MNGT604: Corporate Governance and Financial Management

Lent term 2022

Practice problems Day 1

1. Which one of the following comparisons between debt and equity is correct?

a. Both creditors and stockholders are owners of the firm.

b. Both creditors and stockholders vote to elect the board of directors.

c. Stockholders are the owners of the firm but the creditors vote on all major
decisions.

d. The creditors have first claim to the firm’s assets but the stockholders are the
owners.

e. Since the stockholders are the firm’s owners, they have a higher claim to the
firm’s assets than do the creditors.

d. The creditors have first claim to the firm’s assets but the
stockholders are the owners.

2. For each of the following compute the missing value

Present Value Years Interest Rate Future Value

£81550 17 12%

14 22% £886073

£221 4 £307

£250 4% £1105
 Present Value Years Interest Rate Future Value

£81550 17 12% FV = £81,550(1.12)17

= £559,925.63
PV = £886,073 / (1.22)14
= £54,756.02 14 22% £886073

FV = £307 = £221(1 + r)4;

£221 4 r = (£307 / £221)1/4 – 1 £307
= 8.56%
FV = £1,105 = £250 (1.04)t;
£250 t = ln(£1,105 / £250) / ln 1.04 4% £1105
= 37.89 yrs

3. You won £ 32,000 in ‘Who Wants to be a Millionaire’ and decided to save enough
so that you are a millionaire when you retire in 40 years. If the current interest rate is
12%, what portion of your prize money will be left with you after you save the
required amount? What if the interest rate you get for your savings is 6%?

In order to get £1Million after 40 years, one needs to invest

PV = £1,000,000 / (1.12)40 = £10,746.80
One is left with £21,253.20. Almost enough for one’s new Jag.

If the rate of interest is 6% instead of 12 %, one needs to invest:

PV = £1,000,000 / (1.06) 40 = £97222.19!!!

4. You have an investment opportunity in Japan. It requires an investment of $1

million today and will produce a cash flow of ¥114 million in 1 year with no risk.
Suppose the risk free interest rate in the United States is 2%, the risk free interest
rate in Japan is 2%, and the current competitive exchange rate is ¥110 per $1. What
is the NPV of the investment? Is it a good opportunity?

Cost = $1 million today

5. Joe just inherited the family business, and having no desire to run the family
business, he has decided to sell it to an entrepreneur. In exchange for the family
business, Joe has been offered an immediate payment of $100,000. Joe will also
receive payments of $50,000 in one year, $50,000 in two years, and $75,000 in three
years. The current market rate of interest for Joe is 6%.
A second entrepreneur approaches Joe and offers him $250,000 today for the
business. Should Joe accept the new entrepreneur's offer or stick with the original
offer of $100,000 and the series of payments over three years? Why?

PV of the original offer = $100,000 + $50,000 / (1.06) 1 + $50,000 / (1.06)2 + $75,000 /

(1.06)3 = $254,641

Joe should take the original offer of $100,000 + payments.

6. You have been told that you need £21,600 today in order to have £100,000
when you retire 42 years from now. What rate of interest was used in the present
value computation? Assume interest is compounded annually.

Future Value=£ 100,000 ; Present Value=£ 21,600 ; t=42

Formula: FV =PV × ( 1+r )t

Solve for r :

42
100,000=21,600× ( 1+ r )

( )
1 /42
100,000
r= −1=0.0372(3.72 %)
21,600

7. You just won £25,000 and deposited your winnings into an account that pays
6.2% interest, compounded annually. How long will you have to wait until your
winnings are worth £50,000?

t
50,000=25,000× ( 1+ 0.062 )

50,000 t
=( 1+ 0.062 )
25,000
Take logs of both sides (can also use a financial calculator):

ln 2=t × ln1.062

0.6931
t= =11.52 years
0.06015

8. Suppose two athletes sign 10-year contracts for £20 million. In one case the
20m will be paid in 10 equal instalments. In the other case the 20 m will be still be
paid in 10 instalments, but the instalments will increase 5% every year. Who got the
better deal?

Draw the time line:

1.59 + 1.67 + 1.75 + 1.84 + 1.93 + 2.03 + 2.13 + 2.24 + 2.35 + 2.47 = 20 (no need to
do this step)
The athlete with equal payments got the better deal because the other one got the
higher cash flows towards the end of contract period and those cash should be
discounted more heavily.

9. The Bigelow Co. is considering the purchase of some new equipment. The quote
consists of a monthly payment of $3,660 for 36 months at 7.25 percent interest. What
is the purchase price of the equipment?

10. What is the present value of $500 received at the end of each year for six years
starting in year 5 and ending in year 10 if the discount rate is 8 percent?
11. A company borrow £30,000 3-year loan at 10% from a bank. What is the
amortization schedule for the loan if the company writes a contract to pay ‘fixed
principal’ every year?

The principal repaid every year =

Year Beg. Periodic Interest Principal End.

Balance Payment Paid Paid Balance

Total

What if it chose to make fixed payments?

• Payment every year =

Year Beg. Periodic Interest Principal End.

Balance Payment Paid Paid Balance

1
 2

Total

Fixed principal
The principal repaid every year = 10,000

Periodic
Year Beg. Balance Interest Paid Principal Paid End. Balance
Payment

1 30,000 13,000 3,000 10,000 20,000

2 20,000 12,000 2,000 10,000 10,000

3 10,000 11,000 1,000 10,000 0

Total 36,000 6,000 30,000

Fixed payment

Payment every year = £ 12063.44

Periodic
Year Beg. Balance Interest Paid Principal Paid End. Balance
Payment

1 30,000 13,000 3,000 10,000 20,000

2 20,000 12,000 2,000 10,000 10,000

3 10,000 11,000 1,000 10,000 0

Total 36,000 6,000 30,000