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Selling a Goldmine/Bonds

Part I: Suppose you owned a goldmine. All of the gold will run out in two years, but your expected profits from the gold over the next two years are:

Year 1: $110,000 Year 2: $350,000
A. If the discount rate is 5% what is the present value of your profits at the end of Year 1 and Year 2?
B. With a discount rate of 7% how much would you be willing to sell your goldmine for now? Explain both your reasoning and your calculations
C. If you believed that Interest rates and inflation were going to go up during the next two years, would you want a higher price for your goldmine than your answer in B? Explain your reasoning
D. If your goldmine was located in an unstable third world country rather than the U.S., would you expect potential buyers to pay a higher or lower price for your goldmine?

Part II: Suppose you have a choice between two corporate bonds. Both of which will give you a payment of $1,000 in one year assuming that the corporation is able to meet its financial obligations. One is a bond from Pfizer Inc., the other is a bond from Sirius Satellite Radio.

Which of these two bonds would you pay a higher price for? i.e. which of these two corporations should have a lower discount rate?

Take into account such matters as the riskiness of each company, inflation, interest rate and any other factor that might affect the discount rate you would want from a bond from these firms.

YOU DO NOT have to do any calculations for Part II, just explain which bond you would be willing to pay a higher price for and justify your answer.

Turn in Parts I and II in one Word document. For Part I make sure you show all your work. Part II should be in the form of a two to three page paper explaining your reasoning.

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Part I: Suppose you owned a goldmine. All of the gold will run out in two years, but your expected profits from the gold over the next two years are:
Year 1: $110,000 Year 2: $350,000
A. If the discount rate is 5% what is the present value of your profits at the end of Year 1 and Year 2?
Solution
Cash flow Discounting factor of 5% PV
110000 0.952 104761.9
350000 0.907 317460.3

B. With a discount rate of 7% how much would you be willing to sell your goldmine for now? Explain both your reasoning and your calculations
Solution
With the discount rate of 7%, the amount at which the goldmine can be sold now is the present value of the expected profits for the next two years.
Cash flow Discounting factor of 7% PV
110000 0.935 102803.7
350000 0.873 305703.6
408507.3
Value of sale = $408,507.3

C. If you believed that Interest rates and inflation were going to go up during the next two years, would you want a higher price for your goldmine than your answer in B? Explain your reasoning
Solution
If the interest rates and the inflation rates go up during the next two years then the discount rate will also increase, which in turn will reduce the NPV of the expected profits. So, this will reduce the profits or can say ...

Solution Summary

More than 900 words and all calculation shown.

$2.19