Finance Chapter 5- Discounted Cash Flow Valuation Test Questions and Correct Answers
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Course
Discounted Cash Flow
Institution
Discounted Cash Flow
Multiple Cash Flows - Present Value Example 1:
You are offered an investment that will pay you $200 in one year, $400 the next year, $600 the next year and $800 at the end of the next year. You can earn 12 percent on very similar investments. What is the most you should pay for this one? Find the ...
Finance Chapter 5- Discounted Cash
Flow Valuation Test Questions and
Correct Answers
Multiple Cash Flows - Present Value Example 1:
You are offered an investment that will pay you $200 in one year, $400 the next year,
$600 the next year and $800 at the end of the next year. You can earn 12 percent on
very similar investments.
What is the most you should pay for this one? ✅Find the PV of each cash flows and
add them
Year 1 CF: 200 / (1.12)1 = 178.57
Year 2 CF: 400 / (1.12)2 = 318.88
Year 3 CF: 600 / (1.12)3 = 427.07
Year 4 CF: 800 / (1.12)4 = 508.41
Total PV = 178.57 + 318.88 + 427.07 + 508.41 = 1432.93
Multiple Cash Flows -Future Value Example 2:
You think you will be able to deposit $4,000 at the end of each of the next three years in
a bank account paying 8 percent interest. You currently have $7,000 in the account.
How much will you have in three years?
In four years? ✅Find the value at year 3 of each cash flow and add them together:
Today (year 0): FV = 7000(1.08)3 = 8,817.98
Year 1: FV = 4,000(1.08)2 = 4,665.60
Year 2: FV = 4,000(1.08) = 4,320
Year 3: value = 4,000
Total value in 3 years = 8817.98 + 4665.60 + 4320 + 4000 = 21,803.58
Value at year 4 = 21,803.58(1.08) = 23,547.87
Multiple Cash Flows - FV Example 3:
Suppose you invest $500 in a mutual fund today and $600 in one year. If the fund pays
9% annually, how much will you have in two years? ✅FV = 500(1.09)^2 + 600(1.09)^1
= 1248.05
Multiple Cash Flows - FV Example 4:
, Suppose you plan to deposit $100 into an account in one year and $300 into the
account in three years. How much will be in the account in five years if the interest rate
is 8%? ✅FV = 100(1.08)^4 + 300(1.08)^2 = 136.05 + 349.92 = 485.97
Annuity ✅finite series of equal payments that occur at regular intervals
ordinary annuity ✅If the first payment occurs at the end of the period
annuity due ✅If the first payment occurs at the beginning of the period
Perpetuity ✅infinite series of equal payments
Perpetuities - Basic Formulas ✅PV = C / r
Annuities - Basic Formulas ✅PV = C x {1- 1/(1 + r)^t/r}
FV = C x {((1 + r)^t - 1)/r
Annuity - Car Loan:
After carefully going over your budget, you have determined you can afford to pay $350
per month towards a new sports car. You call up your local bank and find out that the
going rate is 6.99% for 5 years.
How much can you borrow? ✅Always convert your interest rate and number of
payments to the same frequency as your cash flows
r: .0699/12 = .005825
t: 5 x 12 = 60 months
PV =
350
x
[1 - 1/(1.005825)^60]/ .005825}
= 17,679.91
Annuity - Sweepstakes Example:
Suppose you win the Publishers Clearinghouse $10 million sweepstakes. The money is
paid in equal annual installments of $333,333.33 over 30 years. If the appropriate
discount rate is 5%, how much is the sweepstakes actually worth today? ✅PV =
333,333.33
x
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