Question
In: Finance
You are considering investment in one of the following two options. Assume an interest rate of...
You are considering investment in one of the following
two options. Assume an interest rate of 12% per year, compounded
monthly. Option A & Option B
Initial Cost, respectively
-$100,000
-$800,000
Quarterly Maintenance Cost, respectively
-$26,000
-$15,000
Salvage Value, respectively
$16,000
$200,000
Lifespan (years) 2 & 4, respectively
a. What is the effective monthly interest
rate?
b. What is the effective quarterly interest rate (to 2
decimal places)?
c. Draw cash flow diagrams for the two
projects.
d. Calculate the PW of the 2 options, assuming
repeatability. Which option would you choose?
e. Calculate the quarterly worth of the 2 options
(AW). Which option would you choose?
Solutions
Expert Solution
a. Formula for Effective Annual Interest Rate = ((1+i/n)^n)−1
Here i=Nominal interest rate
n=Number of periods of compounding
So putting the given figure here, we get = ((1+ 12%/12)^12)-1
Solving above we get = 12.68%
So effective monthly Interest will be = 12.68%/12 = 1.06%
b.
Effective Quarterly Interest Rate(Based on monthly compounding) = 12.68%/4 = 3.17%
c. Below are the cash flow of the project assming no repeatablity.
| Option A | Option B | |
| Initial cost | -100000 | -800000 |
| Y1Q1 | -26000 | -15000 |
| Y1Q2 | -26000 | -15000 |
| Y1Q3 | -26000 | -15000 |
| Y1Q4 | -26000 | -15000 |
| Y2Q1 | -26000 | -15000 |
| Y2Q2 | -26000 | -15000 |
| Y2Q3 | -26000 | -15000 |
| Y2Q4 | -10000 | -15000 |
| Y3Q1 | 0 | -15000 |
| Y3Q2 | 0 | -15000 |
| Y3Q3 | 0 | -15000 |
| Y3Q4 | 0 | -15000 |
| Y4Q1 | 0 | -15000 |
| Y4Q2 | 0 | -15000 |
| Y4Q3 | 0 | -15000 |
| Y4Q4 | 0 | 185000 |
d. Below is the calculation of Present worth of Option A and Option. We will choose option A, as this option will incurred the less cost.
Formual for Present value = 1/(1+r)^n. Here r = Rate per period (i.e. quarter) which is 3.17%
n= 1,2,3.....
| Option A | Present Value | Option B | Present Value | |
| Initial Value | -100000 | -100000 | -800000 | -800000 |
| Y1Q1 | -26000 | -25201 | -15000 | -14539 |
| Y1Q2 | -26000 | -24427 | -15000 | -14092 |
| Y1Q3 | -26000 | -23676 | -15000 | -13659 |
| Y1Q4 | -26000 | -22949 | -15000 | -13240 |
| Y2Q1 | -26000 | -22244 | -15000 | -12833 |
| Y2Q2 | -26000 | -21560 | -15000 | -12439 |
| Y2Q3 | -26000 | -20898 | -15000 | -12056 |
| Y2Q4 | -110000 | -85697 | -15000 | -11686 |
| Y3Q1 | -26000 | -19633 | -15000 | -11327 |
| Y3Q2 | -26000 | -19030 | -15000 | -10979 |
| Y3Q3 | -26000 | -18445 | -15000 | -10642 |
| Y3Q4 | -26000 | -17879 | -15000 | -10315 |
| Y4Q1 | -26000 | -17329 | -15000 | -9998 |
| Y4Q2 | -26000 | -16797 | -15000 | -9690 |
| Y4Q3 | -26000 | -16281 | -15000 | -9393 |
| Y4Q4 | -10000 | -6069 | 185000 | 112284 |
| -478115 | -864603 |
jeff jeffy answered 2 years agoRelated Solutions
You are considering two payment options on a $500,000 20-year mortgage having an interest rate of...
You are considering two payment options on a $500,000 20-year
mortgage having an interest rate of 2.8% compounded monthly. The
first option is to make monthly payments at the start of each
month, while the second option is to make payments at the end of
each month. How much interest will be saved by choosing the first
option ?
You are considering an investment opportunity with the following costs and benefits. The applicable interest rate...
You are considering an investment opportunity with the following
costs and benefits. The applicable interest rate for this
investment opportunity is 5% (effective annual rate). Calculate the
NPV of this investment opportunity.
