Case 46

73

Case Presentation 73

Discounted Cash Flow Analysis

1. I would review over my options of investments in CD’s and see which interest rate presents the optimal benefit. Furthermore, determined if the interest compounds annually, semiannually, or quarterly. Afterwards calculate potential cash flows from the data and weigh in cost/benefit analysis.

2.

a. The value of $18,000 CD with 8.4% annual interest would equal to $19,512.

b. Future value for CD for 3.2% equal to $18,576

If 16.8% equals to $21,024.

The difference between the two interest rates is $2,448 = ($21,024-$18,576). Interest rates can have a profound impact in the initial investment. Higher interest equals higher returns. However the underling question is how to acquire high interest with compounding.

c. First National Bank semiannual at 8.4% (stated) equals to $19,543.75

For effective annual rate equals to 8.58% = (1+.084/2)^2 – 1

The value of the CD with EAR equals to $19,544.40

The main difference between the CD’s are how often they are compounding. Annual returns compound once. With semiannual nominal interest rate compounding twice splits your interest into half. Benefit of semiannual is its reinvestments of the first compound interest return cash flow. Effective annual interest rate is an investment's annual rate of interest when compounding occurs more often than once a year.

d. Pacific Trust (quarterly nominal rate) investment would equal to $19560.30

EAR = 8.67% FV = $19,560.60

Bay State Savings and Loan (daily nominal rate) would equal to $19,576.15

EAR = 8.76% FV = $19,576.80

Depending on the number of compounding reflects the outcome future values and effective annual return. More compounding equates to more times the return on investment is refolded back into the asset. However, some returns may not always present the optimal return.

e. First National Bank nominal...