Financial Management:Leverage and Capital Structure
Do time lines deal only with years or could other periods be used?
Set up a time line to illustrate the following situation: You currently
have $2,000 in a three-year certificate of deposit (CD) that pays a
guaranteed 4 percent annually.
Explain why this statement is true: “A dollar in hand today is worth
more than a dollar to be received next year.”
What is compounding? What’s the difference between simple inter-
est and compound interest?
What would the future value of $100 be after five years at 10 percent compound interest? At 10 percent simple interest? ($161.05; $150.00)
Suppose you currently have $2,000 and plan to purchase a three-
year certificate of deposit (CD) that pays 4 percent interest com-
pounded annually. How much will you have when the CD matures?
What is “discounting,” and how is it related to compounding? How
is the future value equation (2-1) related to the present value equation (2-2)?
How does the present value of a future payment change as the time
to receipt is lengthened? As the interest rate increases?
Suppose a U.S. government bond promises to pay $2,249.73 three
years from now. If the going interest rate on three-year government
bonds is 4 percent, how much is the bond worth today? How would
your answer change if the bond matured in five rather than three
years?
What if the interest rate on the five-year bond were 6 percent
rather than 4 percent? ($2,000; $1,849.11; $1,681.13)
How much would $1,000,000 due in 100 years be worth today if the
discount rate were 5 percent? If the discount rate were 20 percent?
($7,604.49; $0.0121)
The U.S. Treasury offers to sell you a bond for $585.43. No payments will be made until the bond matures 10 years from now, at which time it will be redeemed for $1,000.
What interest rate would you earn if you bought this bond for $585.43? What rate would you earn if you could buy the bond for $550? For $600? (5.5%; 6.16%; 5.24%)
Microsoft earned $0.12 per share in 1994. Ten years later, in 2004, it
earned $1.04. What was the growth rate in Microsoft’s earnings per
share (EPS) over the 10-year period? If EPS in 2004 had been $0.65
rather than $1.04, what would the growth rate have been? (24.1%;
18.41%
How long would it take $1,000 to double if it were invested in a
bank that pays 6 percent per year? How long would it take if the
rate were 10 percent? (11.9 years; 7.27 years)
Microsoft’s 2004 earnings per share were $1.04, and its growth rate
during the prior 10 years was 24.1 percent per year. If that growth
rate were maintained, how long would it take for Microsoft’s EPS to
double? (3.21 years
What’s the difference between an ordinary annuity and an annuity
due?
Why should you rather receive an annuity due for $10,000 per year
for 10 years than an otherwise similar ordinary annuity?
For an ordinary annuity with five annual payments of $100 and a 10
percent interest rate, how many years will the first payment earn
interest, and what will this payment’s value be at the end?
Answer this same question for the fifth payment. (4 years, $146.41; 0 years, $100)
Assume that you plan to buy a condo five years from now, and you
estimate that you can save $2,500 per year.
You plan to deposit the money in a bank that pays 4 percent interest, and you will make the
first deposit at the end of the year. How much will you have after
five years?
How would your answer change if the interest rate
were increased to 6 percent, or lowered to 3 percent? ($13,540.81;
$14,092.73; $13,272.84)