Question

In: Finance

1. Which of the following statements is most CORRECT regarding sunk costs? A) An example of...

1. Which of the following statements is most CORRECT regarding sunk costs?
A) An example of a sunk cost is the cost associated with restoring the site of a strip mine once the ore has been depleted
B) Sunk costs must be considered if the IRR method is used but if not the firm relies on the NPV method
C) A good example of a sunk cost is money that a banking corporation spent last year to investigate the site for a new office, then expensed that cost for tax purposes, and now is deciding whether to go forward with the project
D) A good example of a sunk cost is a situation where a bank opens a new office, and that new office leads to a decline in deposits of the bank’s other offices.

2. Anne wants to retire in 20 years, and she wants to have an annuity of $50,000 a year for 25 years after retirement. Anne wants to receive the first annuity payment the day she retires. Using an interest rate of 8%, the amount that Anne must invest today in order to have her retirement annuity is closest to:

Expert Solution

Option C. A good example of a sunk cost is money that a banking corporation spent last year to investigate the site for a new office, then expensed that cost for tax purposes, and now is deciding whether to go forward with the project

A sunk cost is a cost which has already been incurred and has no effect in the evaluation of a project. The cost has been incurred and is now a sunk cost.

2. We will first find out the present value annuity of $50,000 for 25 years to find out the balance in the retirement account.

then we will find out the payment done today for that retirement fund

Present value annuity of $50,000 for 25 year @ 8% = P * [ 1 - ( 1 + r)^-n ] / r

PVA = 50000 * [ 1 - ( 1 + 0.08)^-25 ] / 0.08

PVA = 50000 * [ 1 - 0.146018 ] / 0.08

PVA = 50000* 0.853982 / 0.08

PVA = 533738.81

this amount is required after 20 years from today

Amount to be invested today is calculated as follows

PV = PVA / ( 1 + r )ⁿ

PV = 533738.81 / ( 1 + 0.08)²⁰

PV = $114512.70

Anne should invest $114512.70 today for an annuity payment of $50,000 for 25 years after retirement.

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jeff jeffy answered 1 year ago

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