PS 1 Solutions - Solutions to Problem Set 1 Corporate...

Info icon This preview shows pages 1–3. Sign up to view the full content.

Solutions to Problem Set 1 Corporate Finance, Sections 301 and 302 1. The present value formula is = $280 1 + r If = $250, then the discount factor, 1 / (1 + r ) must be: = 1 1 + r = $250 $280 = 0 . 8929 2. Similarly, if $320 = $400 1 + r , then r = $400 $320 - 1 = 0 . 25 so the discount rate is 25%. 3. The bond is a better investment. After 10 years, the PNC bank deposit will have grown to: = 550(1 . 045) 10 = 854 . 13 , which is lower than the face value (of $1000) of the bond. 4. We first need to determine if the project is worth doing. Note that r = 15%, C 0 = - 5 , 000, C 1 = 6 , 000. Then = - 5 , 000 + 6 , 000 1 . 15 = 217 > 0 , so the project is worth doing. Lara starts with initial wealth of $8000. The remaining part of her wealth = 8 , 000 - 5 , 000 = 3 , 000 should be invested in the bank at 15%. Hence the most Lara can consume in old age equals 6 , 000 + 3 , 000(1 . 15) = $9 , 450 5. Again, the first step is to determine the NPV of the project. Using the same reasoning as in the above question, = - 12 , 000 + 15 , 000 1 . 18 = 712 > 0 . 1
Image of page 1

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

So James should undertake the project. Given that James will inherit $3000 in his old age, the most he can consume now is $712 + $3000 1 . 18 = $3254 . 37 . Note that to obtain this level of consumption, he borrowes the full amount, plus $12,000 from the bank. In old age, he then pays this back with interest: ($12 , 000 + $3254 . 37)(1 . 18) = $18 , 000 He can pay back $18000 because of the $15000 from the project, plus the $3000 he inherits.
Image of page 2
Image of page 3
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern