FE PROBLEM 1.1
a. TIME VALUE OF MONEY
rationale: SEE RULE #2 OF THE FOUR DISCOUNTED CASH FLOW RULES
FE PROBLEM 1.2
b. COLLECTIVELY EXHAUSTIVE
rationale: DEFINITION OF COLLECTIVELY EXHAUSTIVE
FE PROBLEM 1.3
d. POSITIVELY
rationale: SEE PRINCIPLE #9 OF THE TEN PRINCIPLES OF ECONOMIC ANALYSIS
FE PROBLEM 1.4
a. AN INTEREST RATE
rationale: SEE THE FOUR DISCOUNTED CASH FLOW RULES
FE PROBLEM 1.5
d. PERFORMING SUPPLEMENTARY ANALYSIS
rationale: SEE SECTION 1.4.6
FE PROBLEM 1.6
d. $130
rationale: $100 (1 + 0.30) = $130
FE PROBLEM 1.4
b. WACC IS A LOWER BOUND FOR MARR
rationale: NEVER INVEST FOR A RETURN LESS THAN IT COSTS TO ACQUIRE
FNDS
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A B C D
PROBLEM 1.1
WYLIE IS OFFERED THIS AMOUNT NOW= $5,000.00
WYLIE IS WILLING TO TAKE THIS AMOUNT IN A YEAR= $5,700.00
THE INCREASE REQ’D BY WYLIE OVER ONE YEAR= $700.00 =$5,700.00-$5,000.00
THEREFORE WYLIE’S TVOM = 14.00% =$700.00/$5,000.00
PROBLEM 1.2
RT LOANS= $20,000.00
RT’S TVOM= 8.00%
RT INTEREST REQ’D= $1,600.00
CYNTHIA BORROWS= $20,000.00
CYNTHIA’S TVOM= 12.00%
CYNTHIA’S EARNINGS= $2,400.00
a YES, THEY SHOULD BE ABLE TO NEGOTIATE THE LOAN
b RT REQUIRES $1,600 OR MORE IN INTEREST
CYNTHIA IS WILLING TO PAY $2400 OR LESS IN INTEREST
THE ACCEPTABLE RANGE IS FROM $1,600 TO $2,400
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A B C D
PROBLEM 1.3
RT LOANS= $20,000.00
RT’S TVOM= 12.00%
RT INTEREST REQ’D= $2,400.00 MINIMUM INTEREST REQUIRED BY RT
CYNTHIA BORROWS= $20,000.00
CYNTHIA’S TVOM= 8.00%
CYNTHIA’S EARNINGS=
$1,600.00
WILLING TO PAY= $2,000.00 MAXIMUM INTEREST CYNTHIA WILLING TO PAY
a
b
NO, THEY SHOULD NOT BE ABLE TO NEGOTIATE THE LOAN UNLESS ONE OR
BOTH CHANGE THEIR MIND
CYNTHIA’S MONEY MUST BE INVESTED AND SHE NEEDS TO BORROW MONEY
NOW, EVEN IF SHE HAS TO PAY $2,000 IN INTEREST. THERE IS STILL NO
ACCEPTABLE RANGE. RT REQUIRES $2,400 OR MORE IN INTEREST; CYNTHIA
WILL PAY $2,000 OR LESS. THEY ARE $400 OFF
RT REQUIRES $2,400 OR MORE IN INTEREST
CYNTHIA CAN EARN $1,600 ON HER MONEY; HOWEVER, CYNTHIA IS WILLING TO
PAY $2,000 IN INTEREST
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A B C D E F G H I J
PROBLEM 1.4
LOAN AMOUNT= $3,000.00
YOUR TVOM= 15.00% OR $450.00 INTEREST
FRIEND’S TVOM= 20.00% OR $600.00 INTEREST
YOU ARE WILLING TO MAKE THE LOAN TO YOUR FRIEND FOR $450.00
INTEREST OR MORE. YOUR FRIEND IS WILLING TO ACCEPT THE LOAN
FOR $600 INTEREST OR LESS.
SO, ANY INTEREST NEGOTIATION WITH YOU AS THE LENDER THAT IS ACCEPTABLE TO BOTH
PARTIES IS BETWEEN $450 AND $600.
YOUR FRIEND IS WILLING TO MAKE THE LOAN TO YOU FOR $600 INTEREST OR MORE. YOU
ARE WILLING TO ACCEPT THE LOAN FOR $450 INTEREST OR LESS. SO, THE ACCEPTABILITY
GAP BETWEEN YOU AND YOUR FRIEND IS $150.
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A B C D E F G H I
PROBLEM 1.5
COSTS IN REVS IN NET CUM CUM CUM
STAGE INVESTMENT TODAY’S $ TODAY’S $ REV-COST COSTS REVS REV-COST
1 STATION $180,000 $270,000 $90,000 $180,000 $270,000 $90,000
2 ANTENNA $30,000 $50,000 $20,000 $210,000 $320,000 $110,000
3 AMPLIFIER $40,000 $30,000 -$10,000 $250,000 $350,000 $100,000
4
LIGHTNING
PROTECTION
$30,000 $60,000 $30,000 $280,000 $410,000 $130,000
5
CONTROL
CONSOLE
$15,000 $5,000 -$10,000 $295,000 $415,000 $120,000
a
b
c 1. IDENTIFY THE INVESTMENT ALTERNATIVES
5. COMPARE THE ALTERNATIVES
7. SELECT THE PREFERRED ALTERNATIVE
5. MARGINAL REVENUE MUST EXCEED MARGINAL COST
6. MONEY SHOULD CONTINUE TO BE INVESTED AS LONG AS EACH ADDITIONAL
INCREMENT OF INVESTMENT YIELDS A RETURN THAT IS GREATER THAN THE INVESTOR’S
TVOM
PURCHASE THE FIRST FOUR STAGES. NOTE THAT THIS GIVES THE HIGHEST
ACCUMULATED TOTAL NET REVENUE-COST. IN TODAY’S $. NOTE THAT THE AMPLIFIER
DOES NOT PAY OUT, BUT IT IS NECESSARY FOR THE LIGHTNING PROTECTION THAT PAYS
OUT NICELY
2. MAKE INVESTMENTS THAT ARE ECONOMICALLY JUSTIFIED
3. CHOOSE THE MUTUALLY EXCLUSIVE INVESTMENT ALTERNATIVE THAT MAXIMIZES
ECONOMIC WORTH
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A B C D E F
THEY IMPACT FUTURE COSTS
1. IDENTIFY THE INVESTMENT ALTERNATIVES
PROBLEM 1.6
ORIGINAL WSI BID= $5,500.00
BARB & FRED EXPENSES= $1,900.00
$1,100.00 MATERIALS – NO RETURN
$400.00 TRENCHER AT $80 FOR 5 DAYS
$400.00 JACKHAMMER AT $80 FOR 5 DAYS
REVISED WSI BID= $4,500.00
$5,500.00 ORIGINAL
-$500.00 MATERIALS
-$500.00 TRENCHING
a$1,900.00 BARBARA AND FRED HAVE ALREADY SPENT
b$6,400.00 TOTAL SPENT AFTER WSI
c$6,000.00 SS CHARGE
$4,500 FUTURE SPENDING WITH WSI
$6,000 FUTURE SPENDING WITH SS
GO WITH WSI, NOT SS.
d
GO WITH WSI, NOT SS. COMPARING SS AT $6,000 AND
WSI AT $6,400 TAKES INTO ACCOUNT SUNK COSTS
7. SELECT THE PREFERRED ALTERNATIVE
SUNK COSTS SHOULD NOT BE CONSIDERED.
2. MAKE INVESTMENTS THAT ARE ECONOMICALLY JUSTIFIED
4. ESTIMATE THE CASH FLOWS
5. COMPARE THE ALTERNATIVES
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A B
PROBLEM 1.7
a EXAMPLES OF NON-MONETARY FACTORS INCLUDE:
QUALITY
SAFETY
ENVIRONMENTAL IMPACT
COMMUNITY ATTITUDES
LABOR-MANAGEMENT RELATIONSHIPS
SYSTEM RELIABILITY
SYSTEM AVAILABILITY
SYSTEM MAINTAINABILITY
SYSTEM OPERABILITY
SYSTEM FLEXIBILITY
IMPACT ON PERSONNEL LEVELS
TRAINING REQUIREMENTS
COMPARISON WITH COMPETITORS
IMPACT ON DIFFERENT UNITS WITHIN THE ORGANIZATION
BRINGING ABOUT CHANGE
EGO
CUSTOMER PREFERENCES
DEPENDING UPON WHAT TYPES OF ALTERNATIVES ARE BEING CONSIDERED, THIS LIST
COULD BE ALMOST LIMITLESS.
