a.
The
a.
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.
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.
The reason for the change in preferred choice in part a when interest rate is lowered.
b.
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.
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.
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Chapter 24 Solutions
Krugman's Economics For The Ap® Course
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