Module 2 – Case
Present Value
Assignment Overview
NOTE: This assignment is in two parts, one
is quantitative problem, the other a short paper. You need to turn in both Part
I and Part II to receive full credit for this assignment.
Part I: This part of the assignments tests
your ability to calculate present value.
A. Suppose your bank account will be worth
$15,000.00 in one year. The interest rate (discount rate) that the bank pays is
7%. What is the present value of your bank account today? What would the present
value of the account be if the discount rate is only 4%?
B. Suppose you have two bank accounts, one
called Account A and another Account B. Account A will be worth $6,500.00 in
one year. Account B will be worth $12,600.00 in two years. Both accounts earn
6% interest. What is the present value of each of these accounts?
C. Suppose you just inherited an gold mine.
This gold mine is believed to have three years worth of gold deposit. Here is
how much income this gold mine is projected to bring you each year for the next
three years:
Year 1: $49,000,000
Year 2: $61,000,000
Year 3: $85,000,000
Compute the present value of this stream of
income at a discount rate of 7%. Remember, you are calculating the present
value for a whole stream of income, i.e. the total value of receiving all three
payments (how much you would pay right now to receive these three payments in
the future). Your answer should be one number – the present value for this gold
mine at a 7% discount rate but you have to show how you got to this number.
Now compute the present value of the income
stream from the gold mine at a discount rate of 5%, and at a discount rate of
3%. Compare the present values of the income stream under the three discount
rates and write a short paragraph with conclusions from the computations.
Part II: Read the following three sample
business plans:
Ice Dreams
R J Wagner & Associates Realty
Interstate Travel Center
Which of these three projects do you think
should have the highest risk from the point of view of investors (potential
providers of funds) and would therefore be evaluated using the highest discount
rate? Which one do you think should have the lowest? Write a paper explaining
your reasoning.
In your assessment of the business plans
consider the possible risk of each plan. Risk is one of the main considerations
when deciding whether a plan should be evaluated and discounted to present
value using a high or a low discount rate.
Note: you are not expected to fully analyze
the numbers and financial statements in these business plans. There are only
forecasts and projections. Nobody really believes them anyway. Use your
intuition rather than calculations to assess risk and potential of each of
these plans.
Assignment Expectations
Turn in both Part I and Part II in one Word
document when completed. Part I should be two pages long and contain your
calculations. Part II should be two pages long.
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Module 2 – SLP
Present Value
One specialized type of security is called
an equity futures. This is a contract that guarantees you a share of a
particular company to be delivered to you not today, but sometime in the
future, at a price that is determined by the market right now. This price is
usually called the futures price of the stock (note – the term is plural –
“futures”). If you ‘buy’ this futures, you don’t pay for the shares
now. You are actually signing a contract whereby you are committed to pay that
price in a particular date in the future, and you are guaranteed to receive one
share of the company at that time, irrespective of its actual market price at
that future date. Suppose for example that the futures price of the XYZ company
is $40. Suppose you ‘buy’ a 6-months futures contract. If six months later the
share price is $45, you gain $5 per share. If the market price in 6 months is
only $35, then you lose $5.
Using the Yahoo Finance take a look at the
five year chart for your reference company (the one you chose for SLP1). Using
this chart and other information you can find on this company, write a paper
answering the following question:
What do you think would the futures price
of 100 shares of your reference company to be delivered to you in one year be
right now?
SLP Assignment Expectations
The paper is to be two pages long. You DO
NOT need to use complex mathematical formulas for this assignment. Instead,
think about how much do you think the market value of 100 shares of your
company will be in one year? In considering the possible answer please reflect
also on the following:
Do you expect the price of the shares in
one year to be much higher? Or lower? Or only a little bit higher?
How risky the stock is. Is its price prone
to wild swings up and down? Or has the price been relatively stable the last
few years?
What alternative investments you have
access to. What rate does your bank give you on a savings account or
certificate of deposit? The greater return you can get on other investments,
the less you would be willing to pay for an equity future.
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