ( 1 + . 07 ) 1
= $ 15. 000 ( 1/ 1. 07 ) = $ 15. 000 ( . 9356 )
PV = $ 14. 019
At one = 4 %
PV = $ 15. 000 ( 1 / ( 1 + . 04 ) 1
= $ 15. 000 ( 1/ 1. 04 ) = $ 15. 000 ( . 9615 )
PV = $ 14. 422. 50

B. Suppose you have two bank histories. one called Account A and another Account B. Account A will be deserving $ 6. 500. 00 in one twelvemonth. Account B will be deserving $ 12. 600. 00 in two old ages. Both histories earn 6 % involvement. What is
the present value of each of these histories?

Solution:

PV = FV n { [ 1/ ( 1 + I ) N }
Where PV = the present value of the future amount of money
FV n = the future value of the investing at the terminal of n old ages
n = the figure of old ages until the payment ( or watercourse ) will be received
I = the one-year price reduction or involvement rate in the job:

For Account A
FV n = $ 6. 500
n = 1 twelvemonth
I = 6 %
PV = $ 6. 500 ( 1 / ( 1 + . 06 ) 1
= $ 6. 500 ( 1/ 1. 06 ) = $ 6. 500 ( . 9434 )
PV = $ 6. 132. 08

For Account B
FV n = $ 12. 600
n = 2 old ages
I = 6 %
PV = $ 12. 600 ( 1 / ( 1 + . 06 ) 2
= $ 12. 600 ( 1/ ( 1. 06 ) 2
= $ 12. 600 ( 1/1. 1236 )
= $ 12. 600 ( . 8899 )
PV = $ 11. 212. 74

C. Suppose you merely inherited a gold mine. This gold mine is believed to hold three old ages worth of gilded sedimentation. Here is how much income this gold mine is projected to convey you each twelvemonth for the following three old ages:

Year 1: $ 49. 000. 000

Year 2: $ 61. 000. 000

Year 3: $ 85. 000. 000

Calculate the present value of this watercourse of income at a price reduction rate of 7 % . Remember. you are ciphering the present value for a whole watercourse of income. i. e. the entire value of having all three payments ( how much you would pay right now to have these three payments in the hereafter ) . Your reply should be one figure – the present value for this gold mine at a 7 % price reduction rate but you have to demo how you got to this figure.

Solution:
Same expression of present value will be used. However. in this job. it will be the amount of all the present values of the future watercourse of sums to be received.

PV = FV n { [ 1/ ( 1 + I ) N }
Where PV = the present value of the future amount of money
FV n = the future value of the investing at the terminal of n old ages
n = the figure of old ages until the payment ( or watercourse ) will be received
I = the one-year price reduction or involvement rate
PV = PV = $ 49. 000. 000 { [ 1/ ( 1 + . 07 ) 1 } + $ 61. 000. 000 { [ 1/ ( 1 + . 07 ) 2 }
+ $ 85. 000. 000 { [ 1/ ( 1 + . 07 ) 3 }
= $ 49. 000. 000 ( 1/1. 07 ) + $ 61. 000 [ 1/ ( 1. 07 ) 2 ] + $ 85. 000. 000 [ 1/ ( 1. 07 ) 3 ] = $ 49. 000. 000 ( . 9346 ) + $ 61. 000. 000 ( . 8734 ) + $ 85. 000. 000 ( . 8163 ) = $ 45. 794. 392. 52 + $ 53. 277. 400 + $ 69. 385. 500

PV= $ 168. 457. 292. 50

At a price reduction rate of 7 % ( or perchance an rising prices rate of 7 % ) . the expected net incomes for the gold mine for the three year-period as valued today will be $ 168. 457. 292. 50 Now compute the present value of the income watercourse from the gold mine at a price reduction rate of 5 % . and at a price reduction rate of 3 % . Compare the present values of the income watercourse under the three
price reduction rates and compose a short paragraph with decisions from the calculations.

Solution:
PV = FV n { [ 1/ ( 1 + I ) N }
Where PV = the present value of the future amount of money
FV n = the future value of the investing at the terminal of n old ages
n = the figure of old ages until the payment ( or watercourse ) will be received
I = the one-year price reduction or involvement rate

At 5 % :
PV = $ 49. 000. 000 { [ 1/ ( 1 + . 05 ) 1 } + $ 61. 000. 000 { [ 1/ ( 1 + . 05 ) 2 }
+ $ 85. 000. 000 { [ 1/ ( 1 + . 05 ) 3 }
= $ 49. 000. 000 ( 1/1. 05 ) + $ 61. 000 [ 1/ ( 1. 05 ) 2 ] + $ 85. 000. 000 [ 1/ ( 1. 05 ) 3 ] = $ 49. 000. 000 ( . 9524 ) + $ 61. 000. 000 ( . 9070 ) + $ 85. 000. 000 ( . 8638 ) = $ 46. 667. 600 + $ 55. 327. 000 + $ 73. 423. 000

PV= $ 175. 417. 600
At a price reduction rate of 5 % ( or perchance an rising prices rate of 5 % ) . the expected net incomes for the gold mine for the three- twelvemonth period as valued today will be $ 175. 417. 600.

