Quiz 3 and quiz 3 question

1 , Bob Terwilliger received $ I 2,3 45 for his services as financial consultant to the mayor's office of his

hometown of Spiingfield. Bob says that his consulting work was his civic dufy and that he should not

receive any compensation. So, hehas invested his paycheck into an account paying 3.98% annual interest

and left thi account in his will to the city of Springfield on the condition that the city could not collect any

money from the account for 200 y*u.s. i-lo* much money will the city receive from Bob's generosity in

200 years?

2. Over the past few years, Microsoft founder Bill Gates' net worth has fluctuated between $20 and $130

billion. hr early 2006, it was about $26 billion-after he reduced his stake in Microsoft from2l percent to

around l4 percent by moving billions into his charitable foundation. Let's see what Bill Gates can do with

his money in the following problerns.

a. Manhattan's native tribe sold Manhattan Island to Peter Minuit for $24 in 1626. Now, 384

years later in 2010, Bill Gates wants to buy the island from the "current natives." How much would

Bill have to pay for Manhattan if the "current natives" want a 6 percent annual return on the original

$24 purchase price?

b. Bill Gates decides to pass on Manlrattan and instead plans to buy the city of Seattle, Washington,

for $50 billion in 10 years. How much would Bill have to invest today at l0 percent compounded

annually in order to purchase Seattle in l0 years?

c. Now assume Bill Gates only wants to invest half his net worth today, $13 billion, in order to buy

Seattle for $50 billion in 10 years, What annualrate of return would he have to earn in order to

complete liis purchase in 10 years?

d. Instead of buying and running large cities, Bill Gates is considering quitting the rigors of the

business world and retiring to work on his golf garne. To fund his retirement, Billwould invest

his $20 billion fortune i1safe investments with an expected annualrate of return of 7 percent' He

also wants to make 40 equal annual withdrawals from this retirement fund beginning a year from

today, running his retirement fund to $0 at the erid of 40 years. How much can his annual

withdrawal be in this case?

3. Peterson Trucking is contemplating the acquisition of Armour Transport, a competing trucking firm,

and estimates that durilg the next year Armour Transport's flows from the acquisition will vary

depending upon the state of the looal economy:

Scenario I Scenario II Scenario III

(State of the Economy)

Probability

(Recession) Q''iormal) (Expansion)

30% 50% 20%

2.

J.

Cash flow for each Scenario $(50,000) $150,000 $250,000

L Calculate the expectecl cash flow for next year using the estimates provided above'

Assume the probability of a recession increases to 40Y0, the normal scenario probability remains

at S1Vo,ancl the expansion probability drops to only l0%. What is your estimate of the expected

cash flow for next year under this circumstance?

Your analysis of the acquisition suggests that for the investment to have at least azero NPV, it

must produce an annual expected cash flow of$100,000 per year over the next five years'

Assuming that the cash flow you estimated in part a is the expected cash flow for years one

through five, what would you like to know about the project cash flows to make you more

comfortable with the idea that you can indeed generate the requisite $ 1 00,000 per year casl, flow?