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Assignment 2

Problem 1:

There are three major business organization forms from start-up to a major corporation. What are these three business organization forms? What are advantages and disadvantages for each organization form?

Problem 2:

Based on the chart below, answer the following two questions.

1.     If the value of the firm is 10 million, and $F is 12 million, how much will be the payoff to debt holders and how much will be the payoff to shareholders?

2.     If the value of the firm is 25 million, and $F is 12 million, how much will be the payoff to debt holders and how much will be the payoff to shareholders?

Problem 3:

Assume that you are nearing graduation and have applied for a job with a local bank. As part of the bank's evaluation process, you have been asked to take an examination that covers several financial analysis techniques. The first section of the test addresses discounted cash flow analysis. See how you would do by answering the following questions.

a.       Draw time lines for (1) a $100 lump sum cash flow at the end of Year 2, and (2) an uneven cash flow stream of -$50, $100, $75, and $50 at the end of Years 0 through 3.

b.     What's the future value of an initial $100 after 3 years if it is invested in an account paying 10% annual interest and compounded annually? How about if the interest is compounded monthly, daily or hourly?

c.       What is the present value of $100 to be received in 3 years if the annual interest rate is 10% and compounded annually? How about if the interest is compounded monthly, daily or hourly?

d.     We sometimes need to find how long it will take a sum of money (or anything else) to grow to some specified amount. For example, if a company's sales are growing at a rate of 20% per year, how long will it take sales to double?

e.       If you want an investment to double in three years, what annual interest rate must it earn?

f.       What is the present value of the following uneven cash flow stream? The annual interest rate is 10%, compounded annually. How about the interest is compounded monthly, daily or hourly?              

g.     What is the effective annual rate (EAR) for an annual percentage rate (APR) or a nominal annual rate of 12%, compounded semiannually? Compounded quarterly? Compounded monthly? Compounded daily? Compounded hourly?  

h.     Will the effective annual rate (EAR) ever be equal to the APR or nominal annual rate (quoted)?

i.       What is the value at the end of Year 3 of the following cash flow stream if the quoted (nominal) interest rate is 10%, compounded semiannually?

j.       What is the present value of the above cash flow stream if the quoted (nominal) annual interest rate is 10%, compounded daily?

k.     Suppose someone offered to sell you a note calling for the payment of $1,000 in two years (or 730 days). They offer to sell it to you for $850. You have $850 deposit in a bank that pays a 6.76649% nominal rate with daily compounding, and you plan to leave the money in the bank unless you buy the note. The note is not risky--you are sure it will be paid on schedule. Should you buy the note? Check the decision in three ways: (1) by comparing your future value if you buy the note versus leaving your money in the bank, (2) by comparing the PV of the note with your current bank account, and (3) by comparing the effective annual rate on the note versus that of the bank account.