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# quanda27 - Chapter 27 1 Whitewater Raft Tour Company can...

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Practice Questions to accompany Mankiw & Taylor: Economics 1 Chapter 27 1. Whitewater Raft Tour Company can purchase rafts today for €100,000. They will earn a €40,000 return on the rafts at the end of each of the next three years. a. If the interest rate were 12 per cent, what is the present value of each of the future returns that Whitewater Raft expects to receive? Answer: €40,000/1.12 = €35,714.29; €40,000/(1.12) 2 = €31,887.76; €40,000/(1.12) 3 = €28,471.21 b. If the interest rate were 12 per cent, should Whitewater Raft invest in the rafts? Explain. Answer: No, the cost is €100,000 but the present value of the return is only €96,073.26. c. If the interest rate were 7 per cent, should Whitewater Raft invest in the rafts? Explain. Answer: Yes. Although the cost is still €100,000, the present value of the returns is now the sum of €40,000/1.07; €40,000/(1.07) 2 ; €40,000/(1.07) 3 which is €104,972.65. d. Compare your answers to parts (b) and (c) above. What general principle about the relationship between investment and the interest rate is demonstrated? Answer:

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quanda27 - Chapter 27 1 Whitewater Raft Tour Company can...

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