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Computation of Present Value
| Part I | |||||||||
| A | |||||||||
| Present Value (PV)= Future Value (FV)*(1/(1+r^n) | |||||||||
| (1/(1+r^n) is the present value factor | |||||||||
| Where n= number of years | |||||||||
| r=interest rates/discount rate | |||||||||
| FV after one year=$15000 | |||||||||
| r=7% | |||||||||
| PV=15000*(1/1.07^1) | |||||||||
| Present Value today= $14018.69 | |||||||||
| When r=4% | |||||||||
| PV=15000*(1/1.04^1) | |||||||||
| Present value=$14423.08 | |||||||||
| B | |||||||||
| After one year | |||||||||
| Bank A | Bank B | ||||||||
| $6,500 | $12,600 | ||||||||
| r | 6% | 6% | |||||||
| n | 1 years | 2 years | |||||||
| Present Value of A= 6500*(1/1.06^1) | |||||||||
| PV Bank A=$6132.08 | |||||||||
| Present Value of B= 12600*(1/1.06^2) | |||||||||
| PV Bank B=$11213.96 | |||||||||
| C | |||||||||
| When r=7% | |||||||||
| Year | Income(000) | present value factor | Present Value (Income*PV factor) | ||||||
| 1 | 49000 | (1/1.07^1) | 45794392.52 | ||||||
| 2 | 61000 | (1/1.07^2) | 53279762.42 | ||||||
| 3 | 85000 | (1/1.07^3) | 69385319.54 | ||||||
| Present Value (PV)= | $168,459,474.48 | ||||||||
| When r=5% | |||||||||
| Year | Income(000) | present value factor | Present Value (Income*PV factor) | ||||||
| 1 | 49000 | (1/1.05^1) | 46666666.67 | ||||||
| 2 | 61000 | (1/1.05^2) | 55328798.19 | ||||||
| 3 | 85000 | (1/1.05^3) | 73426195.88 | ||||||
| Present Value (PV)= | $175,421,660.74 | ||||||||
| When r=3% | |||||||||
| Year | Income(000) | present value factor | Present Value (Income*PV factor) | ||||||
| 1 | 49000 | (1/1.03^1) | 47572815.53 | ||||||
| 2 | 61000 | (1/1.03^2) | 57498350.46 | ||||||
| 3 | 85000 | (1/1.03^3) | 77787041.05 | ||||||
| Present Value (PV)= | $182,858,207.04 | ||||||||
Conclusion
From the above computations of present value, it is evident that present value and interest rates (r) are moving in different directions that is the higher the discount rate the lower the present value and the lower the discount rate the higher the present value.
part II
Financial Risks
Risk is the probability of losing something that has potential value. The loss is caused by vulnerabilities that maybe internal or external. Financial risk is defined as the possibility of investors losing money they have invested in a certain company. The risk is due to a company having debts that take up the company’s revenues to pay the debt. Investors stand to lose their money when the cash flow of the company is inadequate and does not meet the company’s financial obligations. In cases where the government or corporation defaults to pay bonds the bondholders stand to lose their money. Interest rates increase the possibility of incurring financial risks. The interest rates increase the cost of operating a business hence high expenses and low income return. Interest rates that are adjustable increases the rate of fluctuation providing an economy that is unstable (Saunders 2010)
Interstate Travel Center is a travel center that will provide convenience stores, a restaurant, Gas Island and amenities that cater for the demands in trucking business. The startup cost to facilitate the construction of the center is estimated to be $2.75 million. The two owners Janet and Steve will provide $250,000 while the remaining $2.5 million they will borrow inform of a loan. The Interstate Travel Center stands to suffer the highest risk. The centers start-up cost is very high which entails that they have to borrow funds. Borrowing indicates that the business will depend on debts which leads to rise of financial risks.
Due to the start-up nature of the business they are not liable to any discount rate from the financial provider hence high rates for evaluation. The trucking business is unpredictable and there are no estimated returns that will fully repay the debts. Defaults are likely to occur when the center experiences cash deficiency or high budgets cost that exceed the center’s income. Increase in the interest rate of the borrowed money will put the center at a financial risk of paying more money than expected. Investors will lose their money due to increased debt payment as debts have to be paid first before investors. High debts may lead to the collapsing of the center (Hallikas, 2004)
RJ Wagner & Associates Realty, Inc. is a corporation that has a stockholder and one owner who is Regina. The owner is licensed to buy and sell assets in place of other and will be providing funds for the firm. The firm will offer real estate services in Texas. The firm may face low risks due to the presence of the owner who will finance the start-up of firm. Investors face minimal risk as there are no debts to pay. Having a credible sponsor will attract many investors as financial resources to run the firm are available.
Also, the good reputation of the sponsor will give investors the assurance of security on their money hence gaining high returns from their investments. Involving licensed real estate agents will provide quality services minimizes on unproportioned decisions. Availability of a marketing plan will enable the firm to identify risks associated to their operations and mitigate them. Change in the economy is the likely factor to cause financial risks decreasing the rate of returns.
Ice Dreams Company will be selling shave ice and other soft drinks in California. Construction of the company will be on a private owned property. This business is a sole proprietor business owned by Ofelia R. Arellano. Ice Dreams will be a bit risker than the real estate business but incur low investment cost. The start-up cost will be financed by a short-term loan. The short-term loan involves small amount of money that will be paid within a short period. Financial risks are likely to face the company if there is inadequacy of cash flow.
References
Hallikas, J., Karvonen, I., Pulkkinen, U., Virolainen, V. M., & Tuominen, M. (2004). Risk
management processes in supplier networks. International Journal of Production Economics, 90(1), 47-58.
Sarasvathy, D. K., Simon, H. A., & Lave, L. (1998). Perceiving and managing business risks: Differences between entrepreneurs and bankers. Journal of economic behavior & organization, 33(2), 207-225.
Saunders, A., & Allen, L. (2010). Credit risk management in and out of the financial crisis: new approaches to value at risk and other paradigms (Vol. 528). John Wiley & Sons.
Math Index. (2010, May 04). About: Math is fun. Retrieved from Math is fun website: https://www.mathsisfun.com/money/present-value.html
