Question

Q1) Mike is expecting an inheritance of $5 million in four years. If he had the money today, he could earn interest at an annual rate of 5.25 percent. What is the present value of this inheritance? • Q2) Mid Corp. is expecting annual cash flows of $100,000, $200,000, $250,000, and $300,000 over the next four years. If it uses a discount rate of 6.25 percent, what is the present value of this cash flow stream? • Q3) You bought a corporate bond for $850 today. In five years the bond will mature and you will receive $1,000. What is the rate of return on this bond?

Answer 1

Answer to Question 1:

Payment in 4 years = $5,000,000
Interest Rate = 5.25%

Present Value = Payment / (1 + Interest Rate)^Period
Present Value = $5,000,000 / 1.0525^4
Present Value = $4,074,568.15

Answer to Question 2:

Cash Flows:
Year 1 = $100,000
Year 2 = $200,000
Year 3 = $250,000
Year 4 = $300,000

Discount Rate = 6.25%

Present Value = $100,000/1.0625 + $200,000/1.0625^2 + $250,000/1.0625^3 + $300,000/1.0625^4
Present Value = $715,106.38

Answer to Question 3:

Purchase Price = $850
Maturity Value = $1,000
Period = 5 years

Interest Rate = (Maturity Value / Purchase Price)^(1/Period) - 1
Interest Rate = ($1,000 / $850)^(1/5) - 1
Interest Rate = 1.17647^(1/5) - 1
Interest Rate = 1.0330 - 1
Interest Rate = 0.0330 or 3.30%