Ginny's Case

Question 1

Present Value: $4,830,188.68

Future Value: $5,120,000.00

Virginia’s current wealth is $4,830,188.68, which is the amount she can spend and consume today. If she doesn’t consume or spend her money today, she will be able to spend $5,120,000.00.

Question 2

NPV-Ranking:

Rank | Investment | NPV |

1 | $3,000,000 | 1.15 |

2 | $2,000,000 | 1.11 |

3 | $4,000,000 | 1.09 |

4 | $1,000,000 | 0.70 |

When it comes to the decision whether to accept or reject a project, the Net Present Value (NPV) is very helpful. Every project with a positive NPV may be undertaken. When deciding between several projects with a positive NPV, one has to rank each of them and invest in the project with the highest NPV.

According to the above ranking, we’ll advise Virginia to take the $3,000,000 investment opportunity.

When investing $3,000,000, Virginia would still have $1,000,000 to put in the bank (6% interest). So her today’s wealth would be $1,000,000, but her future wealth including the Cash Flow would be $5,460,000 ($1,060,000 + $4,400,000).

Question 3 and 4 combined

Supposing that Virginia has a strong preference for current consumption and is investing $3,000,000 today, she would have to get a loan in the amount of $2,800,000. Otherwise her preferences cannot be met.

Today | End of year 1 |

Investment | - $3,000,000 | Future CF | $4,000,000 |

Rest of endowment | $1,000,000 | Bank loan + interest | - $2,968,000 |

Bank loan | $2,800,000 | | |

Sum | $800,000 | Sum | $1,432,000 |

The Future Cash Flow allows Virginia to get a bank loan in order to have $3,800,000 today for her consumption. She will be able to pay back the loan including its interest ($168,000) by the end of year 1.

Question 5

We have two approaches to this question:

First, both the savers and the spenders are equal in number and have equal power on the corporation (cash of $4 million). Because the question mentions that“ While all individuals prefer current...