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 $10mln, or in parts, where $5.5mln can be provided in year 1, and another $5.5mln can be provided in year 2.
a) Assuming the opportunity interest rate is 6%, what is the present value of the second alternative? According to Douglas, "a dollar received in the present period is worth more than a dollar received in a future period" (2010, ch. 1.4). The reasoning behind this is that an amount received today can be deposited into a bank and earn interest. Therefore an amount received in a year, for example, is valued less today, and conversely, an amount received today is valued to be more in a year from now. For this scenario, using the formula, PV=FVn/(1+r)n for the present value where n represents number of years in the sequence and r represents the rate, which in this case is the opportunity rate of 6%, the present value of the second alternative is $10,070,000. The calculation for this equation is PV($10m) = $5.5m/(1.06) + $5.5m/(1.06)(1.06) = $5.18m + $4.89m = $10,070,000.
b) Which of the two alternatives should be chosen and why?
Using the present value method, I would chose the second alternative as it would net an extra $70,000 that could be put to very good use at the University.
c) How would your decision change if the opportunity interest rate was 12%? My decision would definitely change if the opportunity rate was 12% instead of 6% because the present value of the second alternative would change to $9,290,000. The calculation would be PV($10m) = $5.5m/(1.12) + $5.5m/(1.12)(1.12) = $4.91m + $4.38m = $9,290,000.
2. An angel investor is considering investing in one of two start-up businesses and is evaluating the expected returns along with the risk of each option in order to choose the better alternative. * Business 1 is an innovative protein energy drink, which has ENPV of...
References: Douglas, E. (2012). Managerial Economics (1st ed.). San Diego, CA: Bridgepoint Education.
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