Problem 1: A generous university benefactor has agreed to donate a large amount of money for student scholarships. The money can be provided in one lump sum of $12 million in Year 0 (the current year), or in parts, in which $7 million can be provided at
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| Problem 1: | ||||||||||||||||||||||||||||||||
| A generous university benefactor has agreed to donate a large amount of money for student scholarships. The money can be provided in one lump sum of $12 million in Year 0 (the current year), or in parts, in which $7 million can be provided at the end of Year 1, and another $7 million can be provided at the end of Year 2. | ||||||||||||||||||||||||||||||||
| Describe your answer for each item below in complete sentences, whenever it is necessary. Show all of your calculations and processes for the following points: | ||||||||||||||||||||||||||||||||
| 1. Assuming the opportunity interest rate is 8%, what is the present value of the second alternative mentioned above? Which of the two alternatives should be chosen and why? | ||||||||||||||||||||||||||||||||
| 2. How would your decision change if the opportunity interest rate is 12%? | ||||||||||||||||||||||||||||||||
| 3. Provide a description of a scenario where this kind of decision between two types of payment streams applies in the “real-world” business setting. | ||||||||||||||||||||||||||||||||
| Problem 2: | ||||||||||||||||||||||||||||||||
| The San Diego LLC is considering a three-year project, Project A, involving an initial investment of $80 million and the following cash inflows and probabilities: | ||||||||||||||||||||||||||||||||
| Describe your answer for each question in complete sentences, whenever it is necessary. Show all of your calculations and processes for the following points: | ||||||||||||||||||||||||||||||||
| 1. Describe and calculate Project A’s expected net present value (ENPV) and standard deviation (SD), assuming the discount rate (or risk-free interest rate) to be 8%. What is the decision rule in terms of ENPV? What will be San Diego LLC’s decision regarding this project? Describe your answer. | ||||||||||||||||||||||||||||||||
| 2. The company is also considering another three-year project, Project B, which has an ENPV of $32 million and standard deviation of $10.5 million. Project A and B are mutually exclusive. Which of the two projects would you prefer if you do not consider the risk factor? Explain. | ||||||||||||||||||||||||||||||||
| 3. Describe the coefficient of variation (CV) and the standard deviation (SD) in connection with risk attitudes and decision making. If you now also consider your risk-aversion attitude, as the CEO of the San Diego LLC will you make a different decision between Project A and Project B? Why or why not? | ||||||||||||||||||||||||||||||||
11 years ago
Problem 1: A generous university benefactor has agreed to donate a large amount of money for student scholarships. The money can be provided in one lump sum of $12 million in Year 0 (the current year), or in parts, in which $7 million can be provided at
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