Question

1. Charleston Painless Surgery Center currently has $100,000 in excess cash. Meredith wants to invest the cash in a three-year bank certificate of deposit (CD) where, at maturity, the buyer receives the principal plus accumulated interest.

a. What is the future value of the CD if it pays 2 percent interest compounded annually? 1 percent? 3 percent? (Hint: Use Excel’s “FV” function.)

b. Big Bank offers a CD with 3 percent nominal (stated) interest that is compounded monthly. What is the effective annual rate on this CD? (Hint: Use Excel’s “Effect” function.) What will the value be in three years if the $100,000 is invested in this CD? (Hint: Use Excel’s “FV” function.)

2. Meredith thinks CPSC’s current computer hardware and software system will need to be replaced in three years at an estimated cost of $500,000.

a. What amount must be currently invested in a CD paying 3 percent annual interest to accumulate to $500,000 in three years? (Hint: Use Excel’s “PV” function.)

b. What annual interest rate will allow a current investment of $450,000 to accumulate to $500,000 after three years? (Hint: Use Excel’s “Rate” function.)

c. Another option for accumulating $500,000 in three years is to make three equal annual payments into a savings account earning 4 percent interest, with the first payment being made immediately. What type of annuity is this? What is the amount of the equal annual payments? (Hint: Use Excel’s “Pmt” function.)

3. The surgery center’s building in downtown Charleston has an attached garage, but CPSC employees and patients use only about 50 percent of the garage’s space. Meredith is under discussions to lease the unneeded garage space for five years to a local business. The lessee’s cash flow needs can be accommodated by allowing the lease payments to vary as follows: see spreadsheet

a. What is the present value of the proposed lease payments at Year 0 if the required rate of return is 10 percent annually? (Hint: Use Excel’s “NPV” function.)

b. If the proposed lease payments are invested at 10 percent annually, what will the future value of the payments accumulate to at the end of Year 5?

4. Time value analysis involves using a periodic rate to either discount or compound cash flows. How do we determine the appropriate periodic rate to use?

Answer 1