« previous next »

Author Question: A financial services company offers to pay you 1,000 a year for life in exchange for 20,000 today. ... (Read 100 times)

ishan

  • Hero Member
  • *****
  • Posts: 546
on: Jul 1, 2018
A financial services company offers to pay you 1,000 a year for life in exchange for 20,000 today. What factors affect your decision to take this offer?
 
  What will be an ideal response?

Question 2

Suppose that your college offers you two payment plans for your last two years of college. You may either pay tuition of 20,000 per year at the beginning of each of the next two years, or pay just 38,000 before the start of freshman year. What would the interest rate have to be for you to be indifferent between these two deals? Explain.
 
  What will be an ideal response?
Microeconomics ¦ Perloff ¦ 8th Edition
Buy Test-Bank


tofugiraffe

  • Sr. Member
  • ****
  • Posts: 319
Reply #1 on: Jul 1, 2018
Answer to Question 1

This policy has an internal rate of return of 1/20 = 5. If the interest rate exceeds 5, then there are better investments elsewhere. If the interest rate is less than 5, this is a good deal.

Answer to Question 2

One is indifferent when the future stream of tuition payments has a present value of 38,000.

20,000  1 + 1/(1 + irr) = 38,000
1/(1 + irr) = 0.9 or irr = 11.11

If the interest rate is 11.11, the student can pay the first year's tuition and deposit 18,000 in a bank account today and withdraw 20,000 at the end of the first year to make her second payment. If the interest rate exceeds 11.11, the student can deposit 18,000 today, make the 20,000 payment in Year 2, and still have something left over. If the interest rate is less than 11.11, the student is better paying the 38,000 all at once.


Related Topics

Need homework help now?

Ask unlimited questions for free

Ask a Question
« previous next »
 

Did you know?

The Babylonians wrote numbers in a system that used 60 as the base value rather than the number 10. They did not have a symbol for "zero."

Did you know?

Sperm cells are so tiny that 400 to 500 million (400,000,000–500,000,000) of them fit onto 1 tsp.

Did you know?

Tobacco depletes the body of vitamins A, C, and E, which can result in any of the following: dry hair, dry skin, dry eyes, poor growth, night blindness, abscesses, insomnia, fatigue, reproductive system problems, sinusitis, pneumonia, frequent respiratory problems, skin disorders, weight loss, rickets, osteomalacia, nervousness, muscle spasms, leg cramps, extremity numbness, bone malformations, decayed teeth, difficulty in walking, irritability, restlessness, profuse sweating, increased uric acid (gout), joint damage, damaged red blood cells, destruction of nerves, infertility, miscarriage, and many types of cancer.

Did you know?

In 1864, the first barbiturate (barbituric acid) was synthesized.

Did you know?

In 1835 it was discovered that a disease of silkworms known as muscardine could be transferred from one silkworm to another, and was caused by a fungus.

On March 25, 1911, as scores of young factory girls leaped to their deaths from the eighth, ninth, a On March 25, 1911, as scores of young factory girls leaped to their deaths from the eighth, ninth, a
Many households today include young adults who have not moved out of their parents’ homes (or who ... Many households today include young adults who have not moved out of their parents’ homes (or who ...
Women who reported one, two, or three or more major life events in the past 5 years were ... Women who reported one, two, or three or more major life events in the past 5 years were ...
The Life Cycle of a Midlatitude Cyclone: Cyclogenesis The Life Cycle of a Midlatitude Cyclone: Cyclogenesis
Flowering plant life cycle Flowering plant life cycle
Walking into new year kids drawing Walking into new year kids drawing
Video: Barriers - eye structures, digestive mucosa, respiratory mucosa & genitourinary mucosa

For a complete list of videos, visit our video library