21
CHAPTER 2
Present Values, the Objectives of the Firm,
and Corporate Governance
Answers to Practice Questions
9.
The face value of the treasury security is $1,000.
If this security earns 5%, then
in one year we will receive $1,050.
Thus:
NPV = C
0
+ [C
1
/(1 + r)] =
$1000 + ($1050/1.05) = 0
This is not a surprising result because 5% is the opportunity cost of capital, i.e.,
5% is the return available in the capital market.
If any investment earns a rate of
return equal to the opportunity cost of capital, the NPV of that investment is zero.
10.
NPV =
$1,300,000 + ($1,500,000/1.10) = +$63,636
Since the NPV is positive, you would construct the motel.
Alternatively, we can compute r as follows:
r = ($1,500,000/$1,300,000) – 1 = 0.1538 = 15.38%
Since the rate of return is greater than the cost of capital, you would construct
the motel.
11.
Investment
NPV
Return
(1)
$5,000
1.20
18,000
10,000
80.0%
0.80
10,000
10,000
18,000
(2)
$2,500
1.20
9,000
5,000
80.0%
0.80
5,000
5,000
9,000
(3)
$250
1.20
5,700
5,000
14.0%
0.14
5,000
5,000
5,700
(4)
$1,333.33
1.20
4,000
2,000
100.0%
1.00
2,000
2,000
4,000
a.
Investment 1, because it has the highest NPV.
b.
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 Spring '10
 22
 Net Present Value

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