An investor is faced with the problem of choosing among 2 investment opportunities that have the following deterministic cash flow streams and the interest rate is constant at 5% per year. A = (-25, 5, 10, 15), B = (-20, 20, 5) a) Which investment would you choose according to the net present value criteria? b) What is the internal rate of return of B? c) How would your answer change in part a) if there is a term structure of interest rates so that the spot rates are s1 = 5%, s2 = 8% and s3 = 10%?

FINANCIAL ACCOUNTING
10th Edition
ISBN:9781259964947
Author:Libby
Publisher:Libby
Chapter1: Financial Statements And Business Decisions
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An investor is faced with the problem of
choosing among 2 investment opportunities
that have the following deterministic cash
flow streams and the interest rate is constant
at 5% per year. A = (-25, 5, 10, 15), B = (-20,
20, 5)
a) Which investment would you choose
according to the net present value criteria?
b) What is the internal rate of return of B?
c) How would your answer change in part a) if
there is a term structure of interest rates so
that the spot rates are s1 = 5%, s2 = 8% and
s3 = 10%?
e) What are the short rates for years 1, 2 and
3? What is your forecast of the spot rates for a
term of 1 and 2 years after a year passes by?
%3D
Transcribed Image Text:An investor is faced with the problem of choosing among 2 investment opportunities that have the following deterministic cash flow streams and the interest rate is constant at 5% per year. A = (-25, 5, 10, 15), B = (-20, 20, 5) a) Which investment would you choose according to the net present value criteria? b) What is the internal rate of return of B? c) How would your answer change in part a) if there is a term structure of interest rates so that the spot rates are s1 = 5%, s2 = 8% and s3 = 10%? e) What are the short rates for years 1, 2 and 3? What is your forecast of the spot rates for a term of 1 and 2 years after a year passes by? %3D
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