Question

Assume that you are nearing graduation and that you have applied for a job with a local bank. As part of the bank's evaluation process, you have been asked to take an examination which covers several financial analysis techniques. The first section of the test addresses discounted cash flow analysis. See how you would do by answering the following questions:

Required:
a. Draw time lines for (a) a $100 lump sum cash flow at the end of Year 2 (b) an ordinary annuity of $100 per year for 3 years, and (c) an uneven cash flow stream of -$50, $100, $75, and $50 at the end of Years 0 through 3.
b. What is the future value of an initial $100 after 3 years if it is invested in an account paying 10 percent annual interest?
c. What is the present value of $100 to be received in 3 years if the appropriate interest rate is 10 percent?

Answer 1

Answer:

a)                                                     Years

    0                         1                         2                        3                         4              

                                                         a) $100              

                               b) $100              $100                  $100

   c)-$50                 $100                  $75                    $50

b) What is the future value of an initial $100 after 3 years if it is invested in an account paying 10 percent annual interest?

future value = present value x (1 + interest rate)ⁿ = $100 x (1 + 10%)³ = $100 x 1.331 = $133.10

c) What is the present value of $100 to be received in 3 years if the appropriate interest rate is 10 percent?

present value = future value / (1 + interest rate)ⁿ = $100 / (1 + 10%)³ = $100 / 1.331 = $75.13