Finance and Present Value
Week 1
Capital Budgeting I
Tutorial: Chapter 1, 2
Chapter 1
Introduction to Corporate Finance
Question 3: Investment and financing decisions
Vocabulary test. Explain the differences between:
a. Real and financial assets.
b. Capital budgeting and financing decisions
c. Closely held and public corporations
d. Limited and unlimited liability.
Answer
a. Financial assets, such as stocks or bank loans, are claims held by investors. Corporations sell financial assets to raise the cash to invest in real assets such as plant and equipment. Some real assets are intangible.
b. Capital budgeting means investment in real assets. Financing means raising the cash for this investment.
c. The shares of public corporations are traded on stock exchanges and can be purchased by a wide range of investors. The shares of closely held corporations are not publicly traded and are held by a small group of private investors.
d. Unlimited liability: Investors are responsible for all the firm’s debts. A sole proprietor has unlimited liability. Investors in corporations have limited liability. They can lose their investment, but no more.
Chapter 2
How to calculate Present values
Question 6: Perpetuities
An investment costs $1,548 and pays $138 in perpetuity. If the interest rate is 9%, what is the NPV?
Answer NPV = −1,548 + 138/.09 = −14.67 (cost today plus the present value of the perpetuity). Question 7: Growing perpetuities
A common stock will pay a cash dividend of $4 next year. After that, the dividends are expected to increase indefinitely at 4% per year. If the discount rate is 14%, what is the PV of the stream of dividend payments?
Answer
PV = 4/(.14 − .04) = $40.
Question 19: Present values
As winner of a breakfast cereal competition, you can choose one of the following prizes:
a. $100,000 now
b. $180,000 at the end of five years
c. $11,400 a year forever
d. $19,000 for each of 10 years
e. $6,500
Capital Budgeting I
Tutorial: Chapter 1, 2
Chapter 1
Introduction to Corporate Finance
Question 3: Investment and financing decisions
Vocabulary test. Explain the differences between:
a. Real and financial assets.
b. Capital budgeting and financing decisions
c. Closely held and public corporations
d. Limited and unlimited liability.
Answer
a. Financial assets, such as stocks or bank loans, are claims held by investors. Corporations sell financial assets to raise the cash to invest in real assets such as plant and equipment. Some real assets are intangible.
b. Capital budgeting means investment in real assets. Financing means raising the cash for this investment.
c. The shares of public corporations are traded on stock exchanges and can be purchased by a wide range of investors. The shares of closely held corporations are not publicly traded and are held by a small group of private investors.
d. Unlimited liability: Investors are responsible for all the firm’s debts. A sole proprietor has unlimited liability. Investors in corporations have limited liability. They can lose their investment, but no more.
Chapter 2
How to calculate Present values
Question 6: Perpetuities
An investment costs $1,548 and pays $138 in perpetuity. If the interest rate is 9%, what is the NPV?
Answer NPV = −1,548 + 138/.09 = −14.67 (cost today plus the present value of the perpetuity). Question 7: Growing perpetuities
A common stock will pay a cash dividend of $4 next year. After that, the dividends are expected to increase indefinitely at 4% per year. If the discount rate is 14%, what is the PV of the stream of dividend payments?
Answer
PV = 4/(.14 − .04) = $40.
Question 19: Present values
As winner of a breakfast cereal competition, you can choose one of the following prizes:
a. $100,000 now
b. $180,000 at the end of five years
c. $11,400 a year forever
d. $19,000 for each of 10 years
e. $6,500