978-1259709685 Chapter 4 Solution Appendix

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CHAPTER 4, APPENDIX

NET PRESENT VALUE: FIRST

PRINCIPLES OF FINANCE

Solutions to Questions and Problems

NOTE: All end-of-chapter problems were solved using a spreadsheet. Many problems require multiple

steps. Due to space and readability constraints, when these intermediate steps are included in this

solutions manual, rounding may appear to have occurred. However, the final answer for each problem is

found without rounding during any step in the problem.

1. The potential consumption for a borrower next year is the salary during the year, minus the

repayment of the loan and interest to fund the current consumption. The amount that must be

borrowed to fund this year’s consumption is:

2. The potential consumption for a saver next year is the salary during the year, plus the savings from

the current year and the interest earned. The amount saved this year is:

Amount saved = $50,000 – 35,000 = $15,000

3. Financial markets arise to facilitate borrowing and lending between individuals. By borrowing and

lending, people can adjust their pattern of consumption over time to fit their particular preferences.

4. a. The present value of labor income is the total of the maximum current consumption. So,

solving for the interest rate, we find:

b. The NPV of the investment is the difference between the new maximum current consumption

minus the old maximum current consumption, or:

c. The total maximum current consumption amount must be the present value of the equal annual

consumption amount. If C is the equal annual consumption amount, we find:

5. a. The market interest rate must be the increase in the maximum current consumption to the

maximum consumption next year, which is: