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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:
