Solutions Guide: This is meant as a solutions guide.

Please try reworking the questions and reword the answers to essay type parts so as to guarantee that your answer is an original. Do not submit as your own. 6 (Present value of an annuity) what is the present value of the following annuities? a. $2,500 a year for 10 years discounted back to the present at 7 percent b. $70 a year for 3 years discounted back to the present at 3 percent c. $280 a year for 7 years discounted back to the present at 6 percent d. $500 a year for 10 years discounted back to the present at 10 percent

(a)

PV

n PMT t =1

(1 + i) t 1 (1 + 0.07) t 1

PV PV PV (b) PV

= = = =

10 $2,500 t =1

$2,500 (7.024) $17,560

n PMT t =1 (1 + i) t 1

PV PV PV (c) PV

= = = =

3 1 $70 (1 + 0.03) t t =1 $70 (2.829) $198.03

n PMT t =1 7 $280 t =1 (1 + i) t 1

PV PV PV (d) PV

= = = =

(1 + 0.06) t 1

$280 (5.582) $1,562.96

n PMT t =1 (1 + i) t 1

PV PV PV

= = =

10 $500 t =1

(1 + 0.1) 1
t

$500 (6.145) $3,072.50

6-4 (Required rate of return using CAPM) a. Compute a fair rate of return for Intel common stock, which has a 1.2 beta. The risk free rate is 6 percent, and the market portfolio (NYSE stocks) has an expected return of 16 percent. b. Why is the rate you computed a fair rate? (a) = + Beta = 6 % + 1.2 (16% - 6%) = 18% (b) The 18 percent "fair rate" compensates the investor for the time value of money and for assuming risk. However, only nondiversifiable risk is being considered, which is appropriate.

7-8. Explain the three factors that determine the intrinsic, or economic, value of an asset. The first two factors affecting asset value (the asset characteristics) are the asset's expected cash flows and the riskiness of these cash flows. The third consideration is the investor's required rate of return. The required rate of return reflects the investor's risk-return preference.