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1.

Finding Present Values:


What is the present value of the following future payments:
a) $1,210 in 2 years at a 10% discount rate:
present value = $1,210!1"10)
2
= $1000
#) $1,2$%"&1 in ' years at an (% discount rate:
present value = $1,2$%"&1!1"0()
'
= $1000
c) $1,0)0 in 1 year at a )% discount rate:
present value = $1,0)0!1"0))
1
= $1000
2. General formula for finding the present value of several future annual payments
Present Value = P1/(1+r
1
+ P2/(1+r
2
+ +(F + Pn/(1+r
n
!here 1" 2" n = num#er of years$ r = dis%ount rate$ Pn = payment$ F = fa%e value
&. Finding Present Values 'sing the General Formula:
a) *ou can ma+e two different investments" ,he interest you receive on the first
investment is $110 per year for three years" *ou receive $''0 on the second
investment in the third year and nothing in the first two years" -f your discount rate is
.%, what should you pay for each of these investments/
0resent 1alue of 21 = $110 3 $110 3 $110 = $2%)"0'
!1"0.) !1"0.)
2
!1"0.)
'

0resent 1alue of 22 = $0 3 $0 3 $''0 = $ 2&&"0&
!1"0.) !1"0.)
2
!1"0.)
'

(ou )ill pay more for investment *1
#) *ou can ma+e two different new products at your plant" 0roduct 21 is e4pected to
earn no profit in the first year, $$00 in the second year and $1,000 in the third year"
0roduct 22 is e4pected to earn $$00 per year for three years" 5ssume your cost of
capital is 10%" Which product should you ma+e/
0resent 1alue of 21 = $0 3 $$00 3 $1000 = $ 1,1.)"$'
!1"10) !1"10)
2
!1"10)
'

0resent 1alue of 22 = $$00 3 $$00 3 $$00 = $1,2)'")'
!1"10) !1"10)
2
!1"10)
'

+he present value of future profits is higher for produ%t *2"
c) 5ssume you have a winning lottery tic+et and the state offers you $$,000 now or
payments of $2,000 for three years" -f your discount rate is 10%, which alternative
should you choose/
0resent 1alue = $2000 3 $2000 3 $2000 = $),%&'"&0
!1"10) !1"10)
2
!1"10)
'

,hoose a lump sum payment of -."///.
0. Finding 1ond Pri%es 'sing the General Formula:
a) 6ind the value of a note with a remaining term of three years, a face value of $10,000
and a coupon of $$00 per year" 5ssume the mar+et yield is )%"
1alue = $$00 3 $$00 3 $10,$00 = $10,2&&"21
!1"0))
1
!1"0))
2
!1"0))
'
#) 6ind the value of a note with a remaining term of three years, a face value of $10,000
and a coupon of $$00 per year" 5ssume the mar+et yield is now .%"
1alue = $$00 3 $$00 3 $10,$00 = $%,&'2"(2
!1"0.)
1
!1"0.)
2
!1"0.)
'
1ond pri%es move inversely )ith interest rates. +hey %an #e e2a%tly determined as
interest rates %hange.

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