Chapter 2 Solutions 1

TM 661 Chapter 3 Solutions 1

5) If you desire a real return of 8% on your money, excluding inflation, and inflation is running 3%, what combined discount rate should you be seeking?

Soln:

i = d + f + df

= .08 + .03 + .08(.03)

= .1124 = 11.24%

6) Mellin Transformers Co. uses a required return of 15% in all alternative evaluations. Inflation is running at 5%. What real discount rate, exclusive of inflation, are they implicitly using?

Soln:

d = (i - f)/(1+f)

= (.15 - .05)/(1.05)

= .0952 = 9.52%

Chapter 2 Solutions 2

TM 661 Chapter 3 Solutions 1

8) A landfill has a first cost of $270,000. Annual operating and maintenance costs for the first year will be $40,000. These costs will increase at 11% per year. Income for dumping rights at the landfill will be held fixed at $120,000 per year. The landfill will be in operation for 10 years. Inflation will average 8%, and a real return of 3.6% is desireed.

A) determine the present worth using then-current $.

B) determine the present worth using contant worth $

Soln:

Then current $ are the actual physical cashflow in periods 0-10. The net present value is then computed at the combined interest rate i = d + f + df = 11.89%. Constant worth $ are computed by taking the physical cash flow (then current) and discounting them back to time 0 by the inflation rate. The net present value is then computed by using the real interest rate d = 3.6%. The cash flow streams and net present value are shown below.

d = 3.60%f = 8.00%i = 11.89%

Then Constantt Costs Revenue Current Worth0 270,000 (270,000) (270,000)1 40,000 120,000 80,000 74,0742 44,400 120,000 75,600 64,8153 49,284 120,000 70,716 56,1374 54,705 120,000 65,295 47,9945 60,723 120,000 59,277 40,3436 67,402 120,000 52,598 33,1457 74,817 120,000 45,183 26,3648 83,046 120,000 36,954 19,9659 92,182 120,000 27,818 13,91610 102,321 120,000 17,679 8,189

NPV = 66,148 66,148

Chapter 2 Solutions 3

TM 661 Chapter 3 Solutions 1

16) Dr. Schulz is considering purchasing a bond having a face value of $2,500 and a bond rate of 10% payable semi-annually. The bond has a remaining life of 8 years. How much should she pay for the bond in order to earn a return on investment of 14% compounded semiannually?

Soln:

The bond earns 10% per year or 5% semi-annually. 5% of 2,500 = 125. 8 years remaining equates to 16 semi-annual periods. The physical cash flow for the bond is then shown below.

Since Dr. Schulz wants 14% compounded semi-annually (7%) per period, we can compute the Present worth of the cash flow by

= 125 (P/A, 7, 6) + 2,500 (P/F, 7, 16)

= 125 (9.4466) + 2,500 (.3387)

= 2,027

P

125 125 125

2,500

1 2 3 16