Midterm Solutions

# Midterm Solutions - E120 Midterm Solution Summer 2007...

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E120 Midterm Solution Summer, 2007 Question 1 APR = 12% compounded monthly monthly interest rate is r = 1%. Quarterly interest rate: r q = (1 + 1%) 3 - 1 = 0 . 0303; Annual interest rate: EAR = (1 + 1%) 12 - 1 = 0 . 1268. To decide which investment to make, we need to evaluate the present values of the cash flow related to each investment. If invest in Hi-Tech venture: Invest \$30 , 000 at t = 0; From t = 0 to t = 20, get profit of \$3 , 000 ; At t = 20, get \$45 , 000 from selling the venture. The time internal for this cash flow is quarter. Thus, PV H = - 30000 + 3000 1 - (1+0 . 0303) - 20 0 . 0303 + 45000 0 . 0303 20 = 39278 . 70 If invest in Restaurant: At t = 0 invest \$30 , 000; At t = 1 invest another \$10 , 000; From t = 3 to t = 7, get profit of \$10 , 000; At t = 7, get \$70 , 000 by selling the restaurant. The time internal for this cash flow is annual. Thus PV R = - 30000 + 10000 1 + 0 . 1268 + 10000 1 - (1 + 0 . 1268) - 5 0 . 1268 1 (1 + 0 . 1268) 2 + 70000 (1 + 0 . 1268) 7 = 19388 . 06 1

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Since the cash flow of investing Hi-Tech venture have higher present value, she should invest Hi-Tech venture. Question 2 (a) APR = 12 compounded quarterly Quarterly interest rate: r q = 12% 4 = 3% Assume that it will take t
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