Assignment 3

You submitted this Assignment on Tue 29 Oct 2013 12:37 PM PDT (UTC -0700)
You gota score of 95.00 out of 100.00

Question 1
(5 points) Becky needs another $1,200 in her vehicle fund to purchase the car she wants. Her parents
offer to loan her the money, but want to teach her about the time value of money.They offer to have her
repay the loan in the future using birthday and holiday money. Theyagree that she will repay $450 at each
of her next two birthdays and one holiday season.These events are 3, 6 and 15 months from now. Assume
a 6% cost of capital. Assume there isno risk of default, and that compounding is monthly. What is the
NPV of the loan? (Enter justthe number without the $ sign or a comma; round off decimals.)
Answer for Question 1
You entered: 97

Your Answer Score Explanation
97 Correct 5.00 Correct. You know compounding and figuring out NPV.Total 5.00 / 5.00
Question Explanation
This is a simple NPV problem, where the loan is positive NPV only because Becky cannot borrow at
market rates,

Question 2
(5 points) Jacob has an opportunity to invest in a new retail development in his building. Theinitial
investment is $50,000 and the expected cashflows are as follows: Year 1: $2,500 Year 2: $5,000 Year 3:
$5,000 Year 4: $7,500 Year 5: $10,000 Year 6: $10,000 Year 7: $15,000Year 8: $15,000 What is Jacob's
IRR on this investment?(No more than two decimals in the percentage interest rate, but do not enter the %
sign.)
Answer for Question 2
You entered: 6.34

Your Answer Score Explanation
6.34 Correct 5.00 Correct. This is where a spreadsheet comes in handy.Total 5.00 / 5.00
Question Explanation
This is a simple IRR calculation. Drawing a time line helps.

Question 3
(5 points) Fabrice is looking to buy a new plug-in hybrid vehicle. The purchase price is$12,000 more than
a similar conventional model. However, he will receive a $7,500 federaltax credit that he will realize at
the end of the year. He estimates that he will save $1,200 per year in gas over the conventional model;
these cash outflows can be assumed to occur at theend of the year. The cost of capital (or interest rate) for
Fabrice is 6%. How long will Fabricehave to own the vehicle to justify the additional expense over the
conventional model?( i.e,What is the DISCOUNTED payback period in years? Discount future cash
flows beforecalculating payback and round to a whole year.)Answer for Question 3
You entered:4

Your Answer Score Explanation
4 Incorrect 0.00Total 0.00 / 5.00
Question Explanation
Simple payback calculation, but with discounting.

Question 4
(10 points) Wen Seng operates an ice cream shop. He is trying to decide whether to expandhis business to
include ice cream cakes. He will need some additional space that will cost him$7,200 per year at the end
of each year and some additional equipment that will cost $10,000up front. The ice cream cakes will
provide an extra income of $10,000 per year at the end of each year. The business is expected to last 20
years. The discount rate (or interest rate) for Wen Seng's new business is 10%. What is the Net Present
Value of the ice cream cake project project? (Assume there are no taxes.)
You entered: 13838
Correct 10.00 Correct. You know how to set up and calculate NPV.Total 10.00 / 10.00
Question Explanation: A fairly common NPV problem
Question 5
(10 points) Yassein is looking to refinance his home because rates have gone down fromwhen he bought
his house 10 years ago. He started with a 30-year fixed-rate mortgage of $288,000 at an annual rate of
6.5%. He can now get a 20-year fixed-rate mortgage at anannual rate of 5.5% on the remaining balance
of his initial mortgage. (All loans requiremonthly payments.) In order to re-finance, Yassein will need to
pay closing costs of $3,500.These costs are out of pocket and cannot be rolled into the new mortgage.
How much willrefinancing save Yassein? (i.e. What is the NPV of the refinancing decision?)
You entered: 16975
Correct 10.00Correct. This is a very common situation we all face allthe time.Total10.00 /10.00
Question Explanation
A problem we saw last week, but I expect you to do this routinely now. It is a valuegenerating
opportunity through financing only because interest rates changed

Question 6
(10 points) The United States purchased Alaska in 1867 for $7.2M (where M stands for million). Assume
that federal tax revenue from the state of Alaska (net federal expenditures)will be $50M in 2012 and that
tax revenue started in 1868 and has steadily increased by 3%annually since then. Assume that the cost of
capital (or interest rate) is 7%. What is the NPVof the Alaska purchase? (Hint: Try and imagine you are in
1867 looking forward.)(Enter justthe number without the $ sign or a comma; round off decimals.)Answer
for Question 6
You entered:10515347
Correct 10.00 Correct. You can travel in time, both directions.Total 10.00 / 10.00
Question Explanation
Slightly tricky only if you have not drawn a timeline.