b NONE
c 5. COMPARE THE ALTERNATIVES
6. PERFORM SUPPLEMENTARY ANALYSES
7. SELECT THE PREFERRED ALTERNATIVE
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A B C D E F G H
PROBLEM 1.8
ACCEPT PROPOSAL: 1
REJECT PROPOSAL: 0
a ALT PROP PROP PROP PROP WHY NOT FEASIBLE
A B C D
1 0 0 0 0
2 0 0 0 1
3 0 0 1 0
4 0 0 1 1
5 0 1 0 0 B CONTINGENT ON C OR D
6 0 1 0 1
7 0 1 1 0
8 0 1 1 1
9 1 0 0 0 A CONTINGENT ON D
10 1 0 0 1
11 1 0 1 0 NOT BOTH A AND C A CONTINGENT ON D
12 1 0 1 1 NOT BOTH A AND C
13 1 1 0 0 B CONTINGENT ON C OR D A CONTINGENT ON D
14 1 1 0 1
15 1 1 1 0 NOT BOTH A AND C A CONTINGENT ON D
16 1 1 1 1 NOT BOTH A AND C
b NONE
c 1. IDENTIFY THE INVESTMENT ALTERNATIVES
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W, X, Y
A B C D E F G H
PROBLEM 1.9
ACCEPT PROPOSAL: 1 REJECT PROPOSAL: 0
a ALT PROP PROP PROP PROP PROP WHY NOT FEASIBLE
V W X Y Z
1 0 0 0 0 0 AT LEAST 2 AND NO MORE THAN 4
2 0 0 0 0 1
AT LEAST 2 AND NO MORE THAN 4; Z
CONTINGENT ON X OR Y
3 0 0 0 1 0 AT LEAST 2 AND NO MORE THAN 4
4 0 0 0 1 1
5 0 0 1 0 0 AT LEAST 2 AND NO MORE THAN 4
6 0 0 1 0 1
7 0 0 1 1 0 X AND Y MUTUALLY EXCLUSIVE
9 0 1 0 0 0 AT LEAST 2 AND NO MORE THAN 4
10 0 1 0 0 1 Z CONTINGENT ON X OR Y
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A B C D E F
PROBLEM 1.10
ACCEPT PROPOSAL: 1 REJECT PROPOSAL: 0
ALTERNATIVE PROPOSAL PROPOSAL PROPOSAL WHY NOT FEASIBLE
P Q R
1 0 0 0 EXACTLY 1 OR 2 CHOSEN
2 0 0 1 R CONTINGENT ON P
3 0 1 0
4 0 1 1 R CONTINGENT ON P
5 1 0 0
6 1 0 1
7 1 1 0 P AND Q MUTUALLY EXCLUSIVE
8 1 1 1
EXACTLY 1 OR 2 CHOSEN; P AND
Q MUTUALLY EXCLUSIVE
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A B
PROBLEM 1.13
a
AUTOFOUNDRY SHOULD DO NOTHING AT ALL! THEIR ANALYSIS IS INCORRECT,
EVEN IF ALL DATA WERE RIGHT.
THE MAJOR FLAW IS THAT THE TIME HORIZON IN ONE CASE IS 5 YEARS AND 9 IN
THE OTHER.
b
2. MAKE INVESTMENTS THAT ARE ECONOMICALLY JUSTIFIED
3. CHOOSE THE MUTUALLY EXCLUSIVE INVESTMENT ALTERNATIVE THAT
MAXIMIZES ECONOMIC WORTH
4. TWO INVESTMENT ALTERNATIVES ARE EQUIVALENT IF THEY HAVE THE SAME
ECONOMIC WORTH
5. MARGINAL REVENUE MUST EXCEED MARGINAL COST
8. COMPARE INVESTMENT ALTERNATIVES OVER A COMMON PERIOD OF TIME
(STRONG)
c
1. IDENTIFY THE INVESTMENT ALTERNATIVES
2. DEFINE THE PLANNING HORIZON (STRONG)
4. ESTIMATE THE CASH FLOWS
5. COMPARE THE ALTERNATIVES
7. SELECT THE PREFERRED ALTERNATIVE
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4. TWO INVESTMENT ALTERNATIVES ARE EQUIVALENT IF THEY
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A B C D E F G H
IT HAS A 95% CHANCE OF POCKETING A QUICK PROFIT OF
PROBLEM 1.12
NOTE TO INSTRUCTOR
WHAT YOU SHOULD KNOW ABOUT THIS PROBLEM IS:
THERE IS NO SINGLE CORRECT ANSWER
ECONOMICALLY SPEAKING, THE THREE ARE EQUIVALENT
RETURNED RETURNED
YOU CHANCE OF TO YOU IF CHANCE OF TO YOU IF EXPECTED
ALT INVEST SUCCESS SUCCESS FAILURE FAILURE VALUE
A$100,000.00 95% $110,789.47 5% $95,000.00 $10,000.00
B$100,000.00 60% $150,000.00 40% $50,000.00 $10,000.00
C$100,000.00 20% $510,000.01 80% $10,000.00 $10,000.00
b
c MAY WISH TO MAKE A CASE FOR 2, 3, 4, 5. NUMBER 9 IS FOR SURE.
