Suggested Solutions for the Numerical Questions in Exam I 6. (10) | Mr. Dell has $100 income this year and zero income next year. The market interest rate is 10% per year. Mr. Dell also has an investment opportunity—having the same risk as the market in which he can invest $50 this year and receive $80 next year. Suppose Mr. Dell consumes $50 this year and invests in the project. What is the NPV of the investment opportunity? NPV = (80/1.1) - 50 = + 22.73. | 7. (11) | Ms. Anderson has $60,000 income this year and $40,000 next year. The market interest rate is 10% per year. Suppose Ms. Anderson consumes $80,000 this year. What will be her consumption next year? Borrow $20,000 this year to consume 60,000 + 20,000 = 80,000. Consumption next year = 40,000 - (20,000 × 1.1) = 18,000. |

9. (13) | Mr. Smith has an income of $40,000 this year and $60,000 next year. He can invest in a project that costs $30,000 this year, which generates an income of $36,000 next year. The market interest rate is 10%. What will be his consumption next year if Mr. Smith invests in the project and consumes $50,000 this year? Consumption next year = [40,000 - 30,000 - 50,000] × 1.1 + (60,000 + 36,000) = 52,000. | 14. | Given the following data for Project M:

NPV = -200 + 150/1.05 + 120/(1.05^2) = 51.70. |

15. | Your firm expects to receive a cash flow in two years of $10,816 in nominal terms. If the real rate of interest is 2% and the inflation rate is 4%, what is the real cash flow for year 2? Real cash flow = 10,816/(1.04^2) = 10,000. |

16. | The real cash flow occurring in year 2 is $60,000. If the inflation rate is 5% per year and the realrate of interest is 2% per year, calculate the nominal cash flow for year 2. Nominal cash flow = (60,000)(1.05)^2 = 66,150. |
17. A firm has a general-purpose machine, which has a book value of