Homework # 3 Solutions
3. In order to determine if Floyd should make the investment in the automobile
mechanics course, we need to calculate the net present value of this decision. Since the
cost of the course is incurred at a different point in time than the payoffs, we must put all
monetary costs in present value terms to make them comparable.
Cost of Course: $1,000 (incurred now; year 0)
Forgone Income: $8,000 (incurred now; year 0)
Incremental gain in earnings from course: $13,000$8,000 =$5,000 (received in years 1,2,
3)
Since the costs (direct and indirect) are incurred in the present, they are already in present
value terms. However, the future payoffs need to be placed in present value terms, using
the given interest rate of 10%, and the formula: $future=$now*(1+i)^n
Payoff in year 1: $5,000 =$now_year1*(1+0.10)^1…….$now_year1=$5,000/(1.1)
Payoff in year 2: $5,000=$now_year2*(1+0.10)^2…….
..$now_year2=$5,000/(1.1)^2
Payoff in year 3: $5,000=$now_year3*(1+0.10)^3…….
...$now_year3=$5,000/(1.1)^3
Net present value of investment=
$1,000$8,000+$5,000/(1.1) + $5,000/(1.21) +$5,000/(1.331) = $3,434.26
Since the net present value is positive, Floyd should invest in the automobile mechanics
course.
7. General training is training that is usable at all firms and industries. It enhances the
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 Fall '10
 Bhatt
 Economics, Time Value Of Money, Net Present Value, present value terms

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