Assume that capital markets do not exist. Ryan has $78,000 today (t 0) and will
ID: 2810474 • Letter: A
Question
Assume that capital markets do not exist. Ryan has $78,000 today (t 0) and will receive $97,000 in exactly one year (t 1). The graph below illustrates point Y: having $78,000 now and receiving $97,000 next year. Here, if no capital or financial market exists, then Ryan must consume $78,000 now and $97,000 next year. Next consider this case when borrowing and lending at r-6% are available in the financial markets; Ryan now has a real investment opportunity, or business project. If Ryan decides to accept this opportunity, it will cost $20,000 now (t 0) and will offer a risk-free payoff of $25,000 next year. Now, revisit the point Y where Ryan has $78,000 now and will receive $97,000 next year, but this time the real asset project exists. Assume that he still wants to consume $78,000 now (t0), and answer the following 100,000 (70,000, 90,000) 80,000 60,000 40,000 20,000 0 20,000 40,000 60,000 80,000 Dollars this year a. How much more can Ryan consume next year? Ryan can consume $ b. Calculate the NPV of the project. (Round the final answer to the nearest whole dollar.) NPVExplanation / Answer
a. Since the real project has certain pay off of 25000 against investment of 20000; Ryan will borrow 20000 from next year at 6% and invest in the real project. He will consume 78000 in current year. Next year He will receive 97000 plus 25000 and he has to pay loan and interest on that (20000 * (1+6%)) = 21200. Hence the net amount for consumption next year is 100800 which is incremental amount of 3800
b. NPV of the project = -20000 + 25000/(1+6%) = 3584.91