Note: This Assignment Is In Two Parts, One Is Quantitative P

Notethis Assignment Is In Two Parts One Is Quantitative Problem The

This assignment is in two parts, one is a quantitative problem, the other a short paper. You need to turn in both Part I and Part II to receive full credit for this assignment. Part I involves calculating present values based on different future values and discount rates, including multiple cash flow streams. Part II requires analyzing three sample business plans to assess their relative risks based on intuition regarding the potential riskiness of each project, considering aspects such as certainty, industry stability, and market factors. The goal is to demonstrate understanding of present value calculations and risk assessment in business plans without needing detailed financial analysis.

Paper For Above instruction

Part I: Quantitative Calculation of Present Value and Comparative Analysis

In finance, the concept of present value (PV) is fundamental as it allows investors and managers to determine the current worth of a stream of future cash flows given a certain discount rate, which reflects the time value of money and risk. Accurately calculating PV helps in making informed investment decisions by evaluating whether future cash flows justify current costs or investments.

Part I begins with three core calculations. First, determining the PV of a bank account expected to be worth $15,000 in one year, with two different discount rates (7% and 4%). The PV at any rate is calculated with the formula PV = FV / (1 + r)^n, where FV is the future value, r is the discount rate, and n is the number of periods. For a one-year period, the calculations are straightforward: PV = $15,000 / (1 + r).

At a 7% discount rate, the PV is $15,000 / 1.07 ≈ $14,018.69. At 4%, the PV is $15,000 / 1.04 ≈ $14,423.08. These figures illustrate how a lower discount rate increases the present value, reflecting less discounting of future cash flows.

Secondly, with two accounts earning 6% interest, one worth $6,500 after one year and the other worth $12,600 after two years, the PV calculations involve discounting each future value back to today. For Account A, PV = $6,500 / (1.06)^1 ≈ $6,132.08. For Account B, PV = $12,600 / (1.06)^2 ≈ $11,220.56. This showcases how the timing influences PV; cash flows received sooner are worth more today.

The third calculation involves a projected income stream from a gold mine over three years with specified incomes, discounted at rates of 7%, 5%, and 3%. The PV of each year's income is computed similarly, then summed to get the total PV of the gold mine income stream at each rate. Specifically, for each year, PV = income / (1 + r)^n, and the total PV is the sum of these discounted cash flows.

At a 7% discount rate, the PV calculations are:

• Year 1: $49,000,000 / (1.07)^1 ≈ $45,794,392.52
• Year 2: $61,000,000 / (1.07)^2 ≈ $53,344,167.99
• Year 3: $85,000,000 / (1.07)^3 ≈ $66,258,679.70

The total present value at 7% is approximately $165,397,240.21. Repeating the calculations at 5% and 3% yields higher PVs because lower rates reduce discounting. The PV at 5% sums approximately to $171,917,413, and at 3%, it is about $177,253,993.

These calculations reveal how decreasing the discount rate increases the present value, reflecting reduced risk or time preference, and emphasizing the importance of discount rate selection when valuing future income streams. The significant difference among the PVs highlights that the lower the discount rate, the more valuable the future cash flows, which is critical when assessing projects and investments under varying risk conditions.

Analysis of Risk and Discount Rates

The variation in PVs across different discount rates underscores the impact of perceived risk and time preference. A lower discount rate implies lower risk and greater certainty, thus higher present values. Conversely, higher discount rates are used for riskier projects, diminishing present valuation. For example, a stable, steady industry might warrant a lower discount rate, while a volatile or uncertain market requires a higher rate, reflecting increased risk and potential for income fluctuation.

In summary, understanding how discount rates influence present value calculations is essential in financial decision-making. Lower discount rates favor more optimistic valuations, often associated with safer, more stable investments. Higher rates correspond to riskier investments, where future cash flows are viewed with skepticism, leading to lower present valuations. These principles are widely applied in investment analysis, project valuation, and strategic planning to balance risk and reward.

Evaluation of Business Plans and Risk Assessment

Part II involves evaluating three sample business plans: Ice Dreams, R J Wagner & Associates, Realty Interstate Travel Center. Without detailed financials, the assessment relies on intuition about industry stability, market risk, and operational uncertainties.

Ice Dreams, a business likely involved in frozen desserts or ice-related products, would typically operate in a consumer goods sector that may be relatively stable but sensitive to seasonality and economic cycles. Its risk profile might be moderate, especially if established and with a loyal customer base.

R J Wagner & Associates, potentially a professional services firm, might face lower operational risk given the nature of consulting or advisory work. Its risk depends on client diversification, industry reliance, and reputation stability. Generally, service firms can have lower risk if client sources are broad and market conditions are stable.

The Interstate Travel Center, a transportation or logistics hub catering to travelers, may have a higher risk profile due to dependency on transportation trends, fuel prices, seasonal fluctuations, and economic conditions affecting travel behavior. Industry volatility, operational costs, and location-specific factors could elevate its risk compared to other businesses.

From a risk perspective, the travel center is likely to be evaluated with the highest discount rate, reflecting higher uncertainty and variability in cash flows. The professional services firm would probably be assessed with a lower discount rate, considering its potentially stable income streams and less exposure to market volatility. Ice Dreams would fall somewhere in between, depending on specific market factors and operational risks.

In conclusion, risk assessment based on intuition suggests that the travel center faces the greatest uncertainty, necessitating a higher discount rate in valuation models. Conversely, the professional services firm enjoys a more stable outlook, warranting a lower discount rate, with the consumer-focused Ice Dreams occupying an intermediate risk position. These judgments align with general industry risk profiles and the nature of their respective revenue streams, emphasizing the importance of considering qualitative factors alongside quantitative analysis when evaluating investment risks.

References

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