Finance Questions
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1- Annuity Due. A store offers two payment plans. Under the installment plan, you pay 25 percent down and 25 percent of the purchase price in each of the next 3 years. If you pay the entire bill immediately, you can take a 10 percent discount from the purchase price. Which is a better deal if you can borrow or lend funds at a 5 percent interest rate?
3- Bond Returns. You buy an 8 percent coupon, 20-year maturity bond when its yield to maturity is 9 percent. A year later, the yield to maturity is 10 percent. What is your rate of return over the year?
4- Rate of Return. A bond that pays coupons annually is issued with a coupon rate of 4 percent, maturity of 30 years, and a yield to maturity of 7 percent. What rate of return will be earned by an investor who purchases the bond and holds it for 1 year if the bond's yield to maturity at the end of the year is 8 percent.
5- Constant-Growth Model. Eastern Electric currently pays a dividend of about $1.64 per share and sells for $27 a share.
a. If investors believe the growth rate of dividends is 3 percent per year, what rate of return do they expect to earn on the stock?
b. If investors' required rate of return is 10 percent, what must be the growth rate they expect of the firm?
c. If the sustainable growth rate is 5 percent, and the plowback ratio is .4, what must be the rate of return earned by the firm on its new investments?
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Solution Summary
The solution explains various finance questions relating to annuity due, bond returns, rate of return and constant growth model
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1- Annuity Due. A store offers two payment plans. Under the installment plan, you pay 25 percent down and 25 percent of the purchase price in each of the next 3 years. If you pay the entire bill immediately, you can take a 10 percent discount from the purchase price. Which is a better deal if you can borrow or lend funds at a 5 percent interest rate?
In order to find a better deal we need to find the present value of the payments. The option with a lower present value is a better option
Let the amount be $1,000
Option 1 - Installment Plan
Down payment is 1,000X25%=250
The installment payments are 250 each year for 3 years. The interest rate is 5%. Since the installments are an annuity we use the PVIFA table to get the PV factor. For 3 years and 5% the PV factor is 2.723. The PV of the installment payments is 250X2.723=680.75. The PV with the down payment is 680.75+250=930.75
Option 2 - Discount
The PV is the amount paid less the discount. It is 1,000X0.9=$900
The second option of taking the discount is a better ...
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