TM 661 Chapter 3 Solutions 1 Chapter 2 Solutions 1 5) If you desire a real return of 8% on your money, excluding inflation, and inflation is running 3%, what combined discount rate should you be seeking? Soln: i = d + f + df = .08 + .03 + .08(.03) = .1124 = 11.24% 6) Mellin Transformers Co. uses a required return of 15% in all alternative evaluations. Inflation is running at 5%. What real discount rate, exclusive of inflation, are they implicitly using? d = (i - f)/(1+f) = (.15 - .05)/(1.05) = .0952 = 9.52% Chapter 2 Solutions 1

TM 661 Chapter 3 Solutions 1 Chapter 2 Solutions 2 16) Dr. Schulz is considering purchasing a bond having a face value of $2,500 and a bond rate of 10% payable semi-annually. The bond has a remaining life of 8 years. How much should she pay for the bond in order to earn a return on investment of 14% compounded semiannually? Soln: The bond earns 10% per year or 5% semi-annually. 5% of 2,500 = 125. 8 years remaining equates to 16 semi-annual periods. The physical cash flow for the bond is then shown below. Since Dr. Schulz wants 14% compounded semi-annually (7%) per period, we can compute the Present worth of the cash flow by = 125 (P/A, 7, 6) + 2,500 (P/F, 7, 16) = 125 (9.4466) + 2,500 (.3387) = 2,027 P 125 125 125 2,500 1 2 3 16 Chapter 2 Solutions 2