QUESTION # 1

You are offered an asset costing $600 that has cash flows of $100 at the end of each
of the next 10 years.
a. If the appropriate discount rate for the asset is 8 percent, should you purchase
it?
b. What is the IRR of the asset?

Discount Rate 8%

Year Cash Flows

0 $ (600.00)
1 100 NPV $ 71.01
2 100 IRR 10.56%
3 100
4 100
5 100
6 100
7 100
8 100
9 100
10 100
 Question # 2
You just took a $10,000, five-year loan. Payments at the end of each year are flat
(equal in every year) at an interest rate of 15 percent. Calculate the appropriate
loan table, showing the breakdown in each year between principal and interest.

Amount $ 10,000
Tenure 5
Interest rate 15%
PMT $2,983.16

Year Principal Amount Payment Interest

1 $ 10,000 $2,983.16 $ 1,500.00
2 $ 8,516.84 $2,983.16 $ 1,277.53
3 $ 6,811.22 $2,983.16 $ 1,021.68
4 $ 4,849.74 $2,983.16 $ 727.46
5 $ 2,594.05 $2,983.16 $ 389.11
 on # 2
Payments at the end of each year are flat
of 15 percent. Calculate the appropriate
ach year between principal and interest.

Payment of Principal Remaining Balance

$1,483.16 $ 8,516.84
$1,705.63 $ 6,811.22
$1,961.47 $ 4,849.74
$2,255.69 $ 2,594.05
$2,594.05 0
 Question # 3
You are offered an investment with the following conditions:
• The cost of the investment is $1,000.
• The investment pays out a sum X at the end of the first year; this payout grows
at the rate of 10 percent per year for 11 years.
If your discount rate is 15 percent, calculate the smallest X that would entice you
to purchase the asset. For example, as you can see in the following display, X = $100
is too small—the NPV is negative.

Investment $ 1,000
interest rate 10%
Discount rate 15%

year Cash Flow npv $ 5.53

0 $ (1,000.00)
1 130
2 143
3 157.3
4 173.03
5 190.333
6 209.37
7 230.30
8 253.33
9 278.67
10 306.53
11 337.19
nditions:

this payout grows

.
would entice you
ng display, X = $100
 Question # 4
The following cash-flow pattern has two IRRs. Use Excel to draw a graph of the
NPV of these cash fl ows as a function of the discount rate. Then use the IRR function
to identify the two IRRs. Would you invest in this project if the opportunity
cost were 20 percent?

year Cash flows Discount rate NPV

0 -500 0% -100
1 600 3% -182
2 300 6% -257
3 300 15% -440
4 200 20% -522
5 -1000 25% -592

IRR (1st) 6.339%

IRR (2nd) 60.196%
nction
 QUESTION # 5
In this exercise we solve iteratively for the internal rate of retur
investment that costs 800 and has cash fl ows of 300, 200, 150, 122
(see cells A8:B13 in the following spreadsheet). Setting up the loan
10 percent is greater than the IRR (since the return of principal at
5 is less than the principal at the beginning of the ye

IRR 5.07%

Year Cash Flows Year Principal Amount Payment

0 -800 1 $ 800 $300.00
1 300 2 $ 540.55 $200.00
2 200 3 $ 367.94 $150.00
3 150 4 $ 236.59 $122.00
4 122 5 $ 126.58 $133.00
5 133
QUESTION # 5
ly for the internal rate of return. Consider an
ash fl ows of 300, 200, 150, 122, 133 in years 1–5
readsheet). Setting up the loan table shows that
since the return of principal at the end of year
ipal at the beginning of the year).

Interest Payment of Principal Remaining Balance

$ 40.55 $259.45 $ 540.55
$ 27.40 $172.60 $ 367.94
$ 18.65 $131.35 $ 236.59
$ 11.99 $110.01 $ 126.58
$ 6.42 $126.58 $ 0.00
 QUESTION # 6
An alternative defi nition of the IRR is the rate that makes the principal
beginning of year 6 equal to zero.9 In the preceding printout cell E9 gives th
at the beginning of year 6. Using the Goal Seek function of Excel, fi n
the rate that changes this fi gure to zero (the following picture shows how t
should look).

IRR 5.07%

Year Cash Flows Year Principal Amount Payment

0 -800 1 $ 800 $300.00
1 300 2 $ 540.55 $200.00
2 200 3 $ 367.94 $150.00
3 150 4 $ 236.59 $122.00
4 122 5 $ 126.58 $133.00
5 133 6 $ 0.00
ON # 6
he rate that makes the principal at the
eceding printout cell E9 gives the principal
e Goal Seek function of Excel, fi nd
e following picture shows how the screen
look).

Interest Payment of Principal Remaining Balance

$ 40.55 $259.45 $ 540.55
$ 27.40 $172.60 $ 367.94
$ 18.65 $131.35 $ 236.59
$ 11.99 $110.01 $ 126.58
$ 6.42 $126.58 $ 0.00
 QUESTION # 6
You currently have $25,000 in the bank, in a savings account that draws 5 percent
interest. Your business needs $25,000, and you are considering two options: (a) Use
the money in your savings account or (b) borrow the money from the bank at
6 percent, leaving the money in the savings account.
Your fi nancial analyst suggests that solution (b) is better. His logic: The sum of the
interest paid on the 6 percent loan is lower than the interest earned at the same
time on the $25,000 deposit. His calculations are illustrated in the following spreadsheet.
Show that this logic is wrong. (If you think about it, it couldn’t be preferable
to take a 6 percent loan when you are getting 5 percent interest from the bank.
However, the explanation may not be trivial.)

Interest earned 5%
Interest paid 6%
Initial deposit 25,000

6% Loan
Year Principal AmounPayment Interest Payment of Principa
1 $25,000 $13,635.92 $1,500.00 $12,135.92
2 $12,864.08 $13,635.92 $771.84 $12,864.08

Savings Account
In th Saving
account in the Interest
Year beginning of earned at the In Account at the
the year end of year end of year
1 $25,000 $1,250.00 $26,250.00
2 $26,250.00 $1,312.50 $27,562.50

We should select the savings account option as we should not take loan when we hav
N#6
aws 5 percent
options: (a) Use

The sum of the

d at the same
ollowing spreadsheet.

m the bank.

Remaining Balance
$12,864.08
$-

not take loan when we have initial investment needed to open our business.