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CHAPTER 11
1.1 All are capital except (d), (f), and (i). Capital refers to those goods produced by the economic
1.2 (a) Disagree. Capital is a stock measure and refers to those goods produced by the economic
(b) Disagree. Depreciation is a decline in an assets economic value over time do to use or
(c) Disagree. Social capital does provide services to the public, but social capital can take the
1.3 Physical capital would include the buildings, laboratories, photocopying equipment, chalkboards,
The value of the physical capital stock could be measured by estimating how much it could sell
2.1 When interest rates rise, ceteris paribus, one would except the level of investment spending to
2.2 Savings can be borrowed by business firms, which can purchase new technology, engage in
2.3 Answers will vary. Interest rates differ because of the terms of the loan (how long before the loan
is due) and the risk associated with the loan. Longer term interest rates may reflect expectations
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Solutions to Problems 304
2.4 Households supply the funds (saving), which are used by business firms to purchase capital
equipment.
2.5 Spark Therapeutics has four primary ways of raising funds: issuing stock, issuing bonds, taking
2.6 Answer will vary.
2.7 The Alt-A market and the subprime market serve borrowers with poor credit histories, low credit
2.8 Answers will vary based on the companies chosen, but in general, the more mature company will
2.9 (a) Disagree strongly. Savings is defined as household income minus consumption spending. It is
(b) Disagree. It is important to remember that when a household buys a share of stock or a bond,
(c) Disagree. Higher interest rates encourage saving but discourage investment. Interest rates
3.1 Yes. The total capital cost of the pool hall is $500,000. With revenues of $125,000 and costs of
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Solutions to Problems 305
3.2 Estelar should invest in all projects that have a rate of return greater than the interest rate.
3.3 Answers will vary, but students should refer to assessing how good an investment the purchase of
3.4 Abigail should have information that would allow her to calculate an expected rate of return on
Copyright © 2017 Pearson Education, Inc.
Interest rate
Investment
0
Demand
Solutions to Problems 306
3.5 Firms will only invest in more capital as long as the rate of return on that investment exceeds the
3.6 The expected profit from the florist is $120,000 per year. If the profits are divided equally among
CHAPTER 11 APPENDIX
1A.1 You would not be willing to pay $4,800 because you can get the same $5,000 by depositing
1A.2 The present discounted value (PDV) of the inheritance is $75,000/ (1.025)5 = $66,289.07. You
1A.3 Disagree. The dog park cannot be justified on efficiency grounds, because simply investing the
A B C D E
@8% $1,000 $1,000 $1,052 $1,092 $1,258
At 8% interest, flow E is worth a current expense of $1,235 because its present discounted value
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Solutions to Problems 307
1A.5 (a) $15,000 / (1.035) = $14,492.75.
1A.6 (a) $15,000 / (1.07) = $14,018.69.
1A.7 (a) False
1A.8 More than 4%. If I can get the same flow of profits by depositing $825,445,000 in a bank paying
1A.9 Of course not. X is the amount of money I would have to give to the other person to get the three
1A.10 (a) Teresa will receive ($1,250,000 x 30) = $37,500,000.
(b) At an interest rate of 4 percent the present value of the 30 payments would be calculated as
(c) At an interest rate of 8 percent the present value of the 30 payments would be calculated as
1A.11 (a) Teresa will receive ($2,000,000 x 15) = $30,000,000.
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Solutions to Problems 308
(c) At an interest rate of 8 percent the present value of the 15 payments would be calculated as
