Question

question 2, a) and b)

10 APPENDIX TOWARD A FULLER UNDERSTANDING OF PRESENT VALUE 325 PROBLEMS 1. You have won the provincial lottery. There are two ways in which you can receive your prize. You can either have $1 million in cash now, or you can have $1.2 million that is paid out as follows: $300,000 now, $300,000 in one year's time, $300,000 in two years' time, and $300,000 in three years' time. The interest rate is 20%. How would you prefer to receive your prize? 2. The drug company Pfizer Canada is considering whether to invest in the development of a new cancer of $10 million now, beginning one year from now, the drug will generate annual profits of 54 million for three years. a. If the interest rate is 12%, should Pfizer Canada invest in the development of the new drug Why or why not? b. If the interest rate is 8%, should Pfizer Canada invest in the development of the new drug? Why or why not? drug. Development will require an initial investment WORK IT OUT Interactive step-by-step help with solving this problem can be found online. (i) Close the highway during construction, at an annual cost of $267.5 million per year for two years. 3. Suppose that a major city's main thoroughfare, which is also a highway, will be completely closed Cunun years, from January 2014 to nost of (ii) Keep the highway open during construction, il nost of $200 million per year for

Answer 1

2.

a) net present value = -$10million + ($4million/1.12) + ($4million/1.12²)+($4million/1.12³)
= $-392674.93
since the net present value is negative thus Pfizer should not invest in the development of this drug, it would be profitable if it invests the same amount in a bank that pays 12% interest

b) net present value = -$10million + ($4million/1.08) + ($4million/1.08²)+($4million/1.08³)
= $ 308387.95
since the net present value is positive thus Pfizer should invest in the development of this drug as it would be more profitable in this condition rather depositing the amount in a bank that pays 8% interest