Answer to Question 1:
Question 1.a:
As per the accounting concept, total asset of any company must be equal to the sum of total liabilities and total equities. Hence, if any company maximizes its assets, then it would result in increase of liabilities and/or assets. However, in financial sectors, it is believed that the shareholders’ wealth can be maximized through dividend payments and/or causing rise in the market values of the stocks.
If XYZ limited plans to maximizes its assets, then it may help the company to increase its income. As the result, the company can pay more dividends to its shareholders and the market value may also rise due to the better financial performance. Therefore, it can be stated that maximization of assets may help the company to maximize its shareholders’ wealth (Runkle et al. 2013).
However, it is only possible if the company utilizes its assets efficiently to increase its net profits and pays higher dividends to its shareholders. Moreover, as the market value of stocks are highly dependable on various other factors, it may not rise for the better financial performance only. Hence, it cannot be ensured that maximization of assets will surely maximize shareholder’s wealth (Bodie et al. 2014).
Answer to Question 1.b:
Nominal interest rate is the stated interest rate, which does not incorporate the compounding periods for calculating the interest. It is calculated on the original principal only.
Whereas, compounding period interest rate considers all the compounding periods. While calculating interest at compounding period interest rate, both the principal amount and accumulated interest during the past periods are taken into accounts (Barry and Robison 2014).
Answer to Question 2:
Answer 2.a:
The investment can be considered as a good investment, as the present value of the future cash flows from the investment is higher than the purchase cost of the investment. The calculations are shown below:
|
Particulars
|
|
Amount
|
|
Interest Rate p.a.
|
A
|
12%
|
|
Monthly Interest Rate
|
B=A/12
|
1%
|
|
Repayment after 2 years
|
C
|
$20,000
|
|
PV of Repayment after 2 yrs.
|
D=C/[(1+B)^(2x12)]
|
$15,751
|
|
Repayment after 5 years
|
E
|
$30,000
|
|
PV of Repayment after D yrs.
|
F=E/[(1+B)^(2x12)]
|
$23,627
|
|
PV of Total Repayments
|
G=D+F
|
$39,378
|
|
Investment Value
|
H
|
$30,000
|
|
Profit on Investment
|
I=G-H
|
$9,378
|
Answer 2.b:
Present value of the perpetuity is computed below:
|
Particulars
|
|
Amount
|
|
Perpetuity
|
A
|
$700
|
|
Rate of Return p.a.
|
B
|
8%
|
|
Delayed Period (in years)
|
C
|
3
|
|
|
|
|
|
PV of Cash Flow from Perpetuity
|
D=(A/B)/[(1+B)^(C-1)]
|
$7,502
|
Present value of the uneven cash flows is calculated in the following table:
|
Period
|
Uneven Cash Flows
|
Return Rate
|
PV of Cash Flows
|
|
A
|
B
|
C
|
D=B/(1+C)^A
|
|
1
|
$500
|
8%
|
$463
|
|
2
|
$1,000
|
8%
|
$857
|
|
3
|
$1,500
|
8%
|
$1,191
|
|
4
|
$2,000
|
8%
|
$1,470
|
|
5
|
$2,500
|
8%
|
$1,701
|
|
6
|
$3,000
|
8%
|
$1,891
|
|
|
|
|
|
|
PV of Total Cash Flows
|
|
|
$7,573
|
From the tables, it is clear that the present value of uneven cash flows is higher than the present value of perpetuity. Hence, it is better to buy the investment with uneven cash flows for 6 years.
Answer to Question 3:
Answer 3.a:
|
Particulars
|
|
Amount
|
|
|
|
|
|
Required Fund
|
A
|
$50,000
|
|
Interest Rate p.a.
|
B
|
6%
|
|
Nos. of Installment p.a.
|
C
|
12
|
|
Interest Rate per month
|
D=B/C
|
0.50%
|
|
Total Period (in years)
|
E
|
5
|
|
Total Nos. of Installments
|
F=ExC
|
60
|
|
Amount of Monthly Installment
|
G=(AxD)/[(1+D)^F]-1
|
$716.64
|
Answer 3.b:
Future value of the ETF funds after 35 years are computed below:
|
Particulars
|
|
Amount
|
|
ETF Investment after 5 years
|
A
|
$50,000
|
|
Market Rate of Return p.a.
|
B
|
9%
|
|
Nos. of Installment p.a.
|
C
|
12
|
|
Return Rate per month
|
D=B/C
|
0.75%
|
|
Additional Working Life (in years)
|
E
|
30
|
|
Total Nos. of Installments
|
F=ExC
|
360
|
|
Future Value of Investment after 35 years
|
G=Ax(1+D)^F
|
$736,529
|
Present value of monthly retirement allowance after 35 years are as follows:
|
Particulars
|
|
Amount
|
|
Retirement Allowance per month
|
A
|
$6,000
|
|
Market Rate of Return p.a.
|
B
|
9%
|
|
Nos. of Installment p.a.
|
C
|
12
|
|
Return Rate per month
|
D=B/C
|
0.75%
|
|
Additional Working Life (in years)
|
E
|
25
|
|
Total Nos. of Installments
|
F=ExC
|
300
|
|
Present Value of Total Retirement Allowance after 30 years
|
G=Ax[{1-(1+D)^-F}/D]
|
$714,970
|
As the future value of ETF after 35 years would be higher than the present value of monthly retirement allowance after 35 years, it can be stated the ETF would be sufficient to cover the retirement allowances.
Answer to Question 4:
Answer 4.a:
The present value of the stream of cash flows is shown below:
|
Particulars
|
|
Amount
|
|
Monthly Insurance Coverage
|
A
|
$3,000
|
|
Interest Rate p.a.
|
B
|
8.30%
|
|
Interest Rate per month
|
C=B/12
|
0.69%
|
|
Total Coverage Period (in yrs.)
|
D
|
3
|
|
Total Nos. of Payments
|
E=(Dx12)-1
|
35
|
|
PV of Cash Flows
|
F=Ax[{1-(1+C)^-E}/C]
|
$92,973
|
Answer to 4.b:
As discussed above, compounding interest rate includes the compounding periods, whereas, nominal interest rate does not include the compounding periods.
However, effective interest rate is the rate at which the interests are paid in actual. It is another form of compounding interest rate, which calculates the interest with more accuracy.
Reference & Bibliography:
Barry, P.J. and Robison, L.J., 2014. Economic Rates of Return and Investment Analysis. The Engineering Economist, 59(3), pp.231-236
Bodie, Z., Kane, A. and Marcus, A.J., 2014. Investments, 10e. McGraw-Hill Education
Damodaran, A., 2016. Damodaran on valuation: security analysis for investment and corporate finance (Vol. 324). John Wiley & Sons
Runkle, D.E., DeFusco, R.A., Anson, M.J., Pinto, J.E. and McLeavey, D.W., 2013. Quantitative Investment Analysis. Wiley
