HOWARD UNIVERSITY

SCHOOL OF BUSINESS
FINANCIAL MODELING AND ANALYSIS (FINA 363-02)
SPRING SEMESTER, 2021

QUESTIONS FOR WRITTEN ANSWERS

Page No. Question

Chapter 1 Single Cash Flow

1 Fully list the three equivalent ways of calculating the present value of a single cash
flow.

- PV formula, PV function, PV timeline

2 State and explain the effect on the present value of a single cash flow when you
increase
the:
1. Future Value
2. Discount Rate
3. Number of Periods

- An increase of the future value will lead to an increase in the present value of a single cash
flow.
- The Present value will decrease because the discount rate interest will generate more interest
earned. The higher the discount rate the lower the present value.
- The Present value will decrease because the longer the time period till future amount is
received will lower the present value

Chapter 2 Annuity

5 Fully explain the formula used for calculating the Future Value of Each Cash Flow
in cell C17 of Figure 2.2.

The future value of a series of cash flows is equal to the sum of the future value of each
individual cash flow which is scene in figure 2.2. Future value is the sum of each of the 5
periods which is 450.97. To calculate this, you must find the future value of each period and add
them together. The formula is used to find the future value of that current period. C16 represents
the cash flow of that year. $b$5 represents the interest rate and ($g$15-c15) represents that
period of the cash flow that will earn that interest. This is done for each period in order to find
the future vale and add them together get the total for the 5 periods.

6 What is the name of the term that the Present Value is divided by to get the
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Payment in cell B28 of Figure 2.3? Explain why this formula gives the payment amount.

The term is annuity. This gives the series of equal payments. This formula gives the
payment amount because it calculates the discount rate into a monthly rate by dividing the
the discount rate by the number of periods.

6 Show the formula for calculating the Annuity Present Value (APV) using the
Annuity Future Value (AFV), Discount Rate (r), and Number of Periods (t), in Excel
notation.

AFV= -fv(r/t, Nper,pmt,0)

7 State and explain the effect on an Annuity Future Value if you:

1. Increase the payment amount.
2. Increase the interest rate per period.

- An increase in payment amount will increase the annuity Future value because it is the
total value of those annuity payment. As the payment go up, so will the AFV
- The Future value will get larger as you increase the interest rate

Chapter 3 NPV Using Constant Discounting

8 Can the constant discount rate method shown in Figure 3.1 be used to calculate NPV in
the
general case where the discount rate changes over time? Why or why not?

8 Fully explain the formula using the NPV function that is used to calculate the Net Present
Value in cell B21 of Figure 3.1.

Page No. Question

8 Is the Net Present Value of the project shown in Figure 3.1 acceptable for
investment?
Why or why not?

This is an acceptable NPV for the investment because it is greater than Zero. If the NPV is positive,
it suggests that the values of cash inflows are greater than the cash outflows showing that the
revenues are greater than the costs. The NPV shows that the project is profitable.

9 If we add the inflation rate and the real discount rate to get the nominal discount
rate, fully state what we will miss compared to the formula in cell B9 of Figure 3.2?

Adding the inflation rate and the discount rate will give an estimate of the nominal discount rate and
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not the accurate rate. The nominal rate is currently 8% as seen in Figure 3.2. If I were to add the
inflation rate and real discount it would be (3% + 4.85%) = 7.854% which is not the accurate
nominal rate because it is less than 8%

Chapter 4 NPV Using General Discounting

12 Can the general discount rate method shown in Figure 4.1 be used to calculate NPV
if the discount rate is constant over time? If yes, how?

No and this is because NPV formula uses one constant discount rate

12 In calculating the Present Value of Each Cash Flow in cell G35 of Figure 4.1, why is
the denominator (1 + Cumulative Discount Factor on date t) not raised to the power t?

This is because we used the cumulative discount factor, and it was compounded in the previous
year, so we don’t have to do it again.

12 Can Excel’s NPV function be used to calculate the Net Present Value in the general
case in Figure 4.1, where the discount rate changes over time? Why or why not?

No. this is because the NPV uses one discount rate similar to the previous question. If the discount
rate changes over time it cannot be used.

