solution authoring guidelines - chegg india

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Solution Authoring

Guidelines

Version 9.4

September 2016

2 Copyright@2016 chegg.com

Subject-specific Guidelines – Finance Table of Contents

F1. Content: ...................................................................................................... 3

A. Text/Explanation: ......................................................................................................... 3

B. Equations: ..................................................................................................................... 4

C. Tables: ........................................................................................................................... 4

D. Graphs: .......................................................................................................................... 4

F2. Special points: ........................................................................................... 4

List of changes made over version 9.3

1. Modified C. Tables……………………………………………………………………….……4

2. Modified D. Graphs……………………………………………………………………………4

3. Added point (5) under F2 special points ………………………………………………………6


F1. Content:

A. Text/Explanation:

Interpret the background of the question in simple student-friendly sentences.

Example:

Question:

An investment offers $7,000 per year for 15 years, with the first payment occurring 1 year

from now. If the required return is 9%, what is the value of the investment?

Answer (non-formatted):

As per the above problem, the main concept in the problem is annuities. Hence, the Annuity

is a series or level of cash flows that occur at the end of each period for some fixed number of

periods. It is also called as ordinary annuity.

The present value of an ordinary annuity of C dollars per period for t periods when the rate of

return or interest rate r is,

1 Present valuefactorAnnuity present value

1 1/ (1 )t

Cr

rC

r

Where,

C is the annuity cash amount

t is the number of payment periods

r is the rate of return (or) discount rate

The term in parentheses on the Numerator is sometimes called as the present value interest

factor for annuities and abbreviated PVIFA(r, t).

Introduction: Begin the solution by introducing the concept, analysis, and problem-solving

approach in brief sentences

First, write the formula to calculate the present values of annuities.

1 Present valuefactorAnnuity present value

1 1/ (1 )t

Cr

rC

r


Explain:

State what the terms involved in the formula mean.

Pr esent value annuity

annuity cash amount

Rate of return (or) discount rate

Number of payment periods

PV

C

r

t

Calculate:

Perform the calculations using MathType /Microsoft Equation 3.0, especially when

multiple lines of calculations are involved.

B. Equations:

Use MathType or Microsoft Equation 3.0 available in Word 2007/2010 to include

equations in your solution.

C. Tables:

Use Excel tables for creating tables and paste them in your Microsoft Word file in

JPEG/PNG format. Send respective excels along with the word file. The name of the

Microsoft Excel should have the same name as of the Microsoft Word file. The formatting of

the table should be as per the authoring guidelines (the font type, font size and alignment).

D. Graphs:

Use Excel for drawing graphs. Take only the image (JPEG/PNG) of graphs and paste it on

the word document. Never copy paste directly from the Excel.

F2. Special points:

Guidelines for problems involving spreadsheets:

(1) Always give screenshots of Excel in the solution when asked in the question.

(2) Do not enter commas or dollar signs while making entries in various fields of Excel.

This would give erroneous results.

Best practice:

Solve for Annuity Present Value using MS-Excel “PV” Function:


Using MS-Excel “PV” Function:

Explanation:

Find the Annuity Present Value of the investment using Excel “PV” function. To access the

PV function in Excel,

First, click the function wizard “fx”,

Select function category of financial,

Select “PV” and click OK,

The Function Argument pops up

Input the given data in the required field

Click OK

The Formula result field will show the final answer.

(3) Make the formula visible in problems that involve spreadsheets.

The IRR formula in the spreadsheet will appear as follows:


Year Cash Flow

0 ($1,45,000)

1 $71,000 16.02%

2 $68,000

3 $52,000

Explanation:

Select B column for the cash flows.

Input these cash flows each one in one cell of the column followed by the year 0 cash

flows to year 3 cash flows.

Click on the cell where you want your IRR (Internal Rate of Return)

Select “C4” and enter ‘=IRR (B3:B6) and then Press Enter Key

Then the located cell displays the answer IRR of 16.02%

IRR =16.02%

(4) Use MS-Excel for plotting graphs

(5) Guidelines for problems involving Match the following questions

Identify the correct matching terms and give appropriate matching with sufficient

explanation stating the reasons for the matching. (Refer ‘Finance Example 6:

Matching Type’)

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Example solutions - Finance

List of changes made over Version 9.1

Example 4 has been modified as per MCQ guidelines ……………….page no.16


Example 4 has been modified as per MCQ guidelines ……………….page no.16

Example 5 has been modified as per T/F guidelines ………………….page no.17


Example 6 has been added …………………………….……………….page no.18


Finance Example 1: Calculation Based

Question:

A company has two debt issues, the book value of the 1st debt issue is $60 million with

quoted price of 108% and the 2nd

debt issue is a zero coupon bond with 20 years left to

maturity. The book value of the issue is $70 million and it sells for 26.5% of par, where the

tax rate is 35%. What would be the total market value? What would be t6he after tax-cost of

debt now?

