Mgcr 341 Assignment 1
MGCR 341: Finance 1
Vadim di Pietro
Assignment 1: Solutions
Topic: Time value of money: Retirement savings problem
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1) Today is July 1, 2010. You just graduated university. You plan to take a year off to travel and then start work one year from today. Your first monthly salary of $5,000 will be paid on August 1, 2011. Assume your monthly salary will increase by 0.8% each month thereafter, until you retire. Suppose that you plan to retire on July 1, 2041, right after receiving your last paycheck on that same day. For each pay check, you save a fraction of your salary and the rest is used to pay off your bills. You expect to live for another 40 years after the day you retire. Your goal is to save enough of each pay check such …show more content…
a) What is the per-month real interest rate?
The nominal monthly interest rate is given by APR/12 = 12%/12 = 1%.
If nominal dollars grow by 1% per month, but prices increase by 0.5% per month, then the purchasing power of a risk free investment increases by the real monthly interest rate of
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b) What is the PV of the amount of money you need in retirement? Solve this in two ways: first, by using formulas that involve nominal cash flows and nominal interest rates, and second, by using formulas that involve real cash flows and real interest …show more content…
Might you prefer the first option if you had an amazing investment opportunity for the $100,000 you have at your disposal? How does your answer depend on whether or not you have access to borrowing/lending at the risk free rate?
If you can borrow at the risk free rate (which is always the assumption unless noted otherwise), then you would still prefer the 2nd option, because you can always borrow another $100,000 for your amazing opportunity.
If you can’t borrow, however, then you might actually prefer the 1st option because you would want to use your $100,000 for your amazing investment opportunity.
Topic: Investment Decision Rules
3) You are considering building a power plant. Today is t = 0. Building the power plant will require a $2bn investment at t = 1, and another $300M investment at t = 2. Starting at t = 4, there will be a maintenance cost each year. The maintenance cost at t = 4 is expected to be $30M, and is expected to grow by 3% each year thereafter. The project is expected to generate $200M in revenues at t = 5, $300M in revenues at t = 6, and revenues are expected to grow 4% each year thereafter, forever.
Assume the appropriate discount rate for a project with this type of risk is 10%.
a) Based on the NPV rule, should you proceed with the project?
Vadim di Pietro
Assignment 1: Solutions
Topic: Time value of money: Retirement savings problem
[pic]
1) Today is July 1, 2010. You just graduated university. You plan to take a year off to travel and then start work one year from today. Your first monthly salary of $5,000 will be paid on August 1, 2011. Assume your monthly salary will increase by 0.8% each month thereafter, until you retire. Suppose that you plan to retire on July 1, 2041, right after receiving your last paycheck on that same day. For each pay check, you save a fraction of your salary and the rest is used to pay off your bills. You expect to live for another 40 years after the day you retire. Your goal is to save enough of each pay check such …show more content…
a) What is the per-month real interest rate?
The nominal monthly interest rate is given by APR/12 = 12%/12 = 1%.
If nominal dollars grow by 1% per month, but prices increase by 0.5% per month, then the purchasing power of a risk free investment increases by the real monthly interest rate of
[pic]
b) What is the PV of the amount of money you need in retirement? Solve this in two ways: first, by using formulas that involve nominal cash flows and nominal interest rates, and second, by using formulas that involve real cash flows and real interest …show more content…
Might you prefer the first option if you had an amazing investment opportunity for the $100,000 you have at your disposal? How does your answer depend on whether or not you have access to borrowing/lending at the risk free rate?
If you can borrow at the risk free rate (which is always the assumption unless noted otherwise), then you would still prefer the 2nd option, because you can always borrow another $100,000 for your amazing opportunity.
If you can’t borrow, however, then you might actually prefer the 1st option because you would want to use your $100,000 for your amazing investment opportunity.
Topic: Investment Decision Rules
3) You are considering building a power plant. Today is t = 0. Building the power plant will require a $2bn investment at t = 1, and another $300M investment at t = 2. Starting at t = 4, there will be a maintenance cost each year. The maintenance cost at t = 4 is expected to be $30M, and is expected to grow by 3% each year thereafter. The project is expected to generate $200M in revenues at t = 5, $300M in revenues at t = 6, and revenues are expected to grow 4% each year thereafter, forever.
Assume the appropriate discount rate for a project with this type of risk is 10%.
a) Based on the NPV rule, should you proceed with the project?