# Net Present Value (NPV)

However, do not just fixate on the formulas. While you need to know the formula for the assignments, you also need to understand the logic and intuition behind the formulas. The following links are important not only for the formulas but also to help you understand the material.

Helbaek, M., Lindset, S., & McLellan, B. (2010). Corporate finance. McGraw-Hill Education (read chapter 1). Retrieved from EBSCO.

Part I (2 pages): This part of the assignments tests your ability to calculate present value.

A. Suppose your bank account will be worth \$15,000.00 in one year. The interest rate (discount rate) that the bank pays is 7%. What is the present value of your bank account today? What would the present value of the account be if the discount rate is only 4%?

B. Suppose you have two bank accounts, one called Account A and another Account B. Account A will be worth \$6,500.00 in one year. Account B will be worth \$12,600.00 in two years. Both accounts earn 6% interest. What is the present value of each of these accounts?

C. Suppose you just inherited an gold mine. This gold mine is believed to have three years worth of gold deposit. Here is how much income this gold mine is projected to bring you each year for the next three years:

Year 1: \$49,000,000

Year 2: \$61,000,000

Year 3: \$85,000,000

Compute the present value of this stream of income at a discount rate of 7%. Remember, you are calculating the present value for a whole stream of income, i.e. the total value of receiving all three payments (how much you would pay right now to receive these three payments in the future). Your answer should be one number – the present value for this gold mine at a 7% discount rate but you have to show how you got to this number.

Now compute the present value of the income stream from the gold mine at a discount rate of 5%, and at a discount rate of 3%. Compare the present values of the income stream under the three discount rates and write a short paragraph with conclusions from the computations.

Ice Dreams

R J Wagner & Associates Realty

Interstate Travel Center

Which of these three projects do you think should have the highest risk from the point of view of investors (potential providers of funds) and would therefore be evaluated using the highest discount rate? Which one do you think should have the lowest? Write a paper explaining your reasoning.

In your assessment of the business plans consider the possible risk of each plan. Risk is one of the main considerations when deciding whether a plan should be evaluated and discounted to present value using a high or a low discount rate.

Note: you are not expected to fully analyze the numbers and financial statements in these business plans. There are only forecasts and projections. Nobody really believes them anyway. Use your intuition rather than calculations to assess risk and potential of each of these plans

Part III (2 PAGES)

One specialized type of security is called an equity futures. This is a contract that guarantees you a share of a particular company to be delivered to you not today, but sometime in the future, at a price that is determined by the market right now. This price is usually called the futures price of the stock (note – the term is plural – “futures”). If you ‘buy’ this futures, you don’t pay for the shares now. You are actually signing a contract whereby you are committed to pay that price in a particular date in the future, and you are guaranteed to receive one share of the company at that time, irrespective of its actual market price at that future date. Suppose for example that the futures price of the XYZ company is \$40. Suppose you ‘buy’ a 6-months futures contract. If six months later the share price is \$45, you gain \$5 per share. If the market price in 6 months is only \$35, then you lose \$5.

Using the Yahoo Finance take a look at the five year chart for your reference company (the one you chose for SLP1). Using this chart and other information you can find on this company, write a paper answering the following question:

What do you think would the futures price of 100 shares of your reference company to be delivered to you in one year be right now?

. You DO NOT need to use complex mathematical formulas for this assignment. Instead, think about how much do you think the market value of 100 shares of your company will be in one year? In considering the possible answer please reflect also on the following:

Do you expect the price of the shares in one year to be much higher? Or lower? Or only a little bit higher?

How risky the stock is. Is its price prone to wild swings up and down? Or has the price been relatively stable the last few years?

What alternative investments you have access to. What rate does your bank give you on a savings account or certificate of deposit? The greater return you can get on other investments, the less you would be willing to pay for an equity future.