Problem 1: Continuous Compounding - Compute the future value of $1,000 continuously compounded for:
a. 5 years at a stated annual interest rate of 12 percent
b. 3 years at a stated annual interest rate of 10 percent
c. 10 years at a stated annual interest rate of 5 percent
d. 8 years at a stated annual interest rate of 7 percent
Problem 2: Stock Values - Warren Corporation will pay a $3.60 per share dividend next year. The company pledges to increase its dividend by 4.5 percent per year indefinitely. If you require a 13 percent return on your investment, how much will you pay for the company's stock today?
Problem 3: NPV versus IRR - Consider the following cash flows on two mutually exclusive projects for the Bahamas Recreation Corporate (BRC). Both projects require an annual return of 15 percent.
Year Deepwater fishing New Submarine Ride
0 -$600,000 -$1,800,000
1 270,000 1,000,000
2 350,000 700,000
3 300,000 900,000
Problem 4: As a financial analyst for BRC, you are asked the following questions:
a. If your decision rule is to accept the project with the greater IRR, which project should you choose?
b. Because you are fully aware of the IRR rule's scale problem, you calculate the incremental IRR for the cash flows. Based on your computation, which project should you choose?
c. To be prudent, you compute the NPV for both projects. Which project should you choose? Is it consistent with the incremental IRR rule?
Problem 5: Calculating Project NPV - The Best Manufacturing Company is considering a new investment. Financial projections for the investments are tabulated here. The corporate tax rate is 34 percent. Assume all the sales revenue is received in cash, all operating costs and income taxes are paid in cash, and all cash flows occur at the end of the year. All net working capital is recovered at the end of the project.
Year 0 Year 1 Year 2 Year 3 Year 4
Investment $10,000 - - - -
Sales Revenue - $7000 $7000 $7000 $7000
Operating Costs - 2000 2000 2000 2000
Depreciation 2500 2500 2500 2500
Net Working Capital spending 200 250 300 200 ?
a. Compute the incremental net income of the investment for each year
b. Compute the incremental cash flows of the investment for each year
c. Suppose the appropriate discount rate is 12 percent. What is the NPV of the project?