13 Fully explain why the NPV with general inflation and real discount rates in Figure
4.2 is higher than the NPV with the constant inflation and real discount rates in Figure 3.2.

This is because the general inflation is decreasing over every period and the Discount rate is lower
in 4.2. Whereas the rate in figure 3.2 are constant for the inflation and the discount rate is even
higher in figure 3.2.

Chapter 5 Loan Amortization

16 Fully describe and explain the pattern of interest and principal components over
the 30- year period of the amortized loan in the Chart in Figure 5.1.

This pattern shows that with a constant payment the principal will increase as seen in Figure 5.1.
in addition to this the interest is also falling as the principal balance falls.

17 In which year is the interest component of the payment amount of a 30-year

amortized loan at its lowest level? Why?

It is in period 1. This is where you have the highest loan balance. This is the first initial interest
payment as well, so it is lower. The rest of the balance will go towards the principal
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 component.

17 In which year is the principal component of the payment amount of a 30-year

amortized loan at its lowest level? Why?

This would be the last period. This is because this is where the loan should be at its lowest point.
The interest is lower and rest will go towards the principal.

Chapter 6 Lease Vs. Buy

20 State whether the lease payments for the car in Figure 6.1 represent an ordinary
(deferred)
annuity or annuity due and give the reason for your answer.
This represents an annuity due because an annuity due Is where payments are made at the
beginning of each period where as an ordinary annuity is one in which payments are made at the
end of a period.

20 Based on the present values in Figure 6.1, should you lease or buy the car? Why?
You should lease the car. this because the present value of 14,666 is lower than the cost of buying
the car which is 16,564

21 Fully state what is the appropriate discount rate to use for a corporate lease vs. buy
analysis.
You would need to use the after-cost of debt

Page No. Question

Chapter 6 Lease Vs. Buy (Continued)

22 Based on the lease vs. buy analysis in Figure 6.2, should the corporation lease or buy the
machine? Why?

Chapter 7 Bond Valuation

23 Explain the formula for the bond price in cell B23 of Figure 7.1.

The PV function is used to find the price of a Bond when the FV is 1000, the rate is 2.35%,
the N = 8 and the PMT is 20. This information is used to calculate the PV.

24 Why is the bond in Figure 7.1 selling at a discount below face value?

The bond is selling at a discount below the face value because the interest (2.35%) is much
higher than the coupon rate which is 2%

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 25 Fully list the four equivalent ways of calculating the bond price in Figure 7.2.

1.Yeild to Maturity
2. Bond Price Formula
3. PV Function
4.Price Function

25 State whether the EAR convention results in a higher or lower bond price than the
APR convention in Figure 7.2 and give the reason for this.

The EAR will produce a higher Bond price than the APR. this is the compounded discount
rate is lower than the simple discount.

26 Fully explain the IF statement for calculating the discount rate per period in cell B12
of Figure 7.2.

The IF statement was used to show that when the rate convention is equal to the EAR
because then the discount rate would need to be compounded but if it is not equal then jus
the APR is compounded.

25 Based on the first Chart in Figure 7.2, fully describe and explain the relationship
between bond price and yield to maturity.

Bond price and yield to maturity have an inverse relationship. If the bond price increases the
YTM will decrease. This is because as the yield increases the discounting factor of the cash flow
increases thus making the bond price fall.

25 Based on the second chart in Figure 7.2, fully describe and explain what happens to
a discount bond price as the calendar time approaches maturity.

The discount bond price decreases. This is because it is approaching maturity.

27 State and explain the effect of a lower coupon rate on a bond’s price.

The Bond price will increase with a higher coupon rate because ethe present value of the
coupon payments will increase

Chapter 10 Firm and Project Valuation

49 List the five equivalent methods for firm valuation.

52 Fully list all the broad steps for calculating the Value Added by the Firm with the
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 Adjusted Present Value method in Figure 10.3.

53 Fully list all the broad steps for calculating the Value Added by the Firm with the Free
Cash Flow to Equity method in Figure 10.4.

54 Fully list all the broad steps for calculating the Value Added by the Firm with the Free
Cash Flow to Firm method in Figure 10.5.

Page No. Question

Chapter 10 Firm and Project Valuation (Continued)

55 Fully list all the broad steps for calculating the Value Added by the Firm with the
Dividend Discount Model method in Figure 10.6.

