Exam 14: Investment, Time, and Insurance

Benny was seriously injured at his place of employment and can no longer work. If Benny hadn't been injured, he would have worked five more years and would have earned $60,000 each year. The present discounted value of Benny's lost earnings at a 5% interest rate is $____.

A drug company is considering investing $100 million today to bring a weight loss pill to the market. At the end of one year, the firm will know the payoff; there is a 0.50 probability that the pill will sell at a high price and generate $37 million dollars per year of profit forever and a 0.50 probability that the pill will sell at a low price and generate $1 million per year of profit forever. The interest rate is 10%. Suppose the firm decides to wait one year to determine whether the pill will sell at a high price or a low price. The firm will not invest if it learns that the pill will sell at a low price. What is the option value of waiting one year to make the investment?

If Franco deposits $1,000 today in his account, he will have $1,200 at the end of two years. The annual compounded interest rate on Franco's account is ___%.

Daiyu's parents have decided to save for her college education. They estimate they will need $100,000 18 years from now to pay for it. If the interest rate remains fixed at 5% over this period, how much money will Daiyu's parents have to put into savings today to meet their goal (assuming no more money is saved over the years)?

In the market for capital, the discovery of new productive technologies increases the profitability of investments. The market interest rate _____, and the quantity of capital _____.

Which of the following statements is TRUE?

A restaurant owner is considering refurbishing his restaurant at a cost of $40,000 to generate increased sales. There is a 50% probability that the refurbished restaurant will increase profits by $26,000 each year for the next two years and a 50% probability that profits will increase by only $18,000 each year for the next two years. Calculate the expected net present value of refurbishing the restaurant at an interest rate of 8%. Do you advise the restaurant owner to refurbish the restaurant?

Tom is considering an investment that gives a $400 payout in one year and a $600 payout in two years. If interest rates are 6%, the maximum price that Tom should pay for this investment is $____.

Assume a future payment of $10,000. If r = 1 and T = 1, then the present value of $10,000 is $____.

The demand for capital is Q^D = 100 - 20r and the supply of capital is Q^S = 12r - 28, where r is the interest rate and Q is the quantity of capital in millions of dollars. Assume that households increase savings such that households save $20 million more at every interest rate level. The new equilibrium quantity of capital is ____.

(Table: Gambling and Risk) A _____ person prefers gamble _____ to gamble _____.

(Figure: Utility and Income) Suppose that Sara has an income of $80,000 but if her business burns down, her income drops to $20,000. a. What is Sara's expected income? b. What is the probability that Sara's business will burn down? c. What is Sara's expected utility? d. What is Sara's utility evaluated at her expected income? (You will not be able to give a specific value, so provide a range of values for your answer.) e. What is Sara's certainty equivalent?

A company is considering extracting natural gas from one of its properties. The initial extraction cost is $8 million, and all of the gas will be extracted in two years. The profits from selling the natural gas will be $6 million in one year and $5 million in two years. What is the net present value of this investment at 12%?

(Table: Account Balance) Using an interest rate of 10%, the value of the savings account balance in year 10 is $____.

(Table: Value Analysis I) Complete the table and graph, assuming a future payment of $10,000. What is the relationship between present value and the interest rate, holding time constant? What is the relationship between present value and time, holding the interest rate constant?

Liqin fixes up old cars and sells them to supplement his retirement income. Liqin came across a beat-up 1955 Corvette that she is considering rebuilding and selling. She estimates a 0.2 probability that she will gain 15% on the deal, a 0.2 probability that she will gain 10%, and a 0.6 probability that she will gain 5%. Liqin's expected return for fixing up and selling the Corvette is ____%.

The demand for capital is Q^D = 80 - 15r and the supply of capital is Q^S = 20r - 60, where r is the interest rate and Q is the quantity of capital in millions of dollars. Businesses become more optimistic about the business environment and borrow $70 million more capital at each interest rate level. What happens to the equilibrium interest rate and quantity of capital as a result of this newfound optimism?

The demand and supply of capital are given by Q^D = 200 - 60r and Q^S = 20r - 40, where Q is the quantity of capital in millions of dollars and r is the interest rate measured as a percentage. What is the equilibrium interest rate?

A drug company is considering investing $100 million today to bring a weight loss pill to the market. At the end of one year, the firm will know the payoff; there is a 0.50 probability that the pill will sell at a high price and generate $37 million per year of profit forever and a 0.50 probability that the pill will sell at a low price and generate $1 million per year of profit forever. The interest rate is 10%. Suppose the firm decides to wait one year to determine whether the pill will sell at a high or low price. The firm will not invest if it learns that the pill will sell at a low price. What is the net present value of waiting one year to make the investment?

(Table: Account Balance) Complete the table.