Year
0
1
2
3
4
5
6
Cost
$ (10,000)
$ (5,000)
$ (1,000)
$ -
$ -
$ -
$ -
Benefits
$ -
$ -
$ 5,000
$ 7,500
$7,500
$ 5,000
$ 1,000
1)What is the nature of interest? Mary is considering two investment options for a $5,000 gift...
1)What is the nature of interest? Mary is considering two
investment options for a $5,000 gift she received for graduation.
Both investments have 9% annual interest rates. One offers
quarterly compounding and the other compounds on a semiannual
basis. Which investment should she choose and why?
2)What are the primary characteristics of an annuity?
Differentiate between an “ordinary annuity” and an “annuity
due”
3) Frank is considering the following two investment options that his broker has offered. Which one...
3) Frank is considering the following two investment options
that his broker has offered. Which one should he choose and
why?
(show work)
Option 1) Deposit $50,000 today, and for the next 10 years make
a payment of $1,000 at the end of each month. After 10 years, you
will be able to withdraw a total of $300,000 from your account.
Option 2) Deposit $80,000 today, and for the next 10 years make
a payment of $10,000 at the end...
You are considering two investment options. In option A, you have to invest $6,000 now and...
You are considering two investment options. In option A, you
have to invest $6,000 now and $1,100 three years from now. In
option B, you have to invest $3,200 now, $1,300 a year from
now, and $1,000 three years from now. In both options, you will
receive four annual payments of $2,200 each. (You will get the
first payment a year from now.) Which of these options would you
choose based on (a) the conventional payback criterion, and (b)
the...
Company A is considering two fixed interest long-term debt options: a) borrowing at a fixed rate...
Company A is considering two fixed interest long-term debt
options: a) borrowing at a fixed rate of 3.5% or b) borrowing at a
floating rate of Libor + 0.5% and entering a fixed-for-floating
swap at 3.25% for Libor. Which option should the company take? How
much interest would the company pay for option b) on a $10 million
loan (and swap) at the end of the first year if Libor tuns out to
be 2.9%?
You are comparing two investment options that each pay 6 percent interest, compounded annually. Both options...
You
are comparing two investment options that each pay 6 percent
interest, compounded annually. Both options will provide you with
$12,000 of income. Option A pays $2,000 the first year followed by
two annual payments of $5,000 each. Option B pays three annual
payments of $4,000 each. Which one of the following statements is
correct given these two investment options? Assume a positive
discount rate. which option has a higer preswnr value? show the
calculations of the present value for...
Assume the following information: One-year interest rate in New Zealand 5 percent One-year interest rate in...
Assume the following information:
One-year interest rate in New Zealand
5 percent
One-year interest rate in U.S
12 percent
Spot rate NZ$
$0.60
Forward rate NZ$
$0.54
initial investment of $10,000,000 (US (NZ) dollars for US (NZ)
investor
Is covered interest rate possible for US investors? New Zealand
investors? Explain why covered interest rate arbitrage is or is not
feasible.
Expected rate of return and risk. Syntex, inc is considering an investment in one of two...
Expected rate of return and risk. Syntex, inc is considering an
investment in one of two common stocks. Given the information that
follows, which invest is better, based on the risk (as measured by
the standard deviation) and return? Common stock A Common stock B
Probability Return Probability Return 0.36 13% 0.10 -6% 0.30 17%
0.40 8% 0.35 21% 0.40 16% 0.10 21%
Expected rate of return and risk. Syntex, inc is considering an investment in one of two...
Expected rate of return and risk. Syntex, inc is considering an
investment in one of two common stocks. Given the information in
the table, what is the expected rate of return for stock B? what is
the standard deviation of stock B?what is the expected rate of
return for stock a? based on the risk (as measured by the standard
deviation) and return of each stock which investment is better?
(round to 2 decimal places) Common stock A Common stock...
ADVERTISEMENT
ADVERTISEMENT
Latest Questions
- Rotating bits in C This rotates bits to the left which means the bits that were...
- Implement a method that meets the following requirements: (a) Takes as parameter 1) an int array...
- Write a function that takes a binary search tree as input and produces a linked list...
- XYZ Company is considering purchasing a piece of equipment costing $400,000. It has a useful life...
- Reflection of the short film "How Wolves Change Rivers" and Aldo Leopold's "Thinking Like A Mountain".
- What kind of rebar would be most cost effective for foundation? Would it be to design...
- Why would UnderArmour want to be sure that consumers can clearly see different models ( about...
ADVERTISEMENT