🙋 Student Q&A (Lecture 6)

Click here to learn about timestamps and my process for answering questions. Section agendas can be found here. Email office hour questions to rob.mgmte2000@gmail.com . PS1Q2=“Question 2 of Problem Set 1”

📅 Questions covered Saturday, Mar 8

🕣 covered very near to end of recording
❔ prevailing interest rate in 4c?

✔ It just refers to the interest rate mentioned earlier in the problem.

🕣
❔ when would we need Excel to calculate i?

✔ covered during section

📅 Questions covered Sun, Mar 9

🕣 12:53
❔ If he asks for NPV, how do you solve it? How to use the formula?

✔
For a PV or NPV question, you always

1. come up with a timeline of the cash flows and then
2. drop the cash flows into the equation.

✏️ Suppose that your long lost aunt has gifted you some money. You will receive $20,000 in one year and $10,000 in 3 years. What is the PV of this gift? Assume that you keep most of your assets are in a money market mutual fund that earns 4% per year.

✔ Step 1: Timeline

t	CF
1	$20,000
2	$0
3	$10,000
Step 2: Formula
If your alternative/default investment is earning 4% per year, then you can use 4% as your discount rate. Therefore i=4%.

$$PV=\frac{\$20,000}{(1+4\%)^1} + \frac{\$0}{(1+4\%)^2} + \frac{\$10,000}{(1+4\%)^3}$$

🕣
❔ Is “in one year” equivalent to “at the end of the current year?” Is “at the beginning of this year” equivalent to “now?”

✔ Yes and yes.

🕣
❔ You are evaluating an investment that requires an upfront payment of $50,000 today**. In return, you will receive **$12,000 at the beginning of each year for the next 5 years. If the discount rate is 6%, what is the present value of this investment? Should you proceed with this investment? Show your calculations.

✔ We’re going to use the two steps from above. Step1: Timeline:

T	Cash InFlow	Cash Outflows
0	12,000 (1st year)	50,000
1	12,000 (2nd year)
2	12,000 (3rd year)
3	12,000 (4th year)
4	12,000 (5th year)
5

$$PVInflows = \frac{\$12,000}{(1+6\%)^0} + \frac{\$12,000}{(1+6\%)^1} + \frac{\$12,000}{(1+6\%)^2} + \frac{\$12,000}{(1+6\%)^3} + \frac{\$12,000}{(1+6\%)^4}$$ $$PV Outflows = \frac{\$50,000}{(1+6\%)^0}$$ $$NPV = PV Inflows - PV Outflows = \frac{\$12,000}{(1+6\%)^0} + \frac{\$12,000}{(1+6\%)^1} + \frac{\$12,000}{(1+6\%)^2} + \frac{\$12,000}{(1+6\%)^3} + \frac{\$12,000}{(1+6\%)^4} - \frac{\$50,000}{(1+6\%)^0}$$

Shortcut:

T	Cash InFlow	Cash Outflows	Net Cashflows Inflows - Outflows
0	12,000 (1st year)	50,000	-38,000
1	12,000 (2nd year)		12,000
2	12,000 (3rd year)		12,000
3	12,000 (4th year)		12,000
4	12,000 (5th year)		12,000
5

$$NPV = -\$38,000 + \frac{\$12,000}{1.06} + \frac{\$12,000}{1.06^2} + \frac{\$12,000}{1.06^3} + \frac{\$12,000}{1.06^4} = \$3581.26$$

=20000/(1+4%)^1 + 0/(1+4%)^2 +10000/(1+4%)^3
=20000/(1+4%)1 +10000/(1+4%)3
=-38+12/1.06 + 12/1.06^2 + 12/1.06^3 + 12/1.06^4

Questions covered Mon, Mar 10

🕣 7:44pm
❔ If we are trying to decide whether to take on a project or not, do we have to answer the question with both NPV and IRR or is it sufficient to answer it with just one or the other?

✔ Either the NPV or IRR rule is sufficient to answer a given question. They will typically have exactly the same answer. Note that there are subtle differences. See the slides that we coverd in the recording.

🕣 7:50pm
❔ Would studying mostly the problem sets be mostly sufficient or will it be very important to expand beyond that?

✔ Not quite. The problem sets aren’t comprehensive, but the slides are comprehensive. There are also additional practice problems on my website.