mgt411 assignment soloution

Semester “Spring 2011”

“Money & Banking (MGT411)”

Question # 1: (Marks: 08)

Mr Ahmad, the director of Supreme Textile Limited, is deciding to install a new plant for fiber spinning. Mr Ahmad has a choice to install a plant that will transform the raw cotton into yarn, project costs Rs 2,000,000/- and will generate revenue of Rs 550,000 for the next five years.

Assume the company’s discount rate/cost of borrowing is 9%.

Calculate IRR for above project by using trial and error method.

The IRR is calculated by a trial and error process

1. The NPV is calculated using discount rate r.

2. If the NPV is close to zero then r is the IRR.

3. If the NPV is positive r is increased.

4. If the NPV is negative r is decreased.

First we calculate the NPV using the discount rate which is 9% given in question

NPV = CF0 + CF1/ (1+r) + CF2/ (1+r) 2 + CF3/ (1+r) 3 +CF4/ (1+r) 4 + CF5/ (1+r) 5

0= -2000000+550000/ (1.09) +550000(1.09)2+550000(1.09) 3 +550000(1.09)4 +550000(1.09)5

0= -2000000+504587+462924+424700+389633+357462

0= 139306

It is Positive so we increased our r 9% to 12% and use 12% instead of 9%

NPV = CF0 + CF1/(1+r) + CF2/(1+r)2 + CF3/(1+r)3 +CF4/(1+r)4 + CF5/(1+r)5

0= -2000000+550000/ (1.12) +550000(1.12)2+550000(1.12) 3 +550000(1.12)4 +550000(1.12)5

0= -2000000+491071+438456+391479+349534+312085

0= -17375

Now it is Negative so we decrease rate. Let’s try 11.648

NPV = CF0 + CF1/(1+r) + CF2/(1+r)2 + CF3/(1+r)3 +CF4/(1+r)4 + CF5/(1+r)5

0= -2000000+550000/ (1.11648) +550000(1.11648)2+550000(1.11648) 3 +550000(1.11648)4 +550000(1.648)5

0= -2000000+492620+441226+395193+353964+317035

0= -2000000+2000038

This rate is NEARLY suitable at IRR 11.648

So IRR is 11.648

Question # 2: (Marks: 08)

Find the present value of a coupon bond, having face value Rs 1000/-, coupon rate of 12.5% per annum with 7 years maturity. During current economic conditions the investor’s required rate of return is 5%.

Requirement: Calculate Present value of Coupon Bond.

PV of Coupon Bond =C [(1-(1/1+i) n)/i] +m/(1+i)n

C= Coupon payment

I= Rate of return = 5%

M= Face value =1000

N= periods = 7 years

C= = Coupon Rate* Face value

= 12.5%*1000=125

Now putting value in Formula

PV of Coupon Bond =125[(1-(1/1+.05)7)/.05]+1000/(1+.05)7

PV of Coupon Bond =125[(1-(1/1.4071)/.05]+1000/1.4071

PV of Coupon Bond =125[(1-.7107)/.05] +711

PV of Coupon Bond =125[0.2893/.05] +711

PV of Coupon Bond =125[5.786]+711

PV of Coupon Bond = 723+711

PV of Coupon Bond =1434.25

Question # 3 (Marks: 04)

Prevailing interest rate in the country is 14%, if expected inflation rate is 11% calculate the real

interest rate by using fisher equation.

R=i+𝜋e

R=14%-11%

R=3%