Problem set 1
Student #1 Name____________________ID:____ __
Student #2 Name___________________________ID:_________
Student #3 Name___________________________ID:_________
Group number_______
Instruction
You will earn half of the credits by choosing correct choices.
To get the other half of the credits, you will have to correctly show your calculation in details
on the space provided right after each question. You may write or type your answers.
Submit your work on Canvas
1. A homeowner in a sunny climate has the opportunity to install a solar water heater in his home
for a cost of $2400. After installation the solar water heater will produce hot water for 12 years. The
machine will require maintenance in year 5 and year 10. Each maintenance will cost $700. At least
how much must the homeowner save on water heating costs every year if this is to be a sound
investment? Assume that the useful life of the machine is 12 years, and the interest rate is 11% per
year.
a. $441
b. $456
c. $472
d. $493
Answer:__C __
PV install = $2400
PV 5 = $700 / (1 + 11%)^5 = $415.4
PV 10 = $ 700 / (1 + 11%)^10 = $246.5
PV total = 2400+415.4+246.5 = $3061.9
Annuity
PV = A * (1-(1+r)^-n)/r
If we want the investment to be sound, PV annuity need to equal to 3061.9
A = 3061.9/(1-(1+11%)^-12)/11% = 471.8
Thus, we need to choose C.
2. Your lease calls for payments of $507 at the end of each month for the next 12 months.
Now your landlord offers you a new 1-year lease that calls for zero rent for the first 3
months, then rental payments of $700 at the end of each month for the next 9 months. You
keep your money in a bank time deposit that pays a nominal annual rate of 12 percent. By
what amount would your net worth change if you accept the new lease? (Hint: Your return
per month is 12%/12 = 1%.)
a. -$113.54
b. -$331.94
c. +113.54
d. +$248.60
e. +$331.94
Answer:__C__
Previous lease:
PV = A* (1-(1+r)^-n)/r = $507*(1-(1+1%)^-12)/1% = $5706.3
New lease:
PV new = PV3/(1+r)^3
PV3= A* (1-(1+r)^-n)/r = $700*(1-(1+1%)^-9)/1% = $5996.212
PV new = $5996.212/(1+1%)^3 = $5819.86
Change = PV new – PV = $5819.86 - $5706.3 = 113.5
Thus, we choose C
3. A baseball player is offered a 5-year contract that pays him the following amounts:
Year 1: $1.2 million
Year 2: 1.6 million
Year 3: 2.0 million
Year 4: 2.4 million
Year 5: 2.8 million
Under the terms of the agreement all payments are made at the end of each year.
Instead of accepting the contract, the baseball player asks his agent to negotiate a
contract that has a present value of $1 million more than that which has been
offered. Moreover, the player wants to receive his payments in the form of a 5-year
annuity. The first payment is at t=0 and the last payment is at t=4. All cash flows are
discounted at 4.47 percent. If the team were to agree to the player’s terms, what
would be the player’s annual salary (in millions of dollars)?
a. $1.881
b. $1.951
c. $2.099
d. $2.241
e. $2.368
Answer:___C___
PV = FV1/(1+r)^1+ FV2/(1+r)^2+ FV3/(1+r)^3+ FV4/(1+r)^4+ FV5/(1+r)^5
= $1.2 million/(1+4.47%) + $1.6 million/(1+4.47%)^2 + $2 million/(1+4.47%)^3 + $2.4
million/(1+4.47%)^4 + $2.8 million/(1+4.47%)^5
= 8.6337 million
PV new need to be 8.6337+1 = 9.6337 million
Since the first payment is at t=0, last payment is at t=4, and it is a 5-year annuity.
Thus, PV = A* (1-(1+r)^-n)/r + A (n equals to 4)
Therefore,
9.6337 million = A*(1-(1+4.47%)^-4)/4.47%+A
A = 2.0988
Therefore, we choose C
4. Today is your 20th birthday. Your parents just gave you $5,000 that you plan to use to
open a stock brokerage account. Your plan is to add $500 to the account each year on your
birthday. Your first $500 contribution will come one year from now on your 21 st birthday.
