Business 640 Week 1, Assignment 1

Week 1 Assignment

John R. Smith

Managerial Economics

BUS 640

Dr. Steve McQueen

Week 1 Assignment

Problem 1:

A generous university benefactor has agreed to donate a large amount of money for student scholarships. The money can be provided in one lump sum of $12 million in Year 0 (the current year), or in parts, in which $7 million can be provided at the end of Year 1, and another $7 million can be provided at the end of Year 2.

Describe your answer for each item below in complete sentences, whenever it is necessary. Show all of your calculations and processes for the following points:

1. Assuming the opportunity interest rate is 8%, what is the present value of the second alternative mentioned above? Which of the two alternatives should be chosen and why?

The present value of the second alternative is 12,364,800. With 7,000,000 in year one, and 7,000,000 in year 2 with an opportunity interest rate of 8%, After the first year, the value would be 6,440,000 (7,000,000 x .08 = 560,000, 7,000,000 - 560,000) After year 2, the value would be 12,364,800 (6,440,000 + 7,000,000 in year 2 = 13,440,000 x .08 = 1,075,200). This amount should be chosen over the $12,000,000 lump sum because it will allow the school to have 364,800 more than the $12,000.000

2. How would your decision change if the opportunity interest rate is 12%?

I would go with option two at this point, because with a larger interest rate, the total amount would drop to 11,580,800, 419,200 less than the $12 lump sum alternative (7,000,000 x .12 = 840,000, 70000,000 - 840,000 = 616,000). In year two, 13,160,000 * .12 = 1,579,200 (13,160,000 - 1,579,200 = 11,580,800. With a 419,200 difference, the 12,000,000 alternative is best.

3. Provide a description of a scenario where this kind of decision between two types of payment streams applies in the “real-world” business setting.

One example is when a...