CHAPTER 9

Solutions to Chapter-End Problems

9.1 (a) current

(b) real
(c) current
(d) real
(e) current
(f) current
(g) real

9.3 (a) 400(P/F, 4%, 3)(P/F, 4%, 3) = 400(0.85480)(0.85480) = $292.27

(b) 400(F/P, 4%, 3)(F/P, 4%, 3) = 400(1.1699)(1.1699) = €547.47
(c) 10(P/F, 4%, 1)(P/F, 4%, 1) = 10(0.94154)(0.94154) = $8.86
(d) 350 983(P/F, 4%, 10)(P/F, 4%, 10)
= 350 983(0.67556)(0.67556) = $160 182
(e) 1(F/P, 4%, 1000)(F/P, 4%, 1000) = 1.042000 = £1.659×1034
(f) 1 000 000 000(P/F, 4%, 300)(P/F, 4%, 300)
= 1 000 000 000/1.04600 = $0.06

9.5 (a) The actual dollar MARR, MARRA, is given by

MARRA = (1 + MARRR)(1 + f) – 1 = (1.08)(1.06) – 1 = 0.1448 = 14.48%

(b) PW = 1000(P/A, 14.48%, 10) = 1000(5.1199) = 5119.9

The present worth of the annuity is about $5120.

9.7 (a) PW = –90 000 + 10 000(P/A, i, 10)

The actual dollar internal rate of return is between 1.95% and 2.0% in a
spread sheet approximation. Sample trial and error results are shown
below:
Interest rate PW
0.019 297.65
0.0195 61.29
0.02 –174.15
0.0205 –408.69

(b) If we take the actual dollar internal rate of return to be 2% the real
internal rate of return is obtained as 1.02/1.05 – 1 = –0.02857, or about
–2.9%. Notice that when the actual dollar internal rate of return is less than
the inflation rate the real internal rate of return is negative.
9.9 1 000 000 = 38 000(F/P, 5%, N)
1.05N = 1 000 000/38 000 = 26.316
N = ln(26.316)/ln(1.05) = 67.025
The average person will be a millionaire in about 67 years.

9.11 Real MARR = (1 + 3)/(1 + 2.5) – 1 = 14.3%

9.13 First get the current dollar MARR: MARRC = 1.03/1.1 – 1 = 0.133
The current dollar MARR is about 13.3%.

We then use the series present worth factor:

PW = 2000(P/A, 13.3%, 30) = 14 682.55

The present worth is about $14 683.

9.15 For the real rubles, the present worth is:

PW(real) = 500(P/A, 1.5%, 24) = 500(20.030) = 10 015

For months 13-24:

MARRC = (1 + 0.015)(1 + 0.2) – 1 = 21.8%

For months 0-12:

MARRC = (1 + 0.015)(1 + 0.4) – 1 = 42.1%

PW(current)
= 500(P/A, 21.4%, 12)(P/F, 42.1%, 12) + 500(P/A, 42.1%, 12)
= 500(4.2169)(0.01475) + 500(2.3403) = 1201.25

The total present worth of the contract is about 10 015 + 1 201 = 11 216
million rubles.

9.17 (a) The current IRR of the project can be found by solving for i in:

PW = –200 000 + (22 000 – 2 000)(P/A, i, 20) = 0

(P/A, i, 20) = 200 000/20 000 = 10
i = 0.0775 or 7.75%

The current IRR of the project is 7.75%.

(b) The current MARR is

MARRC = MARRR + f + MARRR × f

= 0.04 + 0.03 + 0.04(0.03) = 0.0712 or 7.12%
 (c) Yes, they should invest, as the current rate of return exceeds the
current MARR.

9.19 (a)

Real Zerts Exchange Real Dollar

Cash Flow Inflation Actual Zerts Rate Actual Dollar Cash Flow Present
Year (2015 Zerts) Factor Cash Flow Factor Cash Flow (2015 dollars) Worth ($)
0 -1 500 000 1 -1 500 000 0.25 -375 000 -375 000 -375 000
1 260 870 1.15 300 000 0.22 67 500 65 534 55 328
2 260 870 1.32 345 000 0.2 69 863 65 852 46 938
3 260 870 1.52 396 750 0.18 72 308 66 172 39 820
4 260 870 1.75 456 263 0.16 74 838 66 493 33 782
5 260 870 2.01 524 702 0.15 77 458 66 816 28 659
6 260 870 2.31 603 407 0.13 80 169 67 140 24 313
7 260 870 2.66 693 918 0.12 82 975 67 466 20 627
Total: -125 532

(b) The present worth of the project is −$125 532 in dollars. It was obtained
by using the real MARR and the real dollar cash flow. The real MARR is
given by

MARRR = (1 + MARRA)/(1 + f) – 1 = 1.22/1.03 – 1 = 0.184

We could also have found the present worth in dollars using the current
dollar MARR and the actual dollar cash flow.

