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Homework7

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Chapter 7 Homework

Work Problems 1-11.

Please work Odd problems: 1,3,5,7,9,11

Answer to the Even numbers are below.

Chapter 7

2. The compound annual growth rate is 14.6 percent.

4. The monthly interest on this loan is 0.417% (5%/12). After the first 12 months with no payments, the balance on the loan will increase to $81,486.

To determine the size of the balloon payment at the end of the sixth year, solve for the future value of the loan given the 5 years of monthly car payments of $1,250. The result is a balloon payment at the end of the 6-year loan of $19,568.

6. The $800 spent to date is sunk; you cannot recoup this money regardless of how the prospective sale works out. You should be willing to spend up to an additional $1,000 if you are confident doing so will land the sale. Here is another way to look at it. Suppose you are certain an additional expenditure of $900 will guarantee the sale. You then have two options: 1. quit trying and lose $800 already spent, or 2. spend the additional $900 for a total expense of $1,700, which net of the $1,000 receipt from the sale results in a loss of $700. I’d rather lose $700 than $800.

8. Applying the with-without principle, the relevant cash flows for the promotional campaign are as follows:

Year 0 1 2 3 4 5
Cash flow ($ millions) –$55 16 16 16 16 16

The annual cash flow with the investment is $1 million, and the annual cash flow without the investment is –$15 million. Taking the difference, $1 million – (–$15 million) = $16 million. In other words, the promotional campaign increases annual cash flows by $16 million. The chief benefit of this investment is it enables the company to avoid losing its shirt.

The PV of the 5-year cash flow of $16 million = $63.9 million. The NPV = –$55 + $63.9 = $8.9 million. Therefore, the campaign is attractive. It prevents a large loss.

The important moral to this problem is that the do-nothing alternative is not always zero. You need to think carefully about the consequences of not making an investment. If the investment avoids a negative outcome, this is a legitimate benefit to the investment.

10. a. Undertake all three investments. The NPV and the IRR indicate that all of the investments are worthwhile.

b. Undertake investment A because it has the highest NPV, and NPV is a direct measure of the increase in wealth from undertaking the investment.

c. If the capital budget is fixed at $5.5 million, invest in C and B, and put the remaining $500,000 in A if possible. This is the bundle of investments with the highest total NPV. One can select this bundle by ranking investments by their IRR, or occasionally more accurately by their BCR.

=RATE(10,0,-.66,2.58) = 14.6%RATE(nper, pmt, pv, [fv], [type], [guess])

=FV(.05/12,12,0,77520) = ($81,486)FV(rate, nper, pmt, [pv], [type])

=FV(.05/12,60,-1250,81486) = ($19,568)FV(rate, nper, pmt, [pv], [type])

=PV(.08,5,16) = ($63.9)

PV(rate, nper, pmt, [fv], [type])

see attached for details

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  • Chapter7Homework.docx

 

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