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A large firm applies for a loan for $1,500,000 from a bank to expand production. The...

A large firm applies for a loan for $1,500,000 from a bank to expand production. The bank approves, and offers the firm two options in which to receive the payment: 1) the full amount is dispersed at once. 2) three payments of $500,000 are dispersed over three years. Assume the nominal interest rate on the loan is constant at 5%, and the firm has perfect information about the future. Which option below is the best choice for the firm, given the circumstances, if it seeks to maximize the monetary value of the payment(s) it receives?

(a) Option 1 if the inflation rate is constant at -2.2% per year.

(b) Option 2 if the inflation rate is constant at -2.2% per year.

(c) Option 2 if the inflation rate is constant at 2.8% per year.

(d) The total amount received is $1,500,000 for both options, so the firm is indifferent.

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Answer #1

The best choice for the firm is Option 2 if the inflation rate is constant at -2.2% per year. With negative inflation, the purchasing power of the money increases hence the firm would want as late as possible

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