5. MARGINAL REVENUE MUST EXCEED MARGINAL COST
9. RISKS AND RETURNS TEND TO BE POSITIVELY CORRELATED
d
1. IDENTIFY THE INVESTMENT ALTERNATIVES
4. ESTIMATE THE CASH FLOWS
7. SELECT THE PREFERRED ALTERNATIVE
HAVE THE SAME ECONOMIC WORTH
MAY WANT TO MAKE A CASE FOR 6, WITH THE EV ANALYSIS –
ALTHOUGH THAT SHOULD NOT BE EXPECTED
$10,789.47 WITH ONLY $5,000 DOWNSIDE
THE STUDENTS SHOULD BE EXPECTED TO DO A “GUT” ANALYSIS –
HOW WOULD THEY ACTUALLY DECIDE HERE?
THE STUDENTS SHOULD NOT BE EXPECTED TO DO A
PROBABILISTIC ANALYSIS – THEY WILL SEE THAT IN CHAPTER 11
ONE WHO SELECTS ALTERNATIVE C IS A RISK SEEKER (OR QUITE
RISK PRONE) – NOT MANY WILL GAMBLE ON B OR C
THE EXPECTED VALUE (PROBABILITY-WEIGHTED RETURNS LESS
PROBABILITY-WEIGHTED FAILURES) IS THE SAME FOR EACH:
$10,000.
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A B
PROBLEM 1.13
a
USE A 10 YEAR PLANNING HORIZON. THE REASON IS THAT EACH PROJECT IS A ONE-
SHOT ALTERNATIVE AND IN ORDER TO CONSIDER EACH, THE PLANNING HORIZON
MUST MATCH THAT OF THE LONGEST-LIVED PROJECT OR ALTERNATIVE.
b
2. MAKE INVESTMENTS THAT ARE ECONOMICALLY JUSTIFIED
3. CHOOSE THE MUTUALLY EXCLUSIVE INVESTMENT ALTERNATIVE THAT MAXIMIZES
ECONOMIC WORTH
8. COMPARE INVESTMENT ALTERNATIVES OVER A COMMON PERIOD OF TIME
c
1. IDENTIFY THE INVESTMENT ALTERNATIVES
2. DEFINE THE PLANNING HORIZON
5. COMPARE THE ALTERNATIVES
7. SELECT THE PREFERRED ALTERNATIVE
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A B
PROBLEM 1.14
a
VIRTUALLY ANY PLANNING HORIZON COULD BE SELECTED. MOST LIKELY IT WOULD
BE SOME NUMBER OF YEARS FROM THE SHORTEST-LIVED ALTERNATIVE (4 YEARS)
TO THE LONGEST-LIVED (10 YEARS), ALTHOUGH THIS IS NOT NECESSARILY SO. THE
DECISION MAKER MUST FIRST ASK “OVER WHAT PERIOD OF TIME DO I WANT TO
MAKE THE BEST DECISION?” FOR ANY SELECTED PLANNING HORIZON, SAY 6 YEARS
FOR EXAMPLE, THE 4 YEAR ALTERNATIVE REQUIRES SPECIFICATION OF WHAT WILL
HAPPEN IN YEARS 5 AND 6 (SUCH AS REPAVING) AND THEN WILL REQUIRE
ESTIMATION OF A RESIDUAL OR SALVAGE VALUE AT THE END OF YEAR 6. IN THE
CASE OF THE RV HOOK UPS, A RESIDUAL OR SALVAGE VALUE WOULD NEED TO BE
ESTIMATED AT THE END OF 6 YEARS TO PROPERLY REFLECT THE REMAINING VALUE
IN THAT ALTERNATIVE AFTER THE 6 YEAR PLANNING HORIZON. SIMILAR THINKING IS
REQUIRED FOR ANY OTHER PLANNING HORIZON SELECTED.
b.
2. MAKE INVESTMENTS THAT ARE ECONOMICALLY JUSTIFIED
3. CHOOSE THE MUTUALLY EXCLUSIVE INVESTMENT ALTERNATIVE THAT MAXIMIZES
ECONOMIC WORTH
8. COMPARE INVESTMENT ALTERNATIVES OVER A COMMON PERIOD OF TIME
c.
1. IDENTIFY THE INVESTMENT ALTERNATIVES
2. DEFINE THE PLANNING HORIZON
5. COMPARE THE ALTERNATIVES
7. SELECT THE PREFERRED ALTERNATIVE