Principles Of Economics: Questions And Answers

Economics Risk

1.

a. Assuming the opportunity interest rate is 8%, what is the present value of the second alternative mentioned above? The present value of second alternative is as follows, The formula to calculate the present value of future amount is given by PV of Future Amount = A / (1+r) ^ n.

Amount Yr end received Rate Present Value

$7,000,000 1st year 8% $7,000,000/(1-0.08)^1 $6,481,481.48

$7,000,000 2nd year 8% $7,000,000/(1-0.08)^2 $6.001.371.74 Present value Second alternative $12,482,853.22

Which of the two alternatives should be chosen and why?

The second alternative s higher in value for the students. This offers them more scholarship to work with. The second alternative is higher in value for the students. Since the

c. Provide a description of a scenario where this kind of decision between two types of payment streams applies in the “real-world” business setting.

“Financial Managers use Present Value (NPV/FPV) calculations to manage and account for the time value of money (NPV). One scenario is providing service is one year and receiving payments in later year. We should assume that the company provides service in December 2011 and agrees to be paid $100 in December 2012. The time value of money tells us that the part of the $100 is interest, which is for waiting one year for the $100. Only $91 of the $100 is service revenue made in 2011, of that only $9 is interest earned in 2012. The calculation of present value will remove the interest, so that the amount of the service revenue can be determined. Another example might involve the purchase of land: the owners will either sell it to for $160,000 if he receives the money today, or for $200,000 if paid at the end of two years. At the end of two years, he would have earned interest for two years on the amount had he received it today.”

Describe and calculate Project A’s expected net present value (ENPV) and standard deviation (SD), assuming the discount rate (or risk-free interest rate) to be 8%. What is the decision rule in terms of ENPV? What will be San Diego LLC’s decision regarding this project? Describe your answer.

Probability Cash flow Probability X Cash flow Variance = Probability 0.3 $70,000,000 $21,000,000 43,200,000,000,000 0.4 $60,000,000 $24,000,000 1,440,000,000,000,000 0.1 $50,000,000 $5,000,000 250,000,000,000,000 0.2 $40,000,000 $8,000,000 320,000,000,000,000

Total cash flow Yr 3 $58,000,000 2,053,200,000,000,000

This was done by standard deviation: √ Variance

Year 1 = √ 919,200,000,000,000 = 30,318,311.30

Year 2 = √ 1,380,000,000,000,000 = 37,148,351.25

Year 3 = √ 2,053,200,000,000,000 =