Asset Pricing & Capital Budgeting
Semester 2.2, 2022-2023
Practical Week II
BDH 3&4
Student name:
Diego Rodriguez
Student number: s4621824
Signature: Diego
Problem 1.
a) True/ False: Arbitrage is a very risky process of trading to take advantage of the same goods
that have different prices in different competitive markets.
True
Note that the market must be competitive
b) Robin is a private fisher. Each day he has 1,000 kilos supply of fish. However, he does not
like fish at all. The market price of fish is $30 per kilo. What is the value of 1,000 kilos supply
of fish to Robin?
o The value of fish to Robin is less than $30 per kilo because he does not like fish.
o The value of fish to Robin is less than $30,000 per thousand kilos because fish is a
perishable good.
o The value of fish is more than $30 per kilo to Robin because he can wait for the market
price to go up.
o The value of fish to Robin is $30,000 per thousand kilos because it is the market
price.
c) Robin’s friend Tom who runs a seafood business wants to offer shrimps in exchange for fish.
He offers 400 kilos of shrimps in exchange for 1,000 kilos of fish. The market price of shrimp
is $60 per kilo. Robin is so excited to hear this news because he likes shrimps so much. In the
end, will Robin accept this offer? And why?
He should not take it, because the PV of fish is 30.000. Whereas the PV of shrimp is 24.000
Therefore Robin should not take this trade because it would leave him a net -6000$ NPV.
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Problem 2
Ford Motor Company is considering installing new AI-assisted parking software on their SUVs
and to make an emphasis on this feature in their marketing campaign. Incorporating this feature
will reduce the profit margin from $12,000 to $10,000. At the same time, the marketing group
estimates that it will increase the sales from 50,000 to 65,000 cars. If the change in sales is the
only consequence of this decision,
What are its benefits and costs? Is it a good idea?
Benefit = difference of cars sold*profit margin= 15000*10000=150000000
Cost = #cars sold*reduction in profit margin= 2000*65000= 130000000
Therefore it is a good idea because NPV is positive
Problem 3
Consider an investment project with an initial cost of $24 million and positive cash flow of $8
million at the end of year 1, $10 million at the end of year 2, and $15 million at the end of year
3. The discount rate for this kind of project is 12 percent.
a) How is the term Net Present Value (NPV) defined? Also, write it down in the form of a
general equation. Calculate the NPV for this investment project.
NPV is defined as the difference between the present value of cash inflows and the present value of
cash outflows over a period of time. (Investopedia).
NPV = PV(Benefit)-PV(Cost)
NPV =25,79- 24million = 1,79 NPV
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Problem 4
Kevin Baker owns his own business and is considering an investment. If he undertakes the
investment, it will pay $5,000 at the beginning of each of the next four years (t=1 to 4). The
opportunity requires an initial investment of $7,000 plus an additional investment at the end of
the third year of $13,000. What is the NPV of this opportunity if the interest rate is 4% per year?
Should Kevin undertake it?
NPV = PV(Benefit)-PV(Cost)
PV Business Revenue = 18.149$
PV(Third final payment) Final cost= 11.112
NPV = 18149-11112-7000= 36,54$
The NPV is positive, therefore it makes sense to take this opportunity
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Problem 5
You are planning of a trip around the world. You have calculated that to cover all expenses
during the trip you will need €15,000, so you decide to put part of your salary, €2000, to a
savings account on yearly basis. APR on this account is 6%. After how many years can you
afford the trip? [hint: remember your Mathematics course – you can take a natural logarithm of
both sides if the unknown is in the exponent].
It takes 34,57 Years
By using the formula FV = PV*(1+r)^n
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Problem 6
You decide to refurbish your kitchen and buy a new kitchen set from IKEA for €6,700. IKEA
offers you two payment schemes:
(1) Pay €130 monthly for 5 years, or
(2) Make 6 annual payments. The payment grows at 2% per year. The first payment
is €1270 and is due immediately, or
(3) Pay € 478.79 per year forever, the first payment starting exactly 4 years from now
(so at the end of year 4),
Which payment scheme gives you the best deal if the discount rate is 6%?
PV(1) = 6571.
1560 annual payment
PV(2)= 4973
PV(3)=6329
Therefore because the second deal offers the lowest PV, that is the correct answer.
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Problem 7
When you purchased your house, you took out a 30-year annual-payment mortgage with an
interest rate of 6% per year. The annual payment on the mortgage is $12,000. You have just
made a payment and have now decided to pay the mortgage off by repaying the outstanding
balance. What is the payoff amount if you have lived in the house for 12 years?
For this exercise I will calculate the PV of the outstanding mortgage debt. I don´t know if this
method is correct, but I will try nevertheless.
PV(Outstanding mortgage) = PV(House)-PV(House Stream of payments for 12 years)
PV (Outstanding Mortgage) = 165177-100606
Note that PV refers to year 0; Therefore the FV(12 years) of the Outstanding Mortgage is
equal to 64571*(1,06)^12
Payoff = 129929$
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– End of practical –
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