Discounting and Present Value Analysis - Essay Example

Since I am the investor in this situation, I would perceive a certain required rate of return based on my own understandings and estimates of current market inflation, risk-free rate, expected rate of return of the market and other risk factors. Thus, it would be my choice to choose an appropriate required rate of return (RRR) keeping in view the above things. In this case, 8% is my RRR and at this rate I would sell the project for $281,893. C. Price and discount rate go inversely while inflation has a direct relation with the interest rates.

If inflation increase, interest rates will rise too and since price goes inversely, it will fall. This would cause me to choose a higher RRR. This in turn, will cause the discount factor in the formula to increase, which would then cause the present value to decline. Thus, the prices I would charge currently will be lower that the previous case. D. If the inflation or interest rate rises in the market, it would cause me to choose a higher rate of return because of the increased risk. In other words, keeping the risk-free rate constant, my risk premium that I demand for a particular investment would rise.

Since in this case, the goldmine is located in a third world country, my choice would be to charge a higher price in the wake of higher uncertainty regarding risk factors like inflation risk, interest rate risk etc. The right choice between the two bonds will correctly . The right choice between the two bonds will correctly be based on bond ratings of the two companies issued by genuine credit rating agency. An authentic source would be ratings by Standard & Poor or Moody's. During the previous fiscal year, General Motors already declared a huge loss and much lower profits than previously projected.

According to news, GM's bond rating was cut to junk status by S&P quite recently. This is a step taken keeping in view the highly unstable state of earning it has shown over the previous period. Moreover, S&P said clearly that GM is in a risky financial position for some time to come. The company has been losing market share to Asian rivals Toyota, Honda, Nissan and Hyundai, even as the overall number of new vehicles purchased each year in North America has hovered at record highs. Rising interest rates could keep the market from growing much more, the ratings agency said, and any reduction in demand would be a traumatic event for GM.

1 On the other hand, Standard & Poor's Equity Research emphasized on a "strong buy" rating on Cisco Systems. The company also occupies a strong ranking among other forums like the Fortune 500. The decision here would be to pay a lower price for the bonds of General Motors than that of Cisco Systems. Even if Cisco Systems were not rated among the AAs, it would still be preferable because of the risk factors attached to General Motor's current status in the automobile industry and an uncertain future due to increased competition from Japanese manufacturers and particularly because of a highly low rated junk status assigned by S&P to its bonds.

In other words, Cisco system bonds require a higher price to be paid today with a lower discount rate than GM.Work CitedGM, Ford Bond Ratings