1. Assuming zero taxes, calculate the future value of a $1,000 lump-sum contribution to a savings plan, compounded annually, at the end of: (a) five years, using a 2% rate of return; (b) thirty years, using a 12% rate of return.
2. A firm has the opportunity to invest in a project that is expected to pay an end-of-year annual return of $1.5 million for each of the next twenty years after taxes and expenses. The current cost of the project would be $7 million. Assuming a discount rate of 12%, as the required rate of return and (opportunity) cost of capital (i.e., economic costs of capital): (a) Calculate the present value of the project to the firm. (b) Calculate the net present value of the project. (c) Using the net present value principle, determine whether or not the firm should make the investment. (d) Using the internal rate of return principle, determine whether or not the firm should make the investment. (e) Using the equilibrium market value of the firm principle, determine whether or not the value of the firm would increase if the firm decided to undertake this investment project.
These questions belong to finance and they deal with calculation of present value and future value. While the first question deals with future value, the second question deals with expected annual return, opportunity cost, present value, etc. Answers to the questions have been given in the excel sheet attached.
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