Question 7
(10 points) This question introduces you to the concept of an annuity with growth. Theformula is given
on p.3, equation (7), of the Note on Formulae, but I would encourage you totry doing it in Excel as well.
(If the first cash flow is C, the next one will be C(1+g), and soon, where g is the growth rate in cash
flow). As an example, the present value of an annuitythat starts one year from now at $100, and grows at
5%, with the last cash flow in year 10,when the discount rate is 7%, is $860. Confirm this before
attempting the problem using boththe formula and excel. What is the NPV of of a new manufacturing
project that costs$100,000 today, but has a cash flow of $15,000 in year 1 that grows at 4% per year till
year 12? Similar investments earn 7.5% per year. (Enter just the number without the $ sign or acomma;
round off decimals.)Answer for Question 7
You entered: 40486

Your Answer Score Explanation
40486 Correct 10.00 Correct. Hope you used both methods.Total 10.00 / 10.00
Question Explanation
This is a set up and calculation problem, nothing new conceptually.

Question 8
(15 points) Diane has just 18 and also completed high school and is wondering about thevalue of a
college education. She is pretty good with numbers, and driven by financialconsiderations only, so she
sits down to calculate whether it is worth the large sum of money.She knows that her first year tuition will
be $12,000, due at the beginning of the year (that is,right away). Based on historical trends she estimates
that tuition will rise at 6% per year for the 4 years she is in school. She also estimates that her living
expense above and beyondtuition will be $8,000 per year (assume this occurs at the end of the year) for
the first year andwill increase $500 each year thereafter to keep up with inflation. She does not plan to
work atall while attending school. Were she to forgo college she would be able to make $25,000 per year
out of high school and expects that to grow 3% annually. With the college degree, sheestimates that she
will earn $45,000/year out of college, again with annual 3% increases insalary. Either way, she plans to
work until 60 (she begins college right away). Theinterest/discount rate is 6%. What is the NPV of her
college education? (Note: All cash flowsexcept tuition payments occur at the end of the year.)
Your Answer Score Explanation
127072
Correct 15.00 Correct. You have analyzed a real world problem.Total 15.00 / 15.00
Question Explanation
This is a multi-step problem that puts everything together. Makes you analyze a problem thatwe all face
all the time; to get something we have to give up something.

Question 9
(15 points) Rafael owned an apartment building that burned down. The empty lot is worth$70,000 and
Rafael has received $200,000 from the insurance company. Rafael plans to buildanother apartment
building that will cost $275,000. His real estate adviser estimates that theexpected value of the finished
building on the real estate market will be $385,000 next year.The discount/interest rate is 10%? What are
the NPV and IRR of this decision?
Your Answer Score Explanation
($5,000,11.59%)Correct 15.00Correct. You know what cash flows matter and how tofigure out both NPV
and IRR, albeit in a simple context
Total15.00 /15.00
Question Explanation
A simple calculation, but the problem has an interesting aspect from real life

Question 10
(15 points) Sairah purchased an investment property for $350,000, 3 years ago. The after-taxcashfow of
the property has been $35,000 per year to date, but market conditions haveimproved and Sairah expects
the cashflow to improve to $42,000 per year for the next 25years (assume these are year end cashflows).
The annual cost of capital (or cap rate) for thisarea is 9%. What is the value of the property today?(Enter
just the number without the $ signor a comma; round off decimals.)
Answer for Question 10
You entered: 412548

Your Answer Score Explanation
412548
Correct 15.00 Correct. You know value derives from the future.Total 15.00 / 15.00
Question Explanation
Here again the calculations are easy if you understand a key aspect of finance; where does value come
from?