Valuation and Discounted Cash Flows

Undergraduate
Case Study
Finance & Accounting
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Student’s Name Professor’s Name Subject October 19, 2011 Valuation and Discounted Cash Flows 1. Effective annual rate (EAR) is the rate of interest in use into account compounding above the year. Following are the formula of EAR, “EAR = [1 + (i/n)] ^n - 1; where i = stated annual interest rate n = number of compounding periods” (Effective Annual Rate (EAR) par…

Introduction

“FVn = PV (1+k) n FVn = Future value at the end of the year n PV = Present value, or original principal amount k = Annual rate of interest paid n = Number of periods” (Future Value Formula 1). A note to Pru-Johntower Life Insurance Company, promising an annual rate of interest of 10%; EAR = [1+10%] ^15-1 = [1.1] ^14 = 3.797 So, the effective annual rate = 3.797. FV = 10,000,000 [1+3.797] 15 = 719550000. A note to Tom Paine Mutual Life Insurance Company, promising a rate of interest of 9.72% per year, compounded monthly. EAR = [1+9.72%] ^15*12-1 = [1.0972] ^180-1 = [1.0972] ^179 = 16261. So, the effective annual rate =16261. FV = 10,000,000 [1+16261] 15*12 = 29271600000000. Above the problem shows comparing the effective annual rates and future required payment of the two notes. In the case of Pru-Johntower Life Insurance Company, EAR is 3.797 and FV is 719550000. And the case of Tom Paine Mutual Life Insurance Company, EAR is 16261 and the FV is 29271600000000. 2. Following are the formula of calculating the mortgage loan. “a = [P (1 + r) Yr] / [(1 + r) Y - 1]” (Mortgage par. 8). Loan amount -$30,000 Annual interest rate- 3% Term of loan: (months) - 30 So the estimated monthly payments are $1,039.22 and they will pay $1,177 in interest over the life of the loan. The first alternative suggests that 30% discount. ...
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