Simple Interest versus Compound Interest First Simple Bank pays 6 percent simple interest on its investment accounts. If First Complex Bank pays interest on its accounts compounded annually, what rate should the bank set if it wants to match First Simple Bank over an investment horizon of 10 years? Calculating EAR You are looking at an investment that has an effective annual rate of 14 percent. What is the effective semiannual return? The effective quarterly return? The effective monthly return?
Calculating Interest Expense You receive a credit card application from Shady Banks Savings and Loan offering an introductory rate of 2.90 percent per year, compounded monthly for the first six months, increasing thereafter to 15 percent compounded monthly. Assuming you transfer the $3,000 balance from your existing credit card and make no subsequent payments, how much interest will you owe at the end of the first year?
Calculating the Number of Periods You are saving to buy a $150,000 house. There are two competing banks in your area, both offering certificates of deposit yielding 5 percent. How long will it take your initial $95,000 investment to reach the desired level at First Bank, which pays simple interest? How long at Second Bank, which compounds interest monthly?
Calculating Future Values You have an investment that will pay you 1.72 percent per month. How much will you have per dollar invested in one year? In two years?
Calculating the Number of Periods You have $1,100 today. You need $2,000. If you earn 1 percent per month, how many months will you wait? Calculating Rates of Return Suppose an investment offers to quadruple your money in 12 months (don't believe it). What rate of return per quarter are you being offered?
Comparing Cash Flow Streams You've just joined the investment banking firm of Dewey, Cheatum, and Howe. They've offered you two different salary arrangements. You can have $75,000 per year for the next two years, or you can have $55,000 per year for the next two years, along with a $30,000 signing bonus today. If the interest rate is 10 percent compounded monthly, which do you prefer? Calculating Present Value of Annuities Peter Piper wants to sell you an investment contract that pays equal $10,000 amounts at the end of each of the next 20 years. If you require an effective annual return of 9.5 percent on this investment, how much will you pay for the contract today?
Calculating Rates of Return You're trying to choose between two different investments, both of which have up-front costs of $30,000. Investment G returns $55,000 in six years. Investment H returns $90,000 in 11 years. Which of these investments has the higher return?
Ross et al.: Fundamentals of Corporate Finance, Sixth Edition, Alternate Edition
III. Valuation of Future Cash Flows
6. Discounted Cash Flow Valuation
© The McGraw-Hill Companies, 2002
CHAPTER 6 Discounted Cash Flow Valuation
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