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ADMS 3541
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Chris Robinson
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Administrative Studies

ADMS 3541

Chris Robinson

Winter

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ADMS 3541 Winter 2013-03-19
Assignment 2
Due Start of Class Week 11
Question 1 (20 marks, 4 marks each part)
The following parts of the question are unrelated:
(a)Fred Heath wants to borrow $500 for 20 days from the Friendly Payday
Loan Inc. The company charges a flat rate of $10 per loan, plus 6% on
the principal, plus EAR of 50% on the first $300 borrowed and EAR of
59% on the next $500. Calculate (i) the cost of the loan for Fred, and
(ii) the EAR of the loan.
(b)Chris Poor just inherited $50,000. He wants to have $1 million in ten
years.
(i)Calculate the required rate of return to achieve his goal.
(ii) If he can borrow at 5% interest to invest in a mutual fund that
has an expected rate of return of 11%, calculate the target debt-to-
equity ratio that will make it possible to achieve his goal.
(c)Jill bought a house 15 years ago for $300,000, and she bought a home
insurance policy to provide coverage for $250,000 of replacement
value. There is an inflation protection provision in the policy so that the
amount of insurance coverage automatically increases every year at
the rate of inflation. The current replacement value of the house is
440,000. The average rate of inflation has been 2.5% per year. The
deductible is $1,000. Recently, the home suffered a fire damage of
$120,000. How much will the insurance company pay her?
(d)Bobby Rich plans to buy a 20-year, 5% coupon Canada government
bond for $9,600. He plans to hold the bond for ten year, at the
end of which he expects to sell it for $9,900. His marginal tax rate
on interest income is 45% and marginal tax rate on realized capital
gain is 25%. The face value of the bond is $10,000. What is the after-
tax EAR?
(e)Lesley Young is a very loyal customer of the local bank, where she
keeps all her investments in various accounts, as follows:-
Chequing account $3,000
Savings account 7,000
Term Deposits 100,000
RRSP (invested in the bank’s GIC’s) 120,000
TFSA (in the bank’s stock mutual fund) 15,000
Joint savings account with husband 130,000 2
Joint savings account with daughter 10,000
After vacationing in Asia for a few weeks, she returned to find out that the
bank was bankrupt. The bank is a CDIC member. To what extent will her
investments be covered by the CDIC?
Question 2 (25 marks)
Gordon and Morgan Ho-Ballantyne have found their dream house in a
small town in Northern Ontario. The owner wants to sell the house
privately on order to save commission. He has agreed to sell for $260,000,
but Gordon thinks it is too high. He wants to estimate the value of the
home himself, by the Cost Approach. With the help of a friend who lives
there, Gordon has collected the following data/information:-
- Lot size = 50’x100’
- Size of the house = 1,850 sq. ft.
- Replacement cost of some damaged broadloom = $2,000
- Two windows and one storm door must be replaced, total costs =
$3,500
- Interior walls need to be painted, at a cost of $1,200
- Cost of land in the neighbourhood = $300 per front foot
- Construction cost of the house = $140 per sq. ft.
The friend has also found three comparable sales in that neighbourhood,
with the following information:-
Features Subject Property Sale 1 Sale 2
Sale 3
Selling Price N/A 260,000 240,000
270,000
Time of Sale recent 3
months recent
Lot Size 50x100 50x95 45x100
55x110
House Size 1,850 sf 2,000sf 2,100sf
1,900sf
Air Conditioning no yes yes yes
Fire Place yes yes no yes
Finished Rec room no no yes
yes
Additional information:
1. House prices increased by 2% per month starting 3 months ago
2. Each foot of frontage on the lot costs $300
3. Each 100 square foot of house size will add $1,000 to value
4. Air conditioning costs $1,000 3
5. Fire place costs $5,000
6. Finished rec room costs $10,000
There is no other observable depreciation.
Required:
(a)What is the value of the house, using the Cost Approach? (6 marks)
(b)What is the value of the house, using the Direct Market Comparison
Approach? (8 marks)
(c)Gordon and Morgan have only $50,000. Their friend reminds them
that they need at least $5,000 for legal and closing costs. To help
them out, the vendor is willing to take back a two-year mortgage at
6% interest and 20 years amortization, conditional on a minimum
selling price of $260,000.
(i) What is the amount of the mortgage? (2 mark)
(ii) What is the monthly payment? (2 mark)
(iii) What is the outstanding balance after two years? (3 marks)
(iv) What is the amount of interest

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