Midterm Exam

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1. You plan to deposit $200 in 1 year, $100 in 2 years, and $300 in 3 years. The interest rate is 5% per year.
a) How much will you have in 3 years? b) What (single) amount do you need to deposit today so as to have the amount (in 3 Years) that you calculated in part a)?

2. You are selling an asset. You can earn an interest rate of 7% (per year) on your savings. You receive the following two (riskless) offers:
Offer 1: Receive $400,000 today Offer 2: Receive $500,000 in 4 years
a) Which offer should you choose? Please substantiate your answer with appropriate calculations. b) At what interest rate would you be indifferent between the two offers? Please substantiate your answer with appropriate calculations.

3. You buy a car for $30,000 and finance it with a 48-month loan (i.e., a 4-year loan) from your bank at 0.25% per month. What is your (fixed) monthly payment? The first payment is due in one month from today.

4. You are 25 years old and decide to save $6,000 per year with the first deposit in one year from now. You will make your last deposit in 35 years from now when you retire at age 60. The interest rate is 5% per year. During retirement, you plan to withdraw funds from the account at the end of each year - your first withdrawal will be at age 61. What constant amount will you be able to withdraw each year if you want the funds to last until you turn 95?

5. You are considering an investment, which requires an upfront cost (today) of $2,000. The expected cash flows of this investment opportunity are $8,000 in 1 year, -$2,000 in 2 years, and $8,000 in 3 years. The interest rate is 5% per year.
a) Calculate the NPV of the investment opportunity. Should you accept the project? b) Why should you not use the IRR rule to evaluate this investment opportunity? Explain concisely. Net present value $10,715.69 NPV > $0

6. The cash flows for a project are: $100 today, $100 in 1 year, $100 in 2 years, and -$400 in 3 years. a. Calculate the IRR for the project. b. If the cost of capital is 10%, will you accept this project? Explain concisely. IPR is 15.09%. This project should be accepted because the rate of return is higher than the cost.

7. Consider the following two mutually exclusive projects:


What problem are you likely to encounter when using the IRR rule to evaluate the above two projects? Answer qualitatively and concisely (in the box below). No calculations required.