ECONOMICS FOR RESEARCHERS

TASK 2
Net present value
Due: 21st January, 2019

If a firm can earn a profit stream of $50,000 per year for 10 years, that profit stream is worth
A) more than $500,000 today.
B) $500,000 today.
C) less than $500,000 today, but a positive amount.
D) nothing today
E) some amount, but whether it is more, less or the same as $500,000 cannot be determined.
Calculation/explanation

The value of future cash flows expressed in the present value is reduced and positive, in this case less than
$500,000 today, but a positive amount.

The present value formula makes it apparent that:

A) a decline in the interest rate will cause a decision maker to weigh recent period returns relatively
more heavily than before the decline.
B) an increase in the interest rate will cause a decision maker to weigh distant (or future) returns
relatively more heavily than before the increase.
C) the present value of a fixed sum decreases as the time until it is to be paid increases.
D) all of the above
E) both A and C.
If the interest rate is 5%, in one period the value of $1 today is
A) $1.20.
B) $1.05.
C) 95 cents.
D) 20 cents.
E) 5 cents.

Calculation/explanation

=1*(1+0,05)^1
FV= $1.05

If the interest rate is 10%, the present value of $1 next year is

A) $1.20.
B) $1.10
C) 91 cents.
D) 10 cents.
E) 9 cents.

Calculation/explanation

=1/(1+0,1)^1
PV= 91 cents

1
You have won a contest and are allowed to choose between two prizes. One option is to receive $200 today
and another $200 one year from now. The second option is $100 today and an additional $325 one year
from now. At what interest rate (if any) is the present value of the two prizes identical?
A) 0 percent
B) 5 percent
C) 10 percent
D) 25 percent
E) none of the above

Calculation/explanation

If interest rate is 25 % the present value is identical $360

Scenario. This year Jacob Verytall signs a ʺFifty Million Dollarʺ contract with the Mission City Muckrakers, a
new basketball team. He will be paid $10 million per year over the next 5 years beginning next year. The
interest rate is 10%, and the Muckrakers have enough in the bank to generate the payment stream.
Refer to scenario. In terms of this yearʹs dollars, this ʺFifty Million Dollarʺ contract is worth approximately
A) $45.4 million.
B) $37.9 million.
C) $10 million.
D) $9.4 million.
E) $7.5 million.

Calculation/explanation

=-PV(10%;5;10000000) Refer to scenario contract is worth $37.907.867,69

Refer to Scenario. If the interest rate falls,

A) the present value of this contract will fall.
B) the present value of this contract will be unaffected.
C) the present value of this contract will rise.
D) Jacob will be paid less than $10 million each year.
E) Jacob will be paid more than $10 million each year as he can invest the money.

Calculation/explanation

If interest rate falls the present value will rise anyway

Refer to Scenario. If the interest rate is expected to fall to 5% in years 4 and 5, in terms of current dollars the
value of the Muckrakers payments will
A) rise.
B) stay the same.
C) fall.
D) change, but we cannot answer this question without further information.

2
Your uncle wants to help you with your college expenses, and he promised to pay you $10,000 next year and
$15,000 in two years. The current interest rate is 6%, and you expect that this interest rate will be the same
for the next year and will increase to 8% in the year after. What is the formula that you should use to
compute the present discounted value of your uncleʹs contribution to your education expenses?
A) 0 + 10,000 + 15,000
B) 10,000/(1.06) + 15,000/((1.06)*(1.06))
C) 10,000/(1.06) + 15,000/((1.06)(1.08))
D) 10,000/(1.06) + 15,000/((1.08)(1.08))
Scenario. Consider the payment streams listed below that are available from different capital projects for
FurrySoftware. The firm must choose to implement just one out of the three possible projects.

Today 1 year 2 years 3 years

Retool offices -100 500 500 500
Rewire Network -50 1000 500 200
Move to California -200 300 600 1200
Refer to Scenario. With no other information available (no interes trate), it is
A) clear Furry should retool the offices.
B) clear Furry should rewire the network.
C) clear Furry should move to Southern California.
D) clear Furry should either retool the offices or rewire the network.
E) not possible to tell which payment stream is most valuable to Furry.

Calculation/explanation

If there is no interest rate it is not possible to tell which payment stream is most valuable to Furry

Refer to Scenario. If the interest rate were 2%, Furry Software should
A) retool the offices.
B) rewire the network.
C) move to Southern California.
D) be indifferent between retooling and rewiring.
E) be indifferent between rewiring and moving.

Calculation/explanation

If interest rate is 2% it is clear Furry should move to California.

Retool offices - 1341,94 Rewire Network 1599,44 Move to California 1801,61

Refer to Scenario. If the interest rate were 20%, Furry Software should
A) retool the offices.
B) rewire the network.
C) move to Southern California.
D) be indifferent between retooling and rewiring.
E) be indifferent between retooling and moving.
Calculation/explanation
If interest rate is 2% it is clear Furry should rewire the network.
Retool offices 953,24 Rewire Network - 1246,30 Move to California- 1161,11