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Lecture 2 Practice Quiz

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Lecture 2 Practice Quiz

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homeworkduetmmrw
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Practice Quiz 2: Time Value of Money

1. What is more valuable: $1,000 today or $1,000 in one year? Why?

2. Using an interest rate of 7%, calculate the present value of $300 to be received in (a) one year, (b)
five years, and (c) ten years.

3. John plans to purchase a one-year Treasury Bill (T-Bill). The T-Bill will pay the holder $1,000 in one
year. If John requires a return of at least 2% on such an investment, what is the most he will be
willing to pay for the T-Bill?

4. Mike is considering quitting his job to start a bakery, his dream work. To do so, he would need to
make an investment of $80,000 today. He estimates that the bakery would generate revenues of
$90,000 over the next five years and would require $20,000 in expenses. At his current job he
earns $50,000. Therefore, Mike estimates that the incremental cash flows from opening the
bakery would be $20,000 per year for the next five years. Calculate the NPV of the business using a
discount rate of 15%. Should Mike quit his job and start the bakery?

5. Calculate the IRR for the project described in problem 4. If Mike requires a return of 15% on the
business, should he start the bakery?

6. If Mike instead invests an additional $5,000 in new equipment and upgrades for the bakery each
year, the bakery will remain operational and generate net cash flows of $15,000 into perpetuity.
Given the same initial investment of $80,000 and discount rate of 15%, calculate the NPV of
opening the bakery. Should Mike quit his job and start the bakery?

7. Bobby buys a scratch-off ticket every day and today he hits it big with a $100,000 winning ticket.
But when he turns in his ticket, he’s informed of the fine print that states the $100,000 is payable
in annual installments of $10,000 per year over the next 10 years. If he wants a lump sum today,
he will only get $85,000. If the interest rate is 5%, is it better for Bobby to take the ten $10,000
annual installments or the $85,000 lump sum?

8. Jordan is considering starting a Widget manufacturing company. The initial investment in tools will
cost $1,500,000. Jordan estimates that he can earn profits of $50,000 a year for the first 2 years
while he establishes the business, $100,000 a year for the next 3 years, and then $200,000 a year
for 10 more years before the tools wear out. The project is risky, because Jordan is not certain he
will earn these profits. To compensate for this risk, Jordan requires a high return of 25% on such an
investment. What is the net present value (NPV) of this business project? Should Jordan
undertake the investment?

9. Alice is a young professional and is considering a certification program for her field. The
certification program is a self-study program that will take three years. The cost is $1,000 per year.
Further, Alice estimates that it will take 200 hours of study time per year, and since she values her
time at her wage of $30 per hour, she considers the $6,000 of lost time per year a cost of the

The George Washington University School of Business Duquès Hall, Suite 450 | 2201 G Street NW | Washington, D.C. 20052 202-994-
7148 | [email protected] | www.gflec.org
program. On average, professionals with the certification make $5,000 more per year. Assuming a
cost of $7,000 per year for the next three years and an increase in income of $5,000 for the
following 30 years, what is the return on this certification? If Alice requires a return of 10%, should
she pursue the certification?

Personal Finance – Practice Quiz 2: Time Value of Money | 2

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