Prepare your responses to these assignment problems in a word processing file; put financial data in a spreadsheet file. As you complete the assignment problems for each lesson, add your responses to these files.
Do not submit your answers for grading until you have completed all parts of Assignment 2.
Note: In assignments, show all calculations to 4 decimal places.
Lesson 5: Assignment Problems
Assume you have $1 million now, and you have just retired from your job. You expect to live for 20 years, and you want to have the same level of consumption (i.e., purchasing power) for each of these 20 years, after adjusting for inflation. You also wish to leave the purchasing power equivalent of $100,000 today to your kids at the end of the 20 years as a bequest (or to pay them to take care of you).
Calculate the actual amount of consumption, in nominal dollars, using the stated assumptions.
How much do you need for your kids?
If you plan to consume $1.03 in year 1, how much will you need to have to keep the same real consumption in year 2? In year 10? In year 20?
How much, in nominal dollars, will $1 of retirement funds earn in year 1? Year 2? Year 10? Year 20?
In an Excel spreadsheet (or in a manual table), calculate the following:
annual investment earnings for each year
total savings after investment earnings for each year
subtract annual consumption from total savings each year
by trial and error, or with the Goal Seek command, determine the amount of consumption that will give you exactly $100,000, in today's purchasing power, at the end of 20 years
Do the calculation again using real rates, and setting inflation to equal 0. If you set up your Excel spreadsheet carefully, you should be able to set the inflation rate to equal 0 and enter the real rate of return as the investment earning rate.
What is the amount of real consumption in year 1? In year 2? In year 10? In year 20?
Show that this is consistent with your calculation using nominal rates.
How much, in real dollars, does that leave for your kids?
Show that your bequest is consistent with the nominal rate results above.
Linus is 18 years old now, and is thinking about taking a 5-year university degree. The degree will cost him $25,000 each year. After he's finished, he expects to make $50,000 per year for 10 years, $75,000 per year for another 10 years, and $100,000 per year for the final 10 years of his working career. If Linus lives to be 100, and if real interest rates stay at 5% per year throughout his life, what is the equal annual consumption he could enjoy until that date?
Linus is also considering another option. If he takes a job at the local grocery store, his starting wage will be $40,000 per year, and he will get a 3% raise, in real terms, each year until he retires at the age of 53. If Linus lives to be 100, what is the equal annual consumption he could enjoy until that date?
From strictly a financial point of view, is Linus better off choosing option A or B?
Are you better off playing the lottery or saving the money? Assume you can buy one ticket for $5, draws are made monthly, and a winning ticket correctly matches 6 different numbers of a total of 49 possible numbers.
What would your $400.43 be worth if you invested it at 1% real interest for 47 years?
If, instead, you wrote down your 6 numbers on a piece of paper, and deposited your $5 in a bank at 1% real interest, how much would you have at the end of the first year?
If you did this every year for 47 years, how much would you have at age 65?
If you earned 5% real interest on your deposits, how much would you have at age 65?
Which option would make you better off at age 65? How many times better off?
Use the Excel spreadsheet named “LeasevsBuyCCA.xls” to answer the following question. You may choose to answer the question without using the spreadsheet, but be very careful to show all work, so your marker can follow your calculation and award part marks as necessary.
Calculate the present value of the lease payments, assuming monthly compounding at the given APR of 8%.
Calculate the present value of the $20,000 salvage value, again using monthly compounding and the given APR of 8%. Which option do you prefer, lease or buy?
Calculate the amount of the salvage value which would make you indifferent between leasing and buying.
If you were able to use this car 100% for business, rendering the lease payments tax-deductible, or alternatively, allowing you to deduct depreciation using straight-line depreciation (depreciated to expected salvage value) and assuming your tax rate is 40%, would you prefer to buy or lease the car?
Do not submit these questions for grading until you have completed all parts of Assignment 2, which is due after Lesson 8.
Lesson 6: Assignment Problems
You may find it helpful to use the Excel file named "Chapter 6 template.xls" to answer the following questions. You may choose to answer the questions without using the spreadsheet, but be very careful to show all work, so your marker can follow your calculation and award part marks as necessary.
In order to ensure that you know how the spreadsheet works, it is recommended that you replicate table 6.5 from page 182 of your textbook before proceeding to answer the following questions. (Note that a completed spreadsheet for Table 6.5 is included with the Excel file as a separate worksheet, so you can check your work.)
You and your friends are thinking about starting a motorcycle company named Apple Valley Choppers. Your initial investment would be $500,000 for depreciable equipment, which should last 5 years, and your tax rate would be 40%. You could sell a chopper for $10,000, assuming your average variable cost per chopper is $3000, and assuming fixed costs, such as rent, utilities and salaries, would be $200,000 per year.
Accounting breakeven: How many choppers would you have to sell to break even, ignoring the costs of financing?
Financial breakeven: How many choppers would you have to sell to break even, if you required a 15% return? (Hint: Use the 15% as the discount rate and calculate net present value. In Excel, you may want to use the Goal Seek command, or simply use trial and error to find the correct amount.)
Assuming you could sell 60 choppers per year, what would be your IRR?
Assuming you could sell 60 choppers per year, what would your selling price have to be to generate a net present value of $150,000 at a 15% discount rate?
If you could sell 60 choppers in the first year, and your sales volume increased by 5% each year until the end of year 5, what would the net present value be at a 15% discount rate?
If you need to invest working capital equal to 10% of the next (coming) year‘s sales revenue, what would be the effect on the net present value of the project? Do you think that working capital investments always reduce the net present value of projects? (Assume a 15% discount rate, and sales volume increases by 5% each year.)
Fill in the missing items in the following table. Assume that the real interest rate is 3% per year, and inflation is expected to be constant at 2% per year.
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Prepare your responses to these assignment problems in a word processing file; put financial data in a spreadsheet file. As you complete the assignment problems for each lesson, add your responses to …