Running head: RISK AND UNCERTAINTY APPLIED PROGRAM
Risk and Uncertainty Applied Program
BUS640 Managerial Economics
Instructor: Professor Jan Tucker
October 26, 2015
Running head: RISK AND UNCERTAINITY APPLIED PROBLEM 1
A generous university benefactor has agreed to donate a large amount of money for student scholarships. The money can be provided in one lump sum of $12 million in Year 0 (the current year), or in parts, in which $7 million can be provided at the end of Year 1, and another $7 million can be provided at the end of Year 2.
Describe your answer for each item below in complete sentences, whenever it is necessary. Show all of your calculations and processes for the following points:
a. Assuming the opportunity interest rate is 8%, what is the present value of the second alternative mentioned above?
The present value of the second alternative is based on the formula calculating the present value of the future amount given by PV of Future Amount = A / (1+r) ^ n Where A = annuity amount, r is opportunity rate of interest and n is number of year when amount will be received. Present value of second alternative is $7000000 / (1+0.08) ^ 1 $6,481,481.48 $7000000 / (1+0.08) ^ 2 $6,001,371.74 $12,482,853.22.
Which of the two alternatives should be chosen and why?
Since the donation received from first alternative is only $12 million, the second alternative best suits as it provides students with $12.48 million, which is $480,000 more than the first scholarship.
RISK AND UNCERTAINTY PROBLEM 2
b. How would your decision change if the opportunity interest rate were 12%?
Now that the opportunity rate of interest is 12%, we can adjust the calculation to show the variances for the new parameters provided. Present Value $7000000 / (1+0.12) ^ 1 $6,250,000.00. $7000000 / (1+0.12) ^ 2 $5,580,357. 14....