56 Fully list all the broad steps for calculating the Value Added by Firm with the Residual
Income method in Figure 10.7.

Chapter 11 The Yield Curve

74 State whether the APR convention results in a higher or lower bond price than the
EAR
convention in Figure 11.2 and give the reason for this.
It would be a lower bond price in comparison to the ear. This is because the simple discount rate is
higher than the compounded discount rate.

74 Why is the coupon bond yield to maturity in cell B44 of Figure 11.2 close to, but not
exactly equal to, the yield to maturity of the four-year treasury strip in cell D11?
This is because it is the weighted averge of the yields of each period. This is why it is close to but
not equal the yeaild of maturity in cell d11
75 Fully explain the formula for calculating the forward rate of the Ten Year Treasury
Strip
in cell E13 of Figure 11.3.
the rate of 10 years is compounded and then it is divided by the 5 year rate. The power of
1/5 is used to represent the yearly value. This number is then subtracted by 1 to get the principal.

75 Based on the Chart in Figure 11.3, state and explain the differences between the
curvatures
of the yield to maturity curve and the forward rate curve.
The yield curve is lower and this is because this curve is a compounded average of the forward
curve.
75 Based on the Yield Curve in Figure 11.3, fully describe the relationship between yield
to
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 maturity and time to maturity, and explain it in terms of the pattern of forward rates
over the 30-year period.
Both the yield to maturity and forward rates will increase but then fall slowly after the 15 years as
the maturity increases.
75.76 Fully explain why the yield curve often has lower yields at the short end and the long
end due to market segmentation.
Because it has higher demand. This results in higher prices and a lower yield.
Chapter 12 US Yield Curve Dynamics

79 List all the static features regarding the shape, level, and curvature of the U.S. yield
curve.
 Flat line
 Direction of slope
 Curve at beginning and end of curve

79-80 List all the key dynamic properties regarding the volatility of the U.S. yield curve.
 Term to maturity
 Coupon

Chapter 14 Project NPV

91 Fully state the main advantage of forecasting the inflation rate separately for calculating
Net
Present Value in Figure 14.1-14.2.

Page No. Question

Chapter 14 Project NPV (Continued)

92 Fully explain why the Discount Rate is increasing over the years in Figure 14.1.

The Discount rate is increasing because of the increasing real cost of capital that also
compounded because of the inflation rate

93 State all the steps for calculating the Operating Cash Flows in Figure 14.2, starting with
Sales Revenue.

1. Sales revenue = unit sales x sales per unit

2. Variable cost = unit sales x variable cost per unit – sa;es
3. Total fixed costs = cash fixed costs + depreciation
4. Operating profit = total fixed costs – gross margin
5. Net profit = operating profit – taxes
6. Add depreciation to the net profit
7. This gives you the operating cash flow
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 96 Fully explain why the NPV falls from $5,822 in Figure 14.2 to $3,180 in Figure 14.4 even
though the investments in working capital in years 0 to 4 are fully recovered in years 5 to
7.
This is because thepresent value of the earlier cash flow is much greater than the present value of
later cash flows

99 Based on the Data Table in Figure 14.6, if the Unit Sales Scale Factor is 90%, what is the
maximum Date 1 Real Cost of Capital at which the project will be acceptable? Why?

It will be 15% ad this is because the NPV will be negative if the real cost of capital moves from
that

99 Based on the Data Table in Figure 14.6, if the Date 1 Real Cost of Capital is 13.0%, what
is the minimum Unit Sales Scale Factor at which the project will be acceptable? Why?

It is 90%. This is because this is where the NPV is positive

Chapter 15 Cost-Reducing Project

103 Fully explain the formula for calculating the With Investment Depreciation in cell C50 of
Figure 15.2.
We are using straight-line depreciation to calculate the investment. This is done by salvage
value subtracted from the investment and then dividing that by number of years

103 List the four primary differences between the With Investment and Without Investment
Cash Flows that are ultimately reflected in the Differential Project Cash Flows in row 62
of
Figure 15.2.
1. labor costs decreasing
2. salvage value in the fifth year
3. depreciation increasing
4. the initial invesment

103 Fully explain why the Cost-Reducing Project in Figure 15.2 has a positive Net Present
Value,
based on the present values of the four cash flow items that are different with and without
the investment.
It is positive because it is the sum of all the cash flows.

