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ECON6033 Corporate Finance Assignment 1 Solution

This document provides solutions to questions on a corporate finance assignment. Question 1 calculates the monthly installment for an original mortgage of $7 million at 5% interest over 120 months as $48,454. It then finds the remaining balance after 26 payments as $3,978,626. Refinancing at a lower rate of 4.5% results in a cash inflow of $2,321,374. Question 2 calculates the present value of a 5-year annuity, finds the change when the interest rate increases, and shows the change can be approximated using duration.

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380 views2 pages

ECON6033 Corporate Finance Assignment 1 Solution

This document provides solutions to questions on a corporate finance assignment. Question 1 calculates the monthly installment for an original mortgage of $7 million at 5% interest over 120 months as $48,454. It then finds the remaining balance after 26 payments as $3,978,626. Refinancing at a lower rate of 4.5% results in a cash inflow of $2,321,374. Question 2 calculates the present value of a 5-year annuity, finds the change when the interest rate increases, and shows the change can be approximated using duration.

Uploaded by

Haiyan LIU
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© © All Rights Reserved
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ECON6033 Corporate Finance

Assignment 1 Solution

Question 1

(a)
𝐶 1
𝑃𝑉 = (1 − )
𝑟 (1 + 𝑟)𝑛𝑇

𝐶 1
7,000,000 × 0.7 = (1 − )
5% − 1.5% 5% − 1.5% 120
12 (1 + )
12
𝐶 = $48454

The monthly installment of the original mortgage is $48454.

(b)

Until Mar 1st 2016, Mr. Wong has paid the installment for 26 months.

𝐶 1
𝑅𝑒𝑚𝑎𝑖𝑛𝑖𝑛𝑔 𝐵𝑎𝑙𝑎𝑛𝑐𝑒 = (1 − )
𝑟 (1 + 𝑟)𝑛𝑇

48454 1
= (1 − )
5% − 1.5% 5% − 1.5% 120−26
12 (1 + )
12
= $3,978,626

By replacing the old mortgage with the new mortgage, Mr. Wong borrowed $9,000,000 and
repaid the old loan and therefore he will have a cash inflow of $(9,000,000*0.7-3,978,626)=
$2,321,374.

(c)

𝐶 1
9,000,000 × 0.7 = (1 − )
5% − 2.5% 5% − 2.5% 120
12 (1 + )
12
𝐶 = $59390

This study source was downloaded by 100000839278794 from CourseHero.com on 12-18-2021 08:21:59 GMT -06:00

https://www.coursehero.com/file/30487755/ECON6033-A1-Solutionpdf/
Question 2

(a)
1,500,000 1
𝑃𝑉 = (1 − ) = $5,834,477
9% (1 + 9%)5
5
1 1500000𝑡
𝐷𝑈𝑅 = ∑ = 2.83 𝑦𝑒𝑎𝑟𝑠
5,834,477 (1 + 9%)𝑡
𝑡=1

(b)
1,500,000 1
𝑃𝑉 = (1 − ) = $5,759,563
9.5% (1 + 9.5%)5

𝐶ℎ𝑎𝑛𝑔𝑒 = 5,759,563 − 5,834,477 = −$74,914

(c)

Change approximated by duration:

∆𝑦 0.5%
𝐶ℎ𝑎𝑛𝑔𝑒 = −𝐷𝑈𝑅 × × 𝑃 = −2.83 × × 5,834,477 = −$75,693
1+𝑦 1.09

The approximated decrease from duration is larger than the actual decrease in the present
value of the annuity.

This study source was downloaded by 100000839278794 from CourseHero.com on 12-18-2021 08:21:59 GMT -06:00

https://www.coursehero.com/file/30487755/ECON6033-A1-Solutionpdf/
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