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Chapter 6: Question 3BE (page 302)
Candice Willis will invest \(30,000 today. She needs \)150,000 in 21 years. What annual interest rate must she earn?
The annual interest rate that she must earn is 5%.
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Leon Tyler’s VISA balance is \(793.15. He may pay it off in 12 equal end-of-month payments of \)75 each. What interest rate is Leon paying?
Chris Spear invested $15,000 today in a fund that earns 8% compounded annually. To what amount will the investment grow in 3 years? To what amount would the investment grow in 3 years if the fund earns 8% annual interest compounded semiannually?
(Analysis of Alternatives) Julia Baker died, leaving to her husband Brent an insurance policy contract that provides that the beneficiary (Brent) can choose any one of the following four options. (a) \(55,000 immediate cash. (b) \)4,000 every 3 months payable at the end of each quarter for 5 years. (c) \(18,000 immediate cash and \)1,800 every 3 months for 10 years, payable at the beginning of each 3-month period. (d) \(4,000 every 3 months for 3 years and \)1,500 each quarter for the following 25 quarters, all payments payable at the end of each quarter.
Instructions If money is worth 2½% per quarter, compounded quarterly, which option would you recommend that Brent exercise?
Ellison Inc., a manufacturer of steel school lockers, plans to purchase a new punch press for use in its manufacturing process. After contacting the appropriate vendors, the purchasing department received differing terms and options from each vendor. The Engineering Department has determined that each vendor’s punch press is substantially identical and each has a useful life of 20 years. In addition, Engineering has estimated that required year-end maintenance costs will be \(1,000 per year for the first 5 years, \)2,000 per year for the next 10 years, and \(3,000 per year for the last 5 years. Following is each vendor’s sales package.
Vendor A: \)55,000 cash at time of delivery and 10 year-end payments of \(18,000 each. Vendor A offers all its customers the right to purchase at the time of sale a separate 20-year maintenance service contract, under which Vendor A will perform all year-end maintenance at a one-time initial cost of \)10,000.
Vendor B: Forty semiannual payments of \(9,500 each, with the first installment due upon delivery. Vendor B will perform all year-end maintenance for the next 20 years at no extra charge.
Vendor C: Full cash price of \)150,000 will be due upon delivery.
Instructions Assuming that both Vendors A and B will be able to perform the required year-end maintenance, Ellison’s cost of funds is 10%, and the machine will be purchased on January 1, from which vendor should the press be purchased?
Danny’s Lawn Equipment sells high-quality lawn mowers and offers a 3-year warranty on all new lawn mowers sold. In 2017, Danny sold \(300,000 of new specialty mowers for golf greens for which Danny’s service department does not have the equipment to do the service. Danny has entered into an agreement with Mower Mavens to provide all warranty service on the special mowers sold in 2017. Danny wishes to measure the fair value of the agreement to determine the warranty liability for sales made in 2017. The controller for Danny’s Lawn Equipment estimates the following expected warranty cash outflows associated with the mowers sold in 2017.
Cash Flow Probability Year Estimate Assessment 2018 \)2,500 20% 4,000 60% 5,000 20% 2019 \(3,000 30% 5,000 50% 6,000 20% 2020 \)4,000 30% 6,000 40% 7,000 30%
Instructions Using expected cash flow and present value techniques determine the value of the warranty liability for the 2017 sales. Use an annual discount rate of 5%. Assume all cash flows occur at the end of the year.
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