FIN 534 homework 2

Assume that you are nearing graduation and have applied for a job with a local bank. The bank’s evaluation process requires you to take an examination that covers several financial analysis techniques. The first section of the test asks you to address these discounted cash flow analysis problems:

1. What is the present value of the following uneven cash flow stream −$50, $100, $75, and $50 at the end of Years 0 through 3? The appropriate interest rate is 10%, compounded annually.

0 1 2 3 Cash Flow

------------- |------------ |------------ |

Annuity

0 1 2 3

|------------- |----------- |-------------|

uneven cash flow stream

-50 100 75 50

An uneven cash flow stream is an irregular series of cash flows which do not constitute an annuity, as in the lower time line. -50 represents a cash outflow rather than a receipt or inflow.

0 10% 1 2 3

|-------------- |----- | --------- |

PV = ? 100

FVn = PV(1 + i)n transforms to:

PV = = FVn = FVn(1 + i)-n

thus: PV = $100 = $100(PVIFi,n) = (0.7513) = $75.13.

2. We sometimes need to find out how long it will take a sum of money (or something else, such as earnings, population, or prices) 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?