Tackle the Test: Free-Response Questions

1. Question

   
   

   1. Calculate the net present value of each of the three hypothetical projects described below. Assume the interest rate is 5%.

      
      

      Project A: You receive an immediate payoff of $1,000.

      
      

      Project B: You pay $100 today in order to receive $1,200 a year from now.

      
      

      Project C: You receive $1,200 today but must pay $200 one year from now.

      
      
   
   

   2. Which of the three projects would you choose to undertake based on your net present value calculations? Explain.

      
      
   
   

   Rubric for FRQ 1 (5 points)

   1 point: Project A net present value: $1,000

   1 point: Project B net present value: –$100 + ($1,200/1.05) = $1,042.86

   1 point: Project C net present value: $1,200 – ($200/1.05) = $1,009.52

   1 point: Choose project B.

   1 point: It has the highest net present value.

2. Question

   
   

   1. What is the future value of a 3-year loan of $1,000 at 5% interest? Show your work.

      
      
   
   

   2. What is the present value of $1,000 received in three years if the interest rate is 5%? Show your work. (4 points)

      
      
   
   

   Rubric for FRQ 2 (4 points)

   1 point: $1,157.63

   1 point: $1,000 × (1.05)3 = $1,000 × 1.16 = $1,157.63

   1 point: $863.84

   1 point: $1,000/(1.05)3 = $863.84