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Corporate Finance and Macroeconomics Questions and Answers

Question 1

1. A corporation decides whether to undertake a project that requires an investment of \$100 million now (in 2019), \$80 million in 2020, and \$20 million in 2021. The project will bring \$50 million in 2022, \$90 million in 2023, and \$100 million in 2024. Find the NPV (i.e., the net present value) of the project and recommend whether the company should or should not pursue the project if the relevant interest rate is:

(a) 5%

(b) 6%

2. A risky project requires an initial investment of \$2 million and is expected to bring you \$2.1 million next year. Would a risk-averse individual invest in the project if he/she can borrow the money at an interest rate of:

(a) 4%; (b) 5%; (c) 6%

3. Ralph has a utility function Wn, where W is his wealth in dollars. Is Ralph risk-averse if: (a) n = 2=3; (b) n = 1; (c) n = 4/3

4. Olivia has a utility function p W, where W is her wealth in millions of dollars. Currently, she has \$4 million. Imagine that she can pursue a project that is equally likely to result in a gain of \$G million and a loss of \$L million. Would she pursue the project if

(a) G=2 and L=2; (b) G=5 and L=3; (c) G=6.2 and L=3.2; (d) G=8 and L=3.8; (e) Is there a case from the ones listed above where Olivia is indi§erent between pursuing and not pursuing the project? if yes, which one?

5.In December 2018, a small island country has an adult population of 25,000. The number of employed is 15,000 and the number of unemployed is 2,000. In June 2019, a foreign bank decides to open a branch in the capital of the country. For this reason, it hires 500 students who graduated from college in May 2019. In July 2019, a local company decides to close its factory laying o§ 4,000 workers. 2,000 of them Önd jobs in other industries, 1,500 spend three months looking for a job, but get discouraged and decide to stay home and wait for better economic conditions, and as of December 2019, the remaining 500 have not found a job yet, but are actively searching. Find the unemployment rate and the labor-force participation rate in December 2019 if the only change in the adult population during the year was the tragic loss of 150 non-working retirees and 10 crew members in a local plane crash.

6.All else equal, how would the unemployment rate and labor-force participation rate be a§ected (increase, decrease, stay the same) if:

(a) a friend of yours graduates from college and immediately Önds a job

(b) a friend of yours who was actively looking for her dream job has no success Önding it and goes to grad school

(c) a friend of yours graduate from college and immediately joins the military

(d) advances in medical technology increase the lifespan of current retirees (assume that they do not decide to pursue a job)

7.A friend of yours produces 1,000 counterfeit hundred-dollar bills. Assuming that the bills are undetectable with current technology, what would be the maximum increase in the money supply if the required reserve ratio is 10%?

8.A bank has a leverage ratio (as deÖned in class) of 8. As a result of an economic boom, bankís assets increase by 10%. Bankís liabilities, however, remain unchanged.

(a) What is the percentage change in bankís capital?

(b) Did the bankís leverage ratio increase, decrease, or stay the same?

9.How would an increase in the usage of cryptocurrencies for transaction purposes a§ect the demand for U.S. dollars? Would the price level in U.S. dollars increase, decrease, or stay the same (absent any policy response) in the long run? Use a supply-demand diagram for the market for money to illustrate your answer. Should the Fed buy or sell U.S. government bonds to keep dollar prices at their initial level?

10.If the tax rate is 20%, compute the before-tax and after-tax real interest rate if:

(a) the nominal interest rate is 3% and the ináation rate is 2%

(b) the nominal interest rate is 2% and there is a DEFLATION of 1%.

11.You took a one-year loan at a 5% interest rate, expecting an ináation of 2%. Ináation, however, turned out to be 1%. Who got lucky: you or the lender?

12.The Central bank surprisingly announces that it will increase the money supply NEXT year. Will the price level increase, decrease, or stay the same THIS YEAR? Explain.

13.15. Do you expect the federal funds rate to increase or decrease if

(a) the Fed increases the overnight reverse repo rate by 25 basis points.

(b) the Fed decreases the interest rate on excess reserves by 25 basis points.