Managerial Finance Assignment 4

Unless otherwise stated, answer in complete sentences, and be sure to use correct English, spelling, and grammar.

Respond to the items below.

Part A:Given the following cash inflow at the end of each year, what is the future value of this cash flow at 6%, 9%, and 15% interest rates at the end of the seventh year?

Year 1                             $15,000

Year 2                             $20,000

Year 3                             $30,000

Years 4 through 6                    $0

Year 7                          $150,000

Part B: County Ranch Insurance Company wants to offer a guaranteed annuity in units of $500, payable at the end of each year for 25 years. The company has a strong investment record and can consistently earn 7% on its investments after taxes. If the company wants to make 1% on this contract, what price should it set on it? Use 6% as the discount rate. Assume that it is an ordinary annuity and that the price is the same as present value.

Part C: A local government is about to run a lottery but doesnot want to be involved in the payoff if a winner picks an annuity payoff. The government contracts with a trust to pay the lump-sum payout to the trust and have the trust (probably a local bank) pay the annual payments. The first winner of the lottery chooses the annuity and will receive $150,000 a year for the next 25 years. The local government will give the trust $2,000,000 to pay for this annuity. What investment rate must the trust earn to break even on this arrangement?

Part D: Your dreams of becoming rich have just come true. You have won the State of Tranquility’s Lottery. The State offers you two payment plans for the $5,000,000 advertised jackpot. You can take annual payments of $250,000 for the next 20 years or $2,867,480 today.

a.     If your investment rate over the next 20 years is 8%, which payoff will you choose?

b.     If your investment rate over the next 20 years is 5%, which payoff will you choose?

c.     At what investment rate will the annuity stream of $250,000 be the same as the lump sum payment of $2,867,480?