# The opportunity cost and negotiating a contract

You are negotiating a contract with your employer. You have been offered three possible 4
year contracts. Your opportunity cost is 10%. Payments are guaranteed, and they would be
made at the end of each year. Terms of each contract are as follows:
Year 1 Year 2 Year 3 Year 4
Contract A \$55,000 \$55,000 \$55,000 \$55,000
Contract B \$55,000 \$56,000 \$58,000 \$60,000
Contract C \$80,000 \$40,000 \$50,000 \$50,000
Which contract would you accept? Show workings.
Question 2: Interest Rates
a)
The nominal interest is 12% with interest paid quarterly. What will be the effective annual
rate?
b)
Minnie has taken a 30-year mortgage for \$500,000. The mortgage requires monthly
payment of \$5,143.06 with an interest rate of 12% per annum.
i. How much interest is in the first payment?
ii. How much repayment of principle is in the first payment?
c)
Mickey is planning to save \$50,000 per quarter for 10 years. Savings will earn interest at an
(nominal) interest rate of 12% per annum. Calculate the present value for this annuity if
interest is compounded semi-annually.
Question 4: Investment Decision Rules (chapter 8)
A firm with a 14% WACC is evaluating 2 projects for this years budget. After-tax cash flows are as
follows:
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
Project A -\$8,000 \$2,200 \$2,200 \$2,200 \$2,200 \$2,200
Project B -\$20,000 \$5,700 \$5,800 \$6,000 \$6,200 \$6,500
i. Calculate NPV for each project.
ii. Calculate IRR for each project.
iii. Calculate MIRR for each project.
iv. Calculate payback for each project.
v. Calculate discounted payback for each project.
Question 4: Risk and Return (chapters 11 and 12)
a)
Consider the following information for two stocks, Stocks Y and Z and the returns on the two
stocks are positively correlated.
Stocks Expected return Standard deviation
Y 9% 15%
Z 15% 17%
i. Assume you held a portfolio consisting of 60% of Stock Y and 40% of Stock Z. Calculate
the average return of the portfolio during this period.
ii. Calculate the standard deviation of the portfolio if the correlation between Stock Y and
Stock Z is 10%.
b)
An Italian restaurant chain will generate the following rates of return in the following
scenarios:
State of economy Probability Rates of return if state of economy occurs
Boom 30% 125%
Normal Economy 50% 15%
Recession 20% -100%
i. Calculate the expected rate of return.
ii. Calculate the standard deviation of return for its shareholders.

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