Acuña, Renzimae BM4A December 15, 2012

Balila, Jennilyn Investment Management

Bautista, Bernadette
Punzalan, Patricia
Relampagos, Mary Jane
Case: Coate’s Decision
A. Assuming that investments A and B are equally risk and using the 12% discount rate, apply the
present-value technique to assess the acceptability of each investment and to determine the
preferred investment. Explain your findings.
Investment A has $ 1,169.39 total present value of benefits which exceeds the $1,150
cost of investment since it has exceeded its cost, the group can say that Investment A is
acceptable. Based on the rule that if the present value of the benefits exceeds the cost, it will be
an acceptable investment because you would earn a rate of return greater than 12%, which is
the discount rate. Likewise, Investment B which has $1,115.48 total present value of benefits
has also exceeded its cost, so the group can say that Investment B is also an acceptable one
because you would also earn a rate of return greater than the discount rate.

B. Recognizing that Investment B is more risky than Investment A, reassess the 2 alternatives,
adding 4% risk premium to the 12% discount rate for Investment A and therefore applying a 16%
discount rate to investment B. Compare your findings relative to acceptability and preference to
those found for question a.
Compared to the group’s findings in question A, when the group added 4% risk premium
to the 12% discount rate for Investment A and applying a 16% discount rate to Investment B,
both investments were found to be acceptable. Investment A has $951.51 total present value of
benefits that is less than $1,050 which is its cost. Since it is less than its cost, the group
concludes that Investment A is not acceptable. According to the rule that if the present value of
benefits is less than the cost, it would not be an acceptable investment because you would earn
a rate of return less than 16%, which is the discount rate. Similarly, Investment B’s total present
value of benefits ($931.95) is also less than its cost, so the group can say that Investment B is
also not acceptable investment because you would also earn a rate of return less than the
discount rate.
C. From your findings in questions A and B, indicate whether the yield for investment A is above or
below 12% and whether that for Investment B is above or below 16%. Explain.
From our findings in question A & B, if the discount rate of Investment A is at 12%, its
price is $1,169.39. That’s above the investment’s current price which is $1,050.00, so the yield
for Investment A is above 12%. On the other hand, if the discount rate of Investment B is at 16%,
its price is $931.95. That’s below the investment’s current price, so the yield for Investment B is
below 16%. Therefore, we need to keep searching for the exact discount rate at which the
investment’s cash flows equal $1,050.00.

D. Use the present-value technique to estimate the yield on each investment. Compare your findings
and contrast them with your response to question C.
Investment A has a yield of 5%. That’s below the discount rate for Investment A which is
12%, so there is a difference between the group’s response to question C regarding Investment
A, because the group answered in question C that since its price is greater than its cost, the yield
for Investment A is above 12%. But when the group computed for its yield, it has resulted that
the yield for Investment A is below the discount rate (12%).For Investment B, it has a yield of
13%.That’s below the discount rate for Investment B which is 16%, and so the group’s response
to question C regarding Investment B are the same.

E. From the information given, which, if either, of the two investments would you recommend that
Dave make? Explain your answer.
From the information given, the group recommends Dave to invest in Investment A
since according to the facts given that the appropriate discount rate for a relatively certain
investment was 12% and Dave was more comfortable in taking Investment A rather than B.
Therefore, Investment A would be a better choice since at 12% discount rate it has a greater
value which is $1,169.39 than Investment B with $1,115.48.

F. Indicate to Dave how much money the extra $50 will have grown to by the end of 2018, assuming
he makes no withdrawals from the savings account.
Assuming that Dave makes no withdrawals from the savings account; his extra money
which is $50 deposited starting 2011 at 5% interest rate compounded annually will have grown
to $73.87 by the end of 2018.