Shrewsbury W1A BUS640
Economics of Risk and Uncertainty Applied Problem
Jessica Shrewsbury
BUS640 Managerial Accounting Instructor Choi
February 23, 2015
Economics of Risk and Uncertainty Applied Problem
Problem 1:
A generous university benefactor has agreed to donate a large amount of money for student scholarships. The money can be provided in one lump sum of $12 million in Year 0 (the current year), or in parts, in which $7 million can be provided at the end of Year 1, and another $7 million can be provided at the end of Year 2.
Describe your answer for each item below in complete sentences, whenever it is necessary. Show all of your calculations and processes for the following points:
a. Assuming the opportunity interest rate is 8%, what is the present value of the second alternative mentioned above? Which of the two alternatives should be chosen and why?
b. How would your decision change if the opportunity interest rate is 12%?
c. Provide a description of a scenario where this kind of decision between two types of payment streams applies in the “real-world” business setting.
Year 0 - Lump Sum
Year 1 - Equal Payments
Year 2 - Equal Payments
Explanation
12,000,000 7,000,000 7,000,000
(482,853)
Gain
12,482,853.22
NPV of two $7 mil. Installments @ 8%
At 8 %, the university should accept two $7 million payments. Given the time value of money, they would be gaining ~$482,853 by accepting two payments. This option should be chosen at the 8% interest rate. 169,643
Loss
11,830,357.14
NPV of two $7 mil. installments @ 12%
At 12%, the university should accept one lump sum payment. Given the time value of money, they would be losing ~$169,643 by foregoing a lump sum payment. The lump sum option should be chosen at the 12% interest rate.
This kind of
Jessica Shrewsbury
BUS640 Managerial Accounting Instructor Choi
February 23, 2015
Economics of Risk and Uncertainty Applied Problem
Problem 1:
A generous university benefactor has agreed to donate a large amount of money for student scholarships. The money can be provided in one lump sum of $12 million in Year 0 (the current year), or in parts, in which $7 million can be provided at the end of Year 1, and another $7 million can be provided at the end of Year 2.
Describe your answer for each item below in complete sentences, whenever it is necessary. Show all of your calculations and processes for the following points:
a. Assuming the opportunity interest rate is 8%, what is the present value of the second alternative mentioned above? Which of the two alternatives should be chosen and why?
b. How would your decision change if the opportunity interest rate is 12%?
c. Provide a description of a scenario where this kind of decision between two types of payment streams applies in the “real-world” business setting.
Year 0 - Lump Sum
Year 1 - Equal Payments
Year 2 - Equal Payments
Explanation
12,000,000 7,000,000 7,000,000
(482,853)
Gain
12,482,853.22
NPV of two $7 mil. Installments @ 8%
At 8 %, the university should accept two $7 million payments. Given the time value of money, they would be gaining ~$482,853 by accepting two payments. This option should be chosen at the 8% interest rate. 169,643
Loss
11,830,357.14
NPV of two $7 mil. installments @ 12%
At 12%, the university should accept one lump sum payment. Given the time value of money, they would be losing ~$169,643 by foregoing a lump sum payment. The lump sum option should be chosen at the 12% interest rate.
This kind of