9.20 The present worths were computed with current dollar cash flows and the
current dollar MARR.

2% Inflation Cash Flows:

In-House Purchase
Current Dollar Act Dollar Other PW Current Dollar PW
Year Labour Cost Operat. Cost (all Op. cost) Purchase ( Purchase)
1 262 500 225 000 406 250 750 000 625 000
2 278 460 234 090 355 938 765 000 531 250
3 295 390 243 547 311 885 780 300 451 563
4 313 350 253 387 273 310 795 906 383 828
5 332 402 263 623 239 529 811 824 326 254
1 586 912 Total PW: 2 317 895
Total PW in-house, including first cost: 1 786 912

(a) $278 460

(b) $243 547
(c) Purchase PW = $2 317 895, In-house PW = $1 786 912

9.26 (a) PW = –1 800 000 + 550 000(P/A, i, 5)

The real Ibernian IRR, based on a spreadsheet approximation, is just over

16.0%. Sample trial and error results are shown below:
 Interest rate PW
0.1575 11414
0.16 862
0.161 –3331
0.1625 –9591

(b) The current pound (CP) internal rate of return is given by

IRRAP = (1 + IRRRP)(1 + fI) – 1

where IRRRP is the real IRR in pounds and fI is the inflation rate in Ibernia.

If we take the real IRR in Ibernian pounds to be 16%, we get the current
pound IRR to be 0.276, or 27.6%

(c) The current dollar IRR is given by

IRRA = (1 + IRRRP)(1 + fI)(1 + fe) – 1

where IRRRP is the real IRR in pounds, fI is the inflation rate in Ibernia, and fe
is the rate of exchange between the dollar and the Ibernian pound.

If we take the real IRR in Ibernian pounds to be 16%, we get 21.2% as the
current dollar IRR.

Alternative method: Get the current dollar IRR by converting current

Ibernian cash flows into actual dollars and computing the current dollar
IRR directly. Sample trial and error results are shown below:

Interest rate PW
0.2075 24899
0.21 12176
0.2125 –430
0.215 –12922

We must compare the 21.2% with Leftway’s current dollar MARR. This is
obtained with the relationship,

MARRC = (1 + MARRR)(1 + f) – 1 = 1.15(1.025) – 1 = 0.179

Leftway’s current dollar MARR is about 18%. This is well below the actual
dollar IRR. The project is, therefore, acceptable.

9.29 (a) We first get the effect of reductions in operating cost and revenue on
 cash flows.
We get the present worth of these flows by discounting at the observed
MARR, 20%.

No Inflation Cash Flow:

Operating PW PW
Year Cost Revenue Oper. Cost Revenue
1 4 262 500 6 050 000 3 552 083 5 041 667
2 4 219 875 5 959 250 2 930 469 4 138 368
3 4 177 676 5 869 861 2 417 637 3 396 910
4 4 135 899 5 781 813 1 994 550 2 788 297
5 4 094 540 5 695 086 1 645 504 2 288 727
6 4 053 595 5 609 660 1 357 541 1 878 664
7 4 013 059 5 525 515 1 119 971 1 542 070
8 3 972 929 5 442 632 923 976 1 265 782
9 3 933 199 5 360 993 762 280 1 038 996
10 3 893 867 5 280 578 628 881 852 843
Total: 17 332 893 24 232 325
i= 0.2 PW = -600 568

We subtract the present worth of variable costs and the first cost from the
present worth of revenue. This gives a present worth of about –€601 000.

(b) The internal rate of return is between 17% and 17.5%. This is both a real
and an current dollar internal rate of return since we assume inflation is zero.
Sample trial and error results are shown below:

Interest rate PW
1.165 262576
1.17 128455
1.175 –1836
1.18 –128438

(c) The required inflation rate is given by

1 + IRRC = (1 + IRRC)(1 + f)
f = (1 + MARRC)/(1 + MARRR) – 1 = 1.2/1.175 – 1 = 0.0213 = 2.13%

(d) The project probably should be rejected. The break-even requires an

inflation rate of over 2.5%. While this is not high by historical standards,
there have been many countries with periods with lower inflation rates.

9.30 (a) The cash flows as well as present worths of operating costs and
revenues under the assumption of zero inflation are shown below.
No Inflation Cash Flows:
Operating PW PW
Year Cost Revenue Oper. Cost Revenue
1 1 200 000 1 500 000 960 000 1 200 000
2 1 248 000 1 530 000 798 720 979 200
3 1 297 920 1 560 600 664 535 799 027
4 1 349 837 1 591 812 552 893 652 006
5 1 403 830 1 623 648 460 007 532 037
 6 1 459 983 1 656 121 382 726 434 142
7 1 518 383 1 689 244 318 428 354 260
8 1 579 118 1 723 029 264 932 289 076
9 1 642 283 1 757 489 220 423 235 886
10 1 707 974 1 792 639 183 392 192 483
f= 0 Total: 4 806 057 5 668 118
i= 0.25 PW = -37 939

We see that the project present worth is negative under the assumption of
zero inflation.

(b) The present worths are shown below.

Inflation rate PW
0 –37939
0.01 –18801
0.02 998

Cash flows under the assumption of 2% inflation are shown below.

2% Inflation Cash Flows:

Operating PW PW
Year Cost Revenue Oper. Cost Revenue
1 1 200 000 1 500 000 960 000 1 200 000
2 1 272 960 1 560 600 814 694 998 784
3 1 350 356 1 623 648 691 382 831 308
4 1 432 458 1 689 244 586 735 691 914
5 1 519 551 1 757 489 497 926 575 894
6 1 611 940 1 828 492 422 560 479 328
7 1 709 946 1 902 363 358 602 398 954
8 1 813 910 1 979 218 304 324 332 058
9 1 924 196 2 059 179 258 261 276 378
10 2 041 187 2 142 369 219 171 230 035
f= 0.02 Total: 5 113 655 6 014 654
i= 0.25 PW = 998

(c) We see that for inflation rates lower than 2%, the project is not profitable.
A conservative decision would be to reject the project. While 2% is on the
low side historically, there have been countries with periods with inflation this
low.