Introduction to Corporate Finance

PART 1: INTRODUCTION

P3-14 Ruth Nail receives two offers for her seaside home. The first offer is for $1 million today. The second

offer is for an owner-financed sale with annual payments as follows:

Year Payment

0 (Today) $200,000

1 200,000

2 200,000

3 200,000

4 200,000

5 300,000

Assuming that Ruth earns a return of 8% each year on her investments, which offer should she take?

P3-15 Melissa Gould wants to invest today to assure adequate funds for her son’s university education.

She estimates that her son will need $20,000 in 18 years, $25,000 in 19 years, $30,000 in 20 years

and $40,000 in 21 years. How much does Melissa have to invest in a fund today if the fund earns

the following interest rates?

a 6% per year with annual compounding

b 6% per year with quarterly compounding

c 6% per year with monthly compounding

P3-16 Assume that you just won the lottery. Your prize can be taken either in the form of $40,000 at

the end of each of the next 25 years ($1 million over 25 years) or as a lump sum of $500,000 paid

immediately.

a If you expect to be able to earn 5% annually on your investments over the next 25 years, which

alternative should you take? Why?

b Would your decision in part (a) be altered if you could earn 7% rather than 5% on your

investments over the next 25 years? Why?

c At approximately what interest rate will the two plans yield the same present value?

P3-17 Use the following table of cash flows to answer parts (a) and (b). Assume an 8% annual discount

rate.

End of year Cash flow

1 $10,000

2 10,000

3 10,000

4 12,000

5 12,000

6 12,000

7 12,000

8 15,000

9 15,000

10 15,000

a Solve for the present value of the cash flow stream by summing the present value of each

individual cash flow.

b Solve for the present value by summing the present value of the three separate annuities (one

current and two deferred).

See the problem 3-15 and

solution explained step by

step on the CourseMate

website.

SMART

SOLUTIONS