At 3 % :
PV = $ 49. 000. 000 { [ 1/ ( 1 + . 03 ) 1 } + $ 61. 000. 000 { [ 1/ ( 1 + . 03 ) 2 }
+ $ 85. 000. 000 { [ 1/ ( 1 + . 03 ) 3 }
= $ 49. 000. 000 ( 1/1. 03 ) + $ 61. 000 [ 1/ ( 1. 03 ) 2 ] + $ 85. 000. 000 [ 1/ ( 1. 03 ) 3 ] = $ 49. 000. 000 ( . 9709 ) + $ 61. 000. 000 ( . 9426 ) + $ 85. 000. 000 ( . 9154 ) = $ 47. 572. 815. 53 + $ 57. 498. 350. 46 + $ 77. 787. 041. 04 PV= $ 182. 858. 206. 04

At a price reduction rate of 3 % ( or perchance an rising prices rate of 3 % ) . the expected net incomes for the gold mine for the three year-period as valued today will be $ 182. 858. 206. 04. The lower the price reduction rate ( or perchance rising prices rate ) . the higher will be the present value of future watercourses of net incomes of a peculiar investing.

Part II: Evaluation of Business Plans

Ice Dreams

R J Wagner & A ; Associates Realty

Interstate Travel Centre

Which of these three undertakings do you believe should hold the highest hazard from the point of position of investors ( possible suppliers of financess ) and would hence be evaluated utilizing the highest price reduction rate? Which one do you believe should hold the lowest? Write a paper explicating your logical thinking. Hazard is the chance of unfavorable result ( Keown. 2002 ) . Hence. hazard is the possibility that an expected result will non be attained. It can be considered as a spread between expected and existent returns. The wider the spread. the higher the grade of hazard. In a layman’s term. hazard is a possible opportunity of a concern failure. This could be brought about by uncertainnesss. A individual would non to the full know what will go on tomorrow. following hebdomad. following month. or following twelvemonth. An investor would non besides be wholly certain on the result of his investing. There is a possibility that he will derive. There is besides a possibility that he will lose from the investing.

There is besides a possibility that he will interrupt even. or he will hold no addition. and no loss. To hold an thought of future results of an investing. investors predict or forecast possible future events and these include future demand. future behavior of rivals. future alterations in the value of money. among others. However. these are merely estimations that were arrived at under certain premises of the investor or the predictor. The premises are really critical in foretelling future results because they will organize the footing in finding whether there will be net income or loss in a peculiar investing. Premises that are formulated should be realistic plenty in order to come up with realistic prognosiss. They should be realistic plenty besides in order to hold a manner of measuring the grade of hazard in a possible investing. Risk in a peculiar investing is usually brought by: alterations in the buying power of purchasers. alterations in their gustatory sensations and penchants. alterations in the monetary value of natural materials/facilities/equipment/rentals. alterations in the value of money or rising prices rates. unemployment rates. population rates. and several others. Some may be quantified. but some can merely be qualified or described.

Hence. no affair how expert a individual is in calculating future results. there will ever be subjectiveness which means that the sums can be influenced by type of individual the predictor is. An optimist may anticipate that everything will turn out right and hence has the inclination to presume higher figures. A pessimist would be really conservative in his premises and hence would hold the inclination to delegate lower figures to of import entries. The three concern programs will be evaluated fundamentally in footings of the selected chief beginnings of hazard. These include: 1. Systematic hazard refers to those factors that affect the returns of the investing 2. 1 market hazard ( associated with the fluctuation in monetary values ) 2. 2 buying power hazard ( associated with the value of money ) 2. Unsystematic hazard. besides referred to as undiversifiable hazard. is caused by factors that are alone in a peculiar investing. 3. 3 Business Hazard ( the hazard associated with the nature of the concern ) 3. 4 fiscal hazard ( associated with the firm’s beginnings of funding

The comparing of the three concern programs on the above beginnings of hazard is shown in Table 1.

Table 1. Comparison OF THE THREE BUSINESS PLANS
ACCORDING TO BASIC SOURCES OF RISK

1. Systematic hazard refers to those factors that affect the returns of the investing 2. 1 market hazard ( associated with the fluctuation in monetary values ) 2. 2 buying power hazard ( associated with the value of money ) 2. Unsystematic hazard. besides referred to as undiversifiable hazard. is caused by factors that are alone in a peculiar investing. 3. 3 Business Hazard ( the hazard associated with the nature of the concern ) 3. 4 fiscal hazard ( associated with the firm’s beginnings of funding

Mentions:

Fraser. Lyn and Ormiston. Aileen ( 2001 ) . Understanding Fiscal Statements. Prentice – Hall. Inc.
Fraser. Lyn and Ormiston. Aileen ( 2001 ) . Understanding Fiscal Statements. Prentice – Hall. Inc.
Fraser. Lyn and Ormiston. Aileen ( 2001 ) . Understanding Fiscal Statements. Prentice – Hall. Inc