Question

Assume that capital markets do not exist. Ryan has $70,000 today (t = 0) and will receive $90,000 in exactly one year (t = 1). The graph below illustrates point Y: having $70,000 now and receiving $90,000 next year. Here, if no capital or financial market exists, then Ryan must consume $70,000 now and $90,000 next year. Next consider this case when borrowing and lending at r = 10% are available in the financial markets; Ryan now has a real investment opportunity, or business project. If Ryan decides to accept this opportunity, it will cost $20,000 now (t = 0) and will offer a risk-free payoff of $25,000 next year. Now, revisit the point Y where Ryan has $70,000 now and will receive $90,000 next year, but this time the real asset project exists. Assume that he still wants to consume $70,000 now (t = 0), and answer the following.
a. How much more can Ryan consume next year, with the investment opportunity, compared to when there was no borrowing or lending opportunity?
b. Calculate the NPV of the project.


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  • CreatedJune 17, 2015
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