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Valuation and Discounted Cash Flows - Case Study Example

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Valuation and Discounted Cash Flows

“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. So they pay $311.766. The second alternative suggests that five-year zero-interest loan and the new loan was to be repaying in 5 equal annual payments. And this alternative would save them well more than $2,000 in interest. So the alternative A is better than the alternative B to pay the mortgage. So the spirit should pursue alternative A. 3) A) If an investor invests $2 million in stock market to purchase shares the return is based on the market. Some time he will get high return on his investment some time he will get loss his investment. The return is based on the economic condition. But the investment in bond will generate constant return to the investor, the investor would get specific percentage of interest at particular period of time also he will get principle amount at the end of specific period of time. I assumed that my investment is $2 million and the return for the investment is $25, 00,000, then the rate of return on investment will be ((Return - Capital) / Capital) ? 100% = Rate of Return ($25, 00,000-$20,00,000/$20,00,000) *100 25% Therefore the rate of return is 25% Bid is the obtainable price at which the investor can sell his share. $1.5 million is the price that the buyer is willing to pay. Minimum bid price $1.3million has already placed, even there is $1.5 million bid I would not sell at $1.5 million I will hold the investment because the Wall Street financial analyst predicted that the successful bid is $ 2.1 million. The investment is also depending the tax imposed by the government authorities. B) In my point in July 1 1992 the capital market provides fair market value to the investment. The investor gained better yield for their investment and the approximate market fair value of the ticket will be $1.5 million because there has been minimum bid for $1.3 million so the fair value would be $1.5 million for the ticket. C) If tax rate is increased for the bond investment it will decrease the return from this bond investment. Then I would prefer the investment in other investment options like shares, mutual fund etc. If tax ...Show more

Summary

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…
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