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Answers to Problem Set 7
1.
(a) The equation is
65+30 δ + 84 δ
2
10 δ
3
 12
δ
4
= 0
(b) Only
δ=.77 makes sense here which in turn gives i*=.2864.
(c )
The balance in the “project account” (see handout) has to be zero at the end of the project.
In year 0 the balance is
Fo=65
Since Fo is negative, the borrowing rate i’ will be used to calculate the interest plus principal which is
(1+i’ )(65).
But at the end of year 1 there is a deposit (positive amount) of 30, therefore the balance at
the end of year 1 will be
F
1
=
(1+i’ )(65)+30
Even at a borrowing rate of 0%, F
1
will be negative and thus the rate i’ should be used again to calculate
the next period’s balance:
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 Winter '11
 Panzer

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