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Brief Principles of Macroeconomics...

8th Edition
N. Gregory Mankiw
ISBN: 9781337091985

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BuyFindarrow_forward

Brief Principles of Macroeconomics...

8th Edition
N. Gregory Mankiw
ISBN: 9781337091985
Textbook Problem

A company has an investment project that would cost $10 million today and yield a payoff of $15 million in 4 years.

a. Should the firm undertake the project if the interest rate is 11 percent? 10 percent? 9 percent? 8 percent?

b. Can you figure out the exact cutoff for the interest rate between profitability and nonprofitability?

Subpart (a):

To determine

Present value.

Explanation

The present value of future cash flow can be calculated as follows:

Present value=Future value(1+Interest)Time peirod=15,000,000(1+0.11)4=15,000,0001.5181=9,880,772.02

The present value is $9,880,772.02. Since the calculated present value is less than the actual present value, the firm should not undertake this project.

The present value of future cash flow can be calculated as follows:

Present value=Future value(1+Interest)Time peirod=15,000,000(1+0.1)4=15,000,0001.4641=10,245,201.83

The present value is $10,245,201.83. Since the calculated present value is greater than the actual present value, the firm should undertake this project.

Since the calculated present value is less than the actual present value, the firm should not undertake this project

Subpart (b):

To determine

Interest rate.

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