Question

4.

Billy is considering the purchase of a rental house. The house costs $240,000 and it will generate annual revenues of $15,000 and annual expenses of $3,000. Nevertheless, Billy will need to borrow $240,000 at an interest rate of 7% per year in case he decides to make this investment. Should Billy purchase this house?

A) No, he will lose money.

B) Yes, his profits will be zero.

C) No, his profits will be positive but close to zero.

D) Yes, he will profit from this investment.

5.

Suppose that CSUSM offers you two payment plans for your last two years of college. You may either pay tuition of $20,000 per year at the beginning of each of the next two years, or pay just $38,000 before the start of freshman year. What would the interest rate have to be for you to be indifferent between these two deals? Explain.

6.A major corporation hires high school students on a part-time basis. It offers a reward of $5,000 to any of its high school seniors who graduate college in four years. What is the present value of that reward to a student who just finished her junior year of high school (i.e., 5 years later to graduate college), assuming a nominal rate of interest of 8%?

Answer 1

Ans 4 :

Here, since no time frame is mentioned, so accessing the valuation for a finite time,

Total money inflow every from reveue and expenses = 15000 - 3000 = $12000

Interest payment = 7/100 * 240000 = $16,800.

thereby, cash inflow every year for the period till he keeps on paying the interest rate = $12000 - $16,800 = (-)$4800

which is negative which means he incurs a loss of 4800 per year due to the borrowing. And thus this summing up to the duration of loan repayment will lead to negative NPV. So, he should not buy.

option A.

Ans 5 :

Here in order to be indifferent , the NPV (Net Present Value) should be zero.

let the interest rate be r% p.a

applying npv ,

38000 = 20000/(1+r) + 20000/(1+r)²

=> r = (1.0349-1) = 3.49% p.a.

Ans 6 :

Here assuming that the $5000 is paid at the end of graduation

She will realise this payment after 5 years and the present value will be discounting @ 8% pa

pv = 5000/(1+r)⁵

r= 8%

so, pv = $3402.916.