1. You just paid $348,000 for a policy that will pay you and your heirs $12,000
ID: 2742843 • Letter: 1
Question
1. You just paid $348,000 for a policy that will pay you and your heirs $12,000 a year forever. What rate of return are you earning on this policy?
2. Marko, Inc. is considering the purchase of ABC Co. Marko believes that ABC Co. can generate cash flows of $6,500, $11,500, and $17,700 over the next three years, respectively. After that time, they feel the business will be worthless. Marko has determined that a rate of return of 12 percent is applicable to this potential purchase. What is Marko willing to pay today to buy ABC Co.?
3. George Jefferson established a trust fund that provides $179,500 in scholarships each year for worthy students. The trust fund earns a 4 percent rate of return. How much money did Mr. Jefferson contribute to the fund assuming that only the interest income is distributed?
4. Your credit card company charges you 1.05 percent per month. What is the annual percentage rate on your account
5. Mr. Miser loans money at an annual rate of 22 percent. Interest is compounded daily. What is the actual rate Mr. Miser is charging on his loans?
1. You just paid $348,000 for a policy that will pay you and your heirs $12,000 a year forever. What rate of return are you earning on this policy?
2. Marko, Inc. is considering the purchase of ABC Co. Marko believes that ABC Co. can generate cash flows of $6,500, $11,500, and $17,700 over the next three years, respectively. After that time, they feel the business will be worthless. Marko has determined that a rate of return of 12 percent is applicable to this potential purchase. What is Marko willing to pay today to buy ABC Co.?
3. George Jefferson established a trust fund that provides $179,500 in scholarships each year for worthy students. The trust fund earns a 4 percent rate of return. How much money did Mr. Jefferson contribute to the fund assuming that only the interest income is distributed?
4. Your credit card company charges you 1.05 percent per month. What is the annual percentage rate on your account
5. Mr. Miser loans money at an annual rate of 22 percent. Interest is compounded daily. What is the actual rate Mr. Miser is charging on his loans?
Explanation / Answer
Solution for Question 1
Value of investment = $348,000
Annual perpetuity payment receive = $12,000
Annual interest rate = $12,000 / $348,000
= 3.45%
Hence, Annual interest rate on insurance payment is 3.45%.
Solution for Question 2
Future cash flow in next three year is $6,500, 11,500, and $17,700.
Require rate of return = 12%
Maximum amount Marko willing to pay is calculated below:
Total Payment = [$6,500 / (1 + 12%) ^1] + [$11,500 / (1 + 12%) ^2] + [$17,700 / (1 + 12%) ^3]
= ($6,500 / 1.12) + ($11,500 / 1.25) + [$17,700 / 1.40)
= $5,803.57 + $9,167.73 + $12,598.51
= $27,569.81
So maximum amount Marko can pay is $27,569.81.
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