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chapter015

# chapter015 - CHAPTER 15 THE EFFECTS OF TIME AND RISK ON...

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CHAPTER 15 THE EFFECTS OF TIME AND RISK ON VALUE Test Problems 1. How much will a \$50 deposit made today be worth in 20 years if the compound rate of interest is 10 percent? d. \$336.37 2. How much would you pay for the right to receive \$80 at the end of 10 years if you can earn 15 percent interest? b. \$19.77 3. How much would you pay to receive \$50 in one year and \$60 in the second year if you can earn 15 percent interest? a. \$88.85 4. What amount invested at the end of each year at 10 percent annually will grow to \$10,000 at the end of five years? b. \$1,637.97 5. How much would you pay for the right to receive nothing a year for the next 10 years and \$300 a year for the following 10 years if you can earn 15 percent interest? a. \$372.17 6. What is the present value of \$500 received at the end of each of the next three years and \$1,000 received at the end of the fourth year, assuming a required rate of return of 15 percent? c. \$1,713.37 7. If a landowner purchased a vacant lot six years ago for \$25,000, assuming no income or holding costs during the interim period, what price would the landowner need to receive today to yield a 10 percent annual return? c. \$44,289.03 8. What is the present value of the following series of cash flows discounted at 12 percent: \$40,000 now; \$50,000 at the end of the first year; \$0 at the end of year the second year; \$60,000 at the end of the third year; and \$70,000 at the end of the fourth year? d. \$171,835.94 9. Assume an income-producing property is priced at \$5,000 and has the following income stream (year 1, \$1,000; year 2, -\$2,000; year 3, \$3,000; and year 4, \$3,000). Would an investor with a required rate of return of 15 percent be wise to invest at the current price? 15-1

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b. No, because the project has a net present value of -\$1,954.91. Study Questions 1. Dr. Bob Jackson owns a parcel of land that a local farmer has offered to rent for the next 10 years. The farmer has offered to pay \$20,000 today or an annuity of \$3,200 at the end of each of the next 10 years. Which payment method should Dr. Jackson accept if his required rate of return is 10 percent? Solution : Dr. Jackson should choose the payment method that maximizes his net present value. If he chooses the lump sum payment, the net present value is simply the \$20,000 he will receive today. If he chooses the annuity plan, the net present value will be only \$19,662.61. N = 10 I = 10 % PV =? PMT = 3,200 FV = 0 Therefore, Dr. Jackson should choose the lump sum payment of \$20,000. 2. You are able to buy an investment for \$1,000 that gives you the right to receive \$438 in each of the next three years. What is the internal rate of return on this investment?
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