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Ross5eChap04sm - 4.4 There would be too much borrowing The...

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Chapter 4: Financial Markets and Net Present Value: First Principles of Finance 4.1 $108,000 – ($135,000 – $85,000) (1.07) = $54,500 In order to consume $135,000 this year Jack will borrow $50,000 and pay $53,500 ($50,000 principal and $3,500 interest) next year, leaving him $54,500 potential consumption next year. 4.2 $38,000 + ($55,000 – $20,000) (1.09) = $76,150 Rich will earn $3,150 interest on the $35,000 he lends out this year, which will increase his potential consumption by $38,150 to $76,150 next year. 4.3 Financial markets arise to facilitate borrowing and lending between individuals. By borrowing and lending, people can adjust their pattern of consumption over time to fit their particular preferences. This allows corporations to accept all positive NPV projects, regardless of the inter–temporal consumption preferences of the shareholders.
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Unformatted text preview: 4.4 There would be too much borrowing. The borrowers would have to be given limited access to the market. This would also be an irresistible arbitrage opportunity that could not last long and a new equilibrium would be set. 4.5 a. Since the PV of labour income is $70, and $70 = $50 + $44 / (1 + r), r must be equal to 120%. b. NPV = $85 – $70 = $15 c. Her wealth is $85. Letting C denote consumption, she wants $85 = C + C/(1 + r) where r = 1.20. Solve for C; C = $58.44 4.6 a. $91,500 / $76,250 – 1 = 0.20 or 20% b. He will invest $10,500 in financial assets and $32,500 in productive assets today. c. NPV = –$32,500 + $52,500 / 1.2 = $11,250 4.7 a. AE. b. CF / BD. The equity will appreciate to BE on the announcement. c. AF / AB. Answers to End–of–Chapter Problems B–20...
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