Your 45th and final $500 contribution will occur on your 65th birthday. You plan to withdraw
$5,000 from the account five years from now on your 25th birthday to take a trip to Europe.
You also anticipate that you will need to withdraw $10,000 from the account 10 years from
now on your 30th birthday to take a trip to Asia. You expect that the account will have an
average annual return of 8.24 percent. How much money do you anticipate that you will
have in the account on your 65th birthday, following your final contribution?
a. $92,665
b. $96,051
c. $99,776
d. $105,833
e. $107,541
Answer:___D___
FVd = D * (1 + r)^n
FVo = P * {[(1 + r)^n - 1] ÷ r}
FV 25th = $5,000*(1+8.24%)^5+$500* {[(1 + 8.24%)^5 - 1] ÷ 8.24%} =$7428.633326+
$2947.370541 = $10376.00387
After withdrawl $5000
FV 25th= $10376.00387 -$5000 = $5376.003867
FV 30 th = $5376*(1+8.24%)^5+ $500* {[(1 + 8.24%)^5 - 1] ÷ 8.24%} = $7987.26655+
$2947.3705 = $10934.63709
After withdrawl $10000
FV 30th = 934.63709
Thus, FV 65th= 934.63709* (1 +8.24%)^35+ $500* {[(1 + 8.24%)^35 - 1] ÷ 8.24%}
= $14935.351+ $ 90897.087
= $105832.44
It is near $105,833, so we choose D.
5. Today is Rachel’s 30th birthday. Five years ago, Rachel opened a brokerage account when
her grandmother gave her $25,000 for her 25th birthday. Rachel added $2,000 to this
account on her 26th birthday, $3,000 on her 27th birthday, $4,000 on her 28th birthday, and
$5,000 on her 29th birthday. Rachel’s goal is to have $400,000 in the account by her 40 th
birthday.
Starting today, she plans to contribute a fixed amount to the account each year on her
birthday. She will make 11 contributions, the first one will occur today, and the final
contribution will occur on her 40th birthday. Complicating things somewhat is the fact that
Rachel plans to withdraw $20,000 from the account on her 35 th birthday to finance the
down payment on a home. How large does each of these 11 contributions have to be for
Rachel to reach her goal? Assume that the account has earned (and will continue to earn)
an effective return of 9.5 percent a year.
a. $15,986.76
b. $16,058.52
c. $16,166.00
d. $16,331.81
e. $18,272.60
Answer: __C__
FVd = D * (1 + r)^n
FVo = P * {[(1 + r)^n - 1] ÷ r}
PV 30th = $25000*(1+9.5%)^5 + $2000*(1+9.5%)^4 + $3000*(1+9.5%)^3 +
$4000*(1+9.5%)^2 + $5000*(1+9.5%) = $56441.18755
[PV 30th * (1+9.5%)^5 + P * {[(1 + 9.5%)^6-1] ÷ 9.5%} - $20,000] * (1+9.5%)^5 + P * {[(1 +
9.5%)^5-1] ÷ 9.5%} = $400,000
According to the previous equation, we can get P = 16166.61 , which is near answer C.
6. Net present value approach suggests that if the total PV of cash inflow is higher than the
total PV of cash outflows, then you should invest.
a. Compute net present value of your decision to complete your MSc program (in EXCEL).
b. What are your key assumptions?
c. From your analysis, your NPV calculation is most sensitive to which factors. Please
identify 2-3 factors
7. Tourism Industry in Hong Kong has been severely affected by Covid-19 pandemic. Some
hotel owners will have to sell their hotels this year. How many % drop of value of a
hypothetical hotel when compared its value at the end of 2024 to its value at the end of
2018. For example, your answer might be “the value of a hotel in HK at the end of 2024 is
around 20% lower than the value of the hotel at the end of 2018”.
Make all calculations in Excel.
There is no additional provided by the instructors. Please create and state all assumptions
you use. This is just a rough calculation. No need to spend too much time for details that
have small impact on valuation.