Solution:

Solution:

Book Value represents the cost paid for acquiring an asset and depreciation will be deducted

from the original cost of the asset.

Calculate the total Book Value of debt.

Total Book Value of debt = First issue Book Value of debt + Second issue Book Value of

debt

First issue Book Value of debt $60,000,000

Second issue Book Value of debt $70,000,000

$ , ,

Total Book Value of debt 130 000 000

Market Value indicates the prevailing price in the market.

It is given that the Quoted Price is 108% of the par value of first debt issue.

First Issue: Book Value = $60,000,000

Quoted Price = 108% of Par value of bond

It is also given that the Quoted Price is 26.5% of the par value of second debt issue.

Second Issue: Book Value = $70,000,000

Quoted Price = 26.5% of Par value of bond

Now, calculate the total market value of the debt.

Total Market Value is the sum of quoted price of first debt issue and second debt issue.

Total Market Value 108% of the Par Value + 26.5% of the Par Value

1.08 $60,000,000 0.265 $70,000,000

$64,800,000 $18,550,000

$83,350,000

Therefore, the total market value of the debt is $83,350,000 .


After-tax cost of debt is the cost paid on the bond that will be exempted from the tax. The

cost of debt is the (yield to maturity) YTM of the bond.

Calculate the YTM for zero-coupon bond:

Face Value of the Debt (Fv) = $130,000,000

Current Price of the Debt (Pv) = $83,350,000

Number of years left to Maturity (Nper) = 20 years

Since the debt issue is a zero-coupon bond, assume the coupon rate to be zero percent. Hence,

the payment (Pmt) would be zero.

The Before-Tax Cost of Debt is the (yield to maturity) YTM of the bond.

1. Open an Excel file and select any cell in any sheet.

2. Use the formula “= Rate (Nper, Pmt, Pv, Fv)”.

3. Place the values in the above formula with (–ve) sign before Fv.

4. Hit the Enter key.

YTM before tax = 2.25% using Rate function of Excel

Now, calculate the after-tax cost of debt using the following formula,

cAfter-tax cost of debt = YTM before tax × 1 – T

Here, Tc is tax cost (or tax rate).

Substitute 2.25% or 0.0225 for YTM(before tax) and 35% or 0.35 for Tc.

cAfter-Tax Cost of debt = YTM before tax × 1 – T

0.0225 1 – 0.

1

35

.46%

Therefore, the after-tax cost of debt is 1.46% .


Finance Example 2: Concept check type

Question:

Finance is the study of how investors allocate their assets over time under conditions of

certainty and uncertainty.

(a) What are the major areas of finance?

(b) Explain the need to understand finance.

Solution:

(a)

The major areas of finance are,

Corporate finance

Investments

Financial institutions

International finance

Corporate Finance is the broadest of the four areas and is important in all types of

businesses including banks and other financial institutions, as well as industrial and retail

firms. Corporate finance includes making decisions regarding plant expansions.

An investment is the area that deals with financial assets such as stocks and bonds. Study of

investments can be broadly classified into two branches: Portfolio Management and Security

Analysis.

i. Portfolio Management involves managing money for individuals.

ii. Security Analysis involves researching of individual investments such as stock in

a particular company and determining appropriate price.

Financial Institutions is the area of Finance that deals primarily with financial matters.

Banks and insurance companies are the most familiar financial institutions.

International Finance is the area that pertains to investments made across non-US

companies and overseas operations that involves exchange risk and political risk.

(b)

Every individual in this world needs knowledge of finance to make many personal decisions,

ranging from investing for one’s retirement to deciding whether to lease or buy a car. There

are also financial implications virtually in all business decisions. Non-financial executives

must know enough about financing to work on their implications and analysis.

Examples for - a need to understand finance:-


Marketers constantly work with budgets and they need to know the greatest pay-off from

marketing expenditures and programs. Analyzing costs and benefits of projects of all types is

one of the most vital aspects of finance. These are also important in marketing research.

Accountants are often required to make financial decisions as well as perform traditional

accounting duties.

The most important area in management is strategy. Thinking about business strategy without

considering financial strategy is an excellent recipe for disaster. As a result, management

strategists must have clear understanding of the financial implications of business plans.

Therefore, if one wants to succeed in any area of business, one must be competent in his/her

own area, but must also be familiar with other business disciplines like finance.


Finance Example 3: Excel Based

Question: (Calculating IRR)

A firm evaluates all of its projects by applying the IRR rule. If the required return is 13

percent, should the firm accept the following project?