104 Explain the reason why the Project NPV is not very sensitive to With Investment Labor
Costs, as shown in Figure 15.3.
It is sensitive because labor cost are lower with the investment
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Chapter 16 Break-Even Analysis

107 Which are the two points that identify the Break-Even Unit Sales in the Chart in Figure
16.1?

108 Based on the Data Table in Figure 16.2, what is the Accounting Profit for Unit Sales of
20,000? Explain why this is the amount of Accounting Profit.

112 Based on the Data Table in Figure 16.5, describe and explain the relationship between Net
Present Value and Year 1 Unit Sales.
Page No. Question

Chapter 16 Break-Even Analysis (Continued)

112 Based on the Data Table in Figure 16.5, describe and explain the relationship between Net
Present Value and Year 2 Sales Growth Rate.

112 Based on the Data Table in Figure 16.5, is the project’s Net Present Value of $2,921 more
sensitive to the Year 1 Unit Sales or to the Year 2 Sales Growth Rate? Justify your answer
with numbers and explain why the NPV is more sensitive to the identified factor.

Chapter 17 Corporate Financial Planning

117 Fully list all the six steps of the solution strategy used to forecast the Financial Statements
in section 17.2.

118 List six major individual (not total) income statement and balance sheet items that are not
nearly constant percentages of sales in the years 2010 through 2013 in Figure 17.4.

119 Do the sales growth forecasts in cells F5:H5 of Figure 17.5 seem reasonable? Why or why
not?

125 Based on the Data Table and Chart in Figure 17.10, fully describe and explain the
relationship between External Funds Needed and Sales Growth Rate.

Chapter 18 Du Pont System of Ratio Analysis

135 List the intuitive interpretations (names) of the five components of the Return on
Equity in the Du Pont System of Ratio Analysis.

1. tax burden ratio

2. interest burden ratio
3. profit margin
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4. asset turnover
5. leverage ratio

135 State whether a firm’s tax-burden ratio will be higher or lower if it pays more
taxes relative to pretax profit and give the reason for your answer.

It will be higher. This is because the pretax net profit will be higher.

135 State whether a firm’s interest-burden ratio will be higher or lower if it pays
less
Interest relative to Earnings Before Interest and Taxes, and give the reason for
your answer.

It will be lower. This is because as the you’re the interest the profit will go down.

Chapter 19 Life-Cycle Financial Planning

137 State whether the contributions are pre-tax or post-tax, whether gains are taxed or not,
and
whether distributions are taxed or not for:
1. Traditional 401(k).
2. Roth 401(k).

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Page No. Question

Chapter 19 Life-Cycle Financial Planning (continued)

138 For which age demographic does a Traditional 401(k) investment generally result in more
retirement income than a Roth 401(k)? Why?

140 Fully explain how the following items are calculated in Year 1 in Figure 19.3:
1. Real Human Capital
2. Real Financial Capital
3. Real Total Wealth

140 Fully describe and explain the patterns of Total Wealth, Human Capital and Financial
Capital between the ages of 30 and 100 in the second chart in Figure 19.3.

Chapter 23 Black-Scholes Option Pricing

190 State the main advantage and main disadvantage of the Black-Scholes option pricing model
compared to the Binomial option pricing model.

190 Explain why the Call Price with continuous dividend in Figure 23.2 is lower than the Call
Price without any dividend in Figure 23.1.

190 In the Black-Scholes Option Pricing Chart in Figure 23.2, why is the Option Price
generally
higher than its Intrinsic Value?

190 State and explain what happens to the call option price when the standard deviation is
increased in Figure 23.2.

190 State and explain what happens to the call option price when the exercise price is increased
in Figure 23.2.

190 State and explain what happens to the call option price when the risk-free rate is increased
in Fig. 23.2.

190 State and explain what happens to the call option price when the time to maturity is
increased
in Figure 23.2.

196 Fully describe what the Chart in Fig. 23.8 shows about the patterns of implied volatilities
of calls and puts, compared to the volatility assumption of the Black-Scholes model.

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