Questions: Shamrock Enterprises is using a discounted cash flow model. Identify which model Shamrock might use to estimate the discounted fair value under each scenario, and calculate the fair value using the present value tables: Scenario 1: Cash flows are fairly certain 260 / year for 5 years Risk-adjusted discount rate is 6% Risk-free discount rate is 3% Scenario 2: Cash flows are uncertain 75% probability that cash flows will be 260 in 5 years 25% probability that cash flows will be 100 in 5 years Risk-adjusted discount rate is 6% Risk-free discount rate is 3% (For calculation purposes, use 5 decimal places as displayed in the factor table provided. Round final answers to 2 decimal places, eg. 5,275.25.) Scenario 1: Shamrock might use Scenario 2: Shamrock might use model. Fair value

Shamrock Enterprises is using a discounted cash flow model. Identify which model Shamrock might use to estimate the discounted fair value under each scenario, and calculate the fair value using the present value tables: Scenario 1: Cash flows are fairly certain 260 / year for 5 years Risk-adjusted discount rate is 6% Risk-free discount rate is 3% Scenario 2: Cash flows are uncertain 75% probability that cash flows will be 260 in 5 years 25% probability that cash flows will be 100 in 5 years Risk-adjusted discount rate is 6% Risk-free discount rate is 3% (For calculation purposes, use 5 decimal places as displayed in the factor table provided. Round final answers to 2 decimal places, eg. 5,275.25.) Scenario 1: Shamrock might use Scenario 2: Shamrock might use model. Fair value
Transcript text: Shamrock Enterprises is using a discounted cash flow model. Identify which model Shamrock might use to estimate the discounted fair value under each scenario, and calculate the fair value using the present value tables: Scenario 1: Cash flows are fairly certain $260 /$ year for 5 years Risk-adjusted discount rate is $6 \%$ Risk-free discount rate is $3 \%$ Scenario 2: Cash flows are uncertain $75 \%$ probability that cash flows will be $260 in 5 years $25 \%$ probability that cash flows will be $100 in 5 years Risk-adjusted discount rate is $6 \%$ Risk-free discount rate is $3 \% (For calculation purposes, use 5 decimal places as displayed in the factor table provided. Round final answers to 2 decimal places, eg. 5,275.25.) Scenario 1: Shamrock might use Scenario 2: Shamrock might use $\square$ model. Fair value $ \square$
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Solution

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Solution Steps

Step 1: Identify the Model for Scenario 1

For Scenario 1, where cash flows are fairly certain, Shamrock might use the traditional approach model.

Step 2: Calculate the Fair Value for Scenario 1
  • Cash flow: $260/year for 5 years
  • Risk-adjusted discount rate: 6%

Using the Present Value of an Annuity of 1 table for 5 years at 6%: \[ PV_{\text{annuity}} = 260 \times 4.21236 = 1095.21 \]

Step 3: Identify the Model for Scenario 2

For Scenario 2, where cash flows are uncertain, Shamrock might use the expected cash flow model.

Step 4: Calculate the Fair Value for Scenario 2
  • 75% probability of $260 in 5 years
  • 25% probability of $100 in 5 years
  • Risk-adjusted discount rate: 6%

Expected cash flow in 5 years: \[ E(CF) = 0.75 \times 260 + 0.25 \times 100 = 195 + 25 = 220 \]

Using the Present Value of 1 table for 5 years at 6%: \[ PV_{\text{factor}} = 0.74726 \] \[ PV = 220 \times 0.74726 = 164.40 \]

Final Answer

  • Scenario 1:
    • Model: Traditional approach
    • Fair value: $1095.21
  • Scenario 2:
    • Model: Expected cash flow
    • Fair value: $164.40
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