Mid Term 2 Question

Use the assets described below to answer the questions

Year A B C
0 -10 -20 -30
1 8 0 0
2 0 0 0
3 0 15 0
4 0 0 20

Assume a 10 % minimum acceptable rate for these assets.

Questions

1. What is the prest worth of asset C?

a) $-11.82
b) $43.66
c) $-16.34
d) None of the above

2. What is the annual worth of asset C?

a) $-5.15
b) $-2.50
c) $26.58
d) None of the above

3. If this is not a service investment, meaning you have the choice of not buying any asset, which asset would you choose?

a) A
b) B
c) C
d) None of the above

Solution

1. P = F(1 + i)N is the equation we will use to determine the present worth of asset C. The idea here is to move all of the none zero values back to time period zero, or in this case Year 0.

P = -30 + 20(1 + 0.10)-4 = $-16.34

Answer is c) $-16.34

2. A = P( (i(1 + i)N) / ( (1 + i)N - 1)) is the equation we will use to determine the annual worth of asset C. The idea here is that you need to use the present worth you found in problem 1 to determine the annual worth correctly. Remember that present worth moves all the value back to time period zero while annual worth spreads it at an even value for all periods observed.

A = -16.34( (0.1(1 + 0.1)4) / ( (1 + 0.1)4 - 1)) = $-5.15

Answer is a) $-5.15

3. To answer this question we could use the same principles and equations we used in the previous two problems, which is absolutely fine, but remember you are on a tight time budget on the exam. Look at the relationship between the values and use your experience with determining the values of asset C in relation to assets A and B. The ending values of all assets are positive but are all smaller than the initial investments. Therefore, we see that the present worth for all of these assets will be less than one, and because we are not forced to select the best of the worst in this case we choose answer d) None of the above. This way we do not loose any money on the investment.

Answer is d) None of the above

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