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Foundation of finance homeworlk Discussion

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CHAPTER 1

3. How are the financial decisions faced by a single person living alone different from those faced by the head of a household with responsibility for several children of school age? Are the tradeoffs they have to make different, or will they evaluate the tradeoffs differently?

4. Family A and Family B both consist of a father, mother, and two children of school age. In Family A both spouses have jobs outside the home and earn a combined income of $100,000 per year. In Family B, only one spouse works outside the home and earns $100,000 per year. How do the financial circumstances and decisions faced by the two families differ?

6. You are thinking of buying a car. Analyze the decision by addressing the following issues:

a. Are there other ways to satisfy your transportation requirements besides buying a car? Make a list of all the alternatives and write down the pros and cons.

b. What are the different ways you can finance the purchase of a car?

c. Obtain information from

8. You are thinking of starting your own business, but have no money.

a. Think of a business that you could start without having to borrow any money.

b. Now think of a business that you would want to start if you could borrow any amount of money at the going market interest rate.

c. What are the risks you would face in this business?

d. Where can you get financing for your new business?

10. Challenge Question: While there are clear advantages to the separation of management from ownership of business enterprises, there is also a fundamental disadvantage in that it may be costly to align the goals of management with those of the owners. Suggest at least two methods, other than the takeover market, by which the conflict can be reduced, albeit at some cost.

CHAPTER 2

5. Suppose you invest in a real-estate development deal. The total investment is $100,000. You invest $20,000 of your own money and borrow the other $80,000 from the bank. Who bears the risk of this venture and why?

6. Give an example of how the problem of moral hazard might prevent you from getting financing for something you want to do. Can you think of a way of overcoming this problem?

7. Give an example of how the problem of adverse selection might prevent you from getting financing for something you want to do. Can you think of a way of overcoming this problem?

9. Give an example of how each of the six functions of the financial system are performed more efficiently today than they were in the time of Adam Smith (1776).

19. Describe your country’s system for financing residential housing. What are the roles played by households, businesses, and government?

CHAPTER 4

1. If you invest $1,000 today at an interest rate of 10% per year, how much will you have

20 years from now, assuming no withdrawals in the interim?

2. a. If you invest $100 every year for the next 20 years starting one year from today and

you earn interest of 10% per year, how much will you have at the end of the 20 years?

b. How much must you invest each year if you want to have $50,000 at the end of the

20 years?

3. What is the present value of the following cash flows at an interest rate of 10% per year?

a. $100 received five years from now.

b. $100 received 60 years from now.

c. $100 received each year beginning one year from now and ending 10 years from now.

d. $100 received each year for 10 years beginning now.

e. $100 each year beginning one year from now and continuing forever. (Hint: You do

not need to use the financial keys of your calculator for this, just some common

sense.)

4. You want to establish a “wasting” fund, which will provide you with $1,000 per year

for four years, at which time the fund will be exhausted. How much must you put in the

fund now if you can earn 10% interest per year?

5. You take a one-year installment loan of $1,000 at an interest rate of 12% per year (1%

per month) to be repaid in 12 equal monthly payments.

a. What is the monthly payment?

b. What is the total amount of interest paid over the 12-month term of the loan?

6. You are taking out a $100,000 mortgage loan to be repaid over 25 years in 300

monthly payments.

a. If the interest rate is 16% per year, what is the amount of the monthly payment?

b. If you can only afford to pay $1,000 per month, how large a loan could you take?

c. If you can afford to pay $1,500 per month and need to borrow $100,000, how

many months would it take to pay off the mortgage?

d. If you can pay $1,500 per month, need to borrow $100,000, and want a 25-year

mortgage, what is the highest interest rate you can pay?

7. In 1626 Peter Minuit purchased Manhattan Island from the Native Americans for

about $24 worth of trinkets. If the tribe had taken cash instead and invested it to earn

8% per year compounded annually, how much would the Indians have had in 1986,

360 years later?

8. You win a $1 million lottery, which pays you $50,000 per year for 20 years. How

much is your prize really worth, assuming an interest rate of 8% per year?

9. Your great-aunt left you $20,000 when she died. You can invest the money to earn

12% per year. If you spend $3,540 per year out of this inheritance, how long will the

money last?

18. Suppose you know that you will need $2,500 two years from now in order to make

a down payment on a car.

a. BankOne is offering 4% interest (compounded annually) for two-year accounts and

BankTwo is offering 4.5% (compounded annually) for two-year accounts. If you

know you need $2,500 two years from today, how much will you need to invest in

BankOne to reach your goal? Alternatively, how much will you need to invest

in BankTwo? Which bank account do you prefer?

b. Now suppose you do not need the money for three years. How much will you need

to deposit today in BankOne? BankTwo?

19. Lucky Lynn has a choice between receiving $1,000 from her great-uncle one year

from today or $900 from her great-aunt today. She believes she could invest the $900

at a one-year return of 12%.

a. What is the future value of the gift from her great-uncle upon receipt? From her

great-aunt?

b. Which gift should she choose?

c. How does your answer change if you believed she could invest the $900 from her

great-aunt at only 10%? At what rate is she indifferent?

20. As manager of short-term projects, you are trying to decide whether or not to invest in

a short-term project that pays one cash flow of $1,000 one year from today. The total

cost of the project is $950. Your alternative investment is to deposit the money in

a one-year bank certificate of deposit, which will pay 4% compounded annually.

a. Assuming the cash flow of $1,000 is guaranteed (there is no risk you will not

receive it), what would be a logical discount rate to use to determine the present

value of the cash flows of the project?

b. What is the present value of the project if you discount the cash flow at 4% per

year? What is the net present value of that investment? Should you invest in the

project?

c. What would you do if the bank increases its quoted rate on one-year CDs to 5.5%?

d. At what bank one-year CD rate would you be indifferent between the two

investments?

CHAPTER 5

1. Fred’s company has a defined-benefit pension plan. Suppose the plan pays a benefit equal to 1% of final salary per year of service. Fred is 40 years old and has worked for the company for 15 years. His last year’s salary was $50,000 and is expected to remain so in real terms until retirement. The expected rate of inflation is 4%.

a. If normal retirement age is 65, the interest rate is 8%, and Fred’s life expectancy is 80, what is the present value of his accrued pension benefit?

2. Analyze the “expert’s” responses to the following questions:

Question: How early do you recommend people begin saving for retirement? Would it

be too early for my 14-year-old to start saving?

Expert: It’s never too early.

Question: For a college student, what would you suggest for a savings plan?

Expert: I’d suggest deciding on a specific amount to set aside each month, then

making sure you do it, no matter the temptations not to.

4. Assume that you are 40 years old and wish to retire at age 65. You expect to be able to

average a 6% annual rate of interest on your savings over your lifetime (both prior to

retirement and after retirement). You would like to save enough money to provide

$8,000 per year beginning at age 66 in retirement income to supplement other sources

(social security, pension plans, etc.). Suppose you decide that the extra income needs to

be provided for only 15 years (up to age 80). Assume that your first contribution to the

savings plan will take place one year from now.

a. How much must you save each year between now and retirement to achieve your

goal?

Requirements: whatever it takes to answer the question precisely | .doc file

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