Reference no: EM13340585

1. Lee plans to retire in 22 years with a nest egg of $8M. He has already saved $500,000 in an investment account that generates a nominal rate of return of 12%, compounded quarterly. However, he needs to withdraw $150,000 from this account in 10 years to finance his son's college education.
(a) Numerically show that whether Lee's investment account balance will reach $8M in 22 years,
based on the information provided above. <$6.12M>
(b) The correct answer for part (a) indicates that Lee's investment account will fall short of his
retirement goal of $8M in 22 years. Thus, he continues his pursuit by making additional fixed contributions at the end of every quarter to the same investment account until he retires 22 years later. How big should be his quarterly contribution in order to achieve his goal? <$4,522.18>
(c) Assume now that Lee retires and has $8M in his investment account. If he wants to leave $10M to each of his two children upon his death after enjoying 25 years of retirement. What is the maximum annual withdrawal from the investment account Lee can make at the beginning of every year during his retirement? <$818,587.57>


2. Maryanne, a baby boomer who turns 50 today, begins to save for retirement with $200,000 that she just receives from a trust fund. She immediately invests this $200,000 in a stock fund. In addition, she plans to contribute $10,000, $15,000, and $20,000, respectively, at the end of the next 3 years to the same stock fund. The stock fund generates a nominal rate of return of 10%, compounded annually.
(a) What will be the value of her stock fund when she retires at the age of 67? <$1,195,452.48>
(b) Right after her retirement, she transfers her nest egg into a conservative investment that
compounds monthly. If Maryanne wants to withdraw a fixed monthly payment of $7,000 from this investment indefinitely, what should be the annual rate of return of this conservative investment? <7.03%>


3. Consider the following two mutually exclusive projects, X and Y, and their cash flows information,
?Project
X
Y (a)
(b) (c)
Year 0
($1,400)
Year 1
$350
Year 2
$750
Year 3
$650
Year 4
$650
($1,000)
Assume that the discount rate is 12%, compute the payback period, the IRR, NPV and PI of project X. <2.46 years; 23.49%; $386.13; 1.276>
Use the McKinsey's approach to compute the Modified IRR (MIRR) for project X. <19.03%> Apply the incremental IRR analysis to compute the crossover rate for projects X and Y, and select between these two mutually exclusive projects. <19.41%>

4. The following are two popular approaches used by automobile dealers:
(a) Cash Rebate Versus Low Rate Dealer Financing
You are given two mutually exclusive options from the dealer on a $20,000 car: (i) $1,500 cash rebate or (ii) 36-month low rate loan at 3% APR. The prevailing APR on 36-month auto loan from a typical bank is 8%. Which option is a better deal?
<$579.72; $581.62>
(b) Buying Versus Leasing
You are interested in a $25,000 car. A simplified leasing contract includes the following: (i) up- front cost of $3,000, (ii) $400 monthly lease payment over a 36-month period, and (iii) purchase cost of $12,000 at the end of the lease. What are the "implied" APR and EAR of the lease? Should you lease the car or buy and finance the car with a loan from the bank in (a)?

5. You have been asked by the president of your firm to evaluate the proposed acquisition of new special-purpose equipment. The equipment's base price is $500,000, and another $50,000 for its installation costs. The equipment falls into the MACRS 3-year class, and it will be sold at the end of the project's 2-year life for $250,000. Use of the equipment will require net working capital investment equivalent to 20% of the following year's incremental revenues. The equipment will increase annual revenues by $100,000, and save the firm $200,000 in annual operating costs. The annual revenues and operating costs are expected to grow at an annual rate of 10% during the 2nd-year of the project. This equipment will be placed in an unoccupied site, which can otherwise be sold for $100,000 today. This site will be sold for the same price at the termination of the project. The depreciation of this site that your firm owns can be ignored. The firm's tax rate is 30 percent and the discount rate for the project is 12%.
(a) Compute the initial outlay of the project. <-$670,000>
(b) Compute the operating cash flows (OCF) in Years 1 and 2. <$264,995; $304,326>
(c) Compute the non-operating cash flows (i.e., capital spending and change in NWC) at the end of
Year2. <$333,679>
(d) What is your recommendation on this project according to the conceptually most correct capital
budgeting method? Why? Be concise! <$73,430>