Chapter 24, Problem 1CYU

a.

To determine

The net present value of the project where the interest rate will be 2%.

Explanation of Solution

Given Information:

Projects	Current value of the dollar realized today	Dollar realized after one year	Present value	Net present value at 10%
A	$100	-	$100	$100
B	-$10	$115	-$10+$115 (1+r)	$94.55
C	$119	-$20	$119-$20(1+r)	$100.82

If the interest rate is 2%, then the net resent value will be calculated as follows:

Projects	Current value of the dollar realized today	Dollar realized after one year	Present value	Net present value at 2%
A	$100	-	$100	$100
B	-$10	$115	-$10+$115 (1+r)	$102.7451
C	$119	-$20	$119-$20(1+r)	$99.39

In this, project B should be selected as it has the highest NPV.

Economics Concept Introduction

Interest rates: The rates that were charged by the investor who is ready to lend his/her money for a certain period of time to the borrower.

Present value of money: This is the concept that is used by every investor or financial dealer where the value of the dollar received today is compared with the value of the dollar that is expected to be received later by using interest rates.

b.

To determine

The reason for the change in preferred choice in part a when interest rate is lowered.

Explanation of Solution

If the interest rate is 2% then discounting effect is less on the dollar realized after one year. In the previous case, project C was better as NPV for project C was the highest. Therefore, project B is better if the interest rate is lowered.

Economics Concept Introduction

Interest rates: The rates that were charged by the investor who is ready to lend his/her money for a certain period of time to the borrower.

Present value of money: This is the concept that is used by every investor or financial dealer where the value of the dollar received today is compared with the value of the dollar that is expected to be received later by using interest rates.