Solution:

IRR (Internal Rate of Return) is a discount rate that forces the PV of cash inflows to equal

the cost. This is equivalent to forcing the NPV to equal zero. The IRR is an estimate of the

project’s rate of return, and it is comparable to the YTM on a bond.

The given data is summarized as,

Required rate of return = 13%

Calculations to decide whether the project should be accepted or not.

The IRR is evaluated by calculating the NPV of the Project at different levels of discount

rates.

Internal rate of return is given by,

Outflow = Inflow

2 3

$71,000 $68,000 $52000$145,000 = + +

1+R (1+R) (1+R)

The following table gives the NPV at different Discount rates:

Therefore, the NPV is zero at 16.02%, so 16.02% is the IRR.

Since the value 16.02% is more than the required rate of return, which is 13%, accepting the

project would be beneficial for the firm.


Calculate the IRR for the above cash flows using excel spreadsheet.

The formula is “=IRR (values)”

The IRR formula in the spreadsheet will appear as follows:

Year Cash Flow

0 ($145,000)

1 $71,000 16.02%

2 $68,000

Explanation:

Select B column for the cash flows.

Input these cash flows each one in one cell of the column followed by the year 0 cash

flows to year 3 cash flows.

Click on the cell where you want your IRR

Select “C4” and enter ‘=IRR (B3:B6) and then Press Enter Key

Then your located cell displays the answer IRR of 16.02%

IRR =16.02%


Calculate IRR using “Insert Function” of MS Excel.

Calculate IRR from row B2 to B5.

Explanation:

Find the number of periods of your investment using Excel “IRR” function. To access the

IRR function in Excel, follow the steps below:

First click the function wizard “fx”.


Select function category of financial.

Select “IRR” and click OK.

Then, the Function Argument pops up

Input the given data in the required field

Click OK

Now, the formula result field will show the final answer.

The IRR of this project is 16.02 %. Since the IRR exceeds the required rate of return of 13%,

the project can be accepted.


Finance Example 4: Multiple Choices Type Question:

A term life insurance policy that can be extended for another term without the insured taking

a medical exam has,

(a) Convertibility

(b) Decreasing protection

(c) Permanent life protection

(d) Guaranteed renewability

Solution:

The convertibility clause allows conversion from term insurance to permanent life insurance

without any additional proof of insurability.

Therefore, Convertibility is not the correct option.

Decreasing the protection allows the premium to remain unchanged from year to year, while

there is a decrease in the protection it purchases.

Therefore, option (b) decreasing protection is incorrect.

Permanent life protection is life protection with investment. It is permanent because it does

not have to be renewed. In this case, only the due premium has to be paid to keep the policy

in force.

Therefore, option (c) permanent life protection is incorrect.

Guaranteed renewability allows the renewal of the term insurance for the next term without

further proof of insurability like, a medical examination.

Therefore, (d) guaranteed renewability is the correct option.


Finance Example 5: True or False Type

Question:

The process of developing a plan for what will happen to your wealth and dependents when

you die is known as probate planning. True or False?

Solution:

Estate is the term used to describe the assets or net worth after the death of a person. It

includes cash, houses, other real estate properties, jewelry, artworks, vehicles and any other

types of assets. Value of estate is determined after factoring into account the debts

outstanding at the time of death.

Estate planning is planning for distribution of estate or net assets after death. It involves

determining how much one would be worth at the time of death and how would one like to

pass on assets to one’s heirs after his death. This would also require survey of legal and tax

status after death so that taxes and legal issues can be minimized.

Estate planning is required to prevent the estate from being probate. Under probate, a court

appoints a guardian who estimates the net worth, assets and liabilities of the person. Once this

is done, he determines who the possible beneficiaries are.

Probate process may not be optimal process for distribution of assets after death. It is also

prone to delays and litigation. Estate planning process addresses this issue.

Hence, statement is false.


Finance Example 6: Matching Type

Question:

Match the following:

Answer:

The terms current yield, YTM, and coupon rate are rates related to bonds. While investing in

bonds, a bond holder considers these rates to check the performance of the bonds.

Current yield is a return on the bond considering the initial cash outlay and current annual

income. It is a proportion of the initial cash outlay by the bondholder.

It will be calculated by dividing current annual coupon with current price of the bond. Hence,

the current yield refers to the current rate of return on the investment.

Therefore, option (a) matches with option 2 .

Yield to maturity (YTM) is the yield that can be earned on the bond if the bondholder holds it

until maturity.

Hence, the YTM is the rate of return on the investment over the maturity period.

Therefore, option (b) matches with option 3 .

Coupon rate is the rate at which the bond pays interest/coupon to the bond holder.

Therefore, option (c) matches with option 1 .

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