©2006 Dr. Howard Godfrey – Extra File for Chapter 11 1 Chapter 11- B Extra PowerPoint Slides This file contains explanations of compound interest computations and a selection of short capital budgeting problems.

©2006 Dr. Howard Godfrey – Extra File for Chapter 11

Interest- Annual Compounding-1

Interest- Semiannual Compounding-2

Interest- Semiannual Compounding-3 Compare the balances on the previous slides on: December 31, 2001 December 31, 2002 December 31, 2003 Why are they different?

Review of Interest Computations-4

Review of Interest Computations-4-A

Review of Interest Computations-5

Review of Interest Computations-6

Review of Interest Computations-7

Review of Interest Computations-8

Review of Interest Computations-9

Review of Interest Computations-10

Review of Interest Computations-11 Compute Present Value of an Annuity We have land for sale. Buyer “A” offers to pay $60,000 for our land, payable $20,000 per year for 3 years (payment at end of each year). Our rate of interest on alternative investments is 10%. Buyer “B” will make an offer with immediate payment. How much "immediate payment" is equivalent to the annuity? OR, What is P.V. of the series of payments of $20,000 each?

Review of Interest Computations-12

Review of Interest Computations-13

Review of Interest Computations-14 In preceding example, we could have been considering a wide variety of ventures, such as the proposed lease of a machine for $20,000 per year for 3 years, after which the machine would belong to us. We would rather pay $20,000 per year for 3 years than to pay $60,000 today for the asset. At what price would we choose to pay cash, rather than choosing the lease alternative, assuming our cost of capital is 10%?

Interest Problem-Cooper Cooper plans to invest $2,000 at the end of each of the next ten years. Cooper will earn interest at an annual rate of 6% compounded annually. The future amount of an ordinary annuity of $1 for ten periods at 6% is The present value of $1 for ten periods at 6% is The present value of an ordinary annuity of $1 for ten periods at 6% is The investment at end of ten years would be: a. $14,720 b. $21,200 c. $26,362 d. $27,478

Interest Problem-Cooper

Boone-Interest Computations Boone has incurred an investment of $18,492 and will received $4,000 per year for the next six years. Ignoring tax effects, the internal rate of return (rounded to the nearest percent) is: (Use interest tables.) a. 6% b. 8% c. 10% d. 12% e. 16%

Present Value of $1

P. V. of Annuity of $1 for n Periods

Future Value of $1

Future Value of Annuity of $1

NPV Example Original investment (cash outflow): $6,075 Useful life: four years Annual income generated from investment (cash inflow): $2,000 Minimum desired rate of return: 10%

NPV Question A proposed project has an expected economic life of eight years. In the calculation of the net present value of the proposed project, salvage value would be a. Excluded from the calculation of the net present value. b. Included as a cash inflow at the estimated salvage value. c. Included as a cash inflow at the future amount of the estimated salvage value. d. Included as a cash inflow at the present value of the estimated salvage value.