1. There are two alternative (mutually exclusive) projects. The first project promises a profit of $100,000 in each of the next four years, while the second project promises a profit of $75,000 in each of the next six years. a. Calculate the NPV of both projects if the discount rate of the firm is 10 percent. b. Determine and explain which of two investment projects a manager should choose in (a). c. Calculate the NPV of both projects if the discount rate of the firm is 20 percent. d. Determine and explain which of two investment projects a manager should choose in (b). e. Explain the difference in the decisions in (b) and (d) if any.
2. Suppose that households change their preferences so that they wish to consume more and save less in the current year. Since the households reduce savings, the interest rate in the economy increases. a. Show on a graph (with axes L and real wage rate w) the effects on the labor market. What happens to the equilibrium labor input and real wage rate? b. Show on a graph (with axes K and real interest r; assume that the supply of capital is perfectly elastic) the effects on the market for capital services. What happens to the equilibrium level of capital and interest rate ?
3. Use the spreadsheet on Ricardian equivalence with three periods and assume that – the government spendings are 100, 150 and 150; – households’ salary is 300 in each period. Also assume that households preper smoothed consumption and there is no discounting. a. Assume that the government imposes equal (in each period) taxes to finance all spendings. For each period, determine the government bond issuances and repayments, households’ disposable income, consumption and savings. b. Assume that the government cannot issue debt or save and finances its spendings by taxes only. For each period, determine households’ disposable income, consumption and savings with perfect consumption smoothing. c. Using the results in (a) and (b) explain why the timing of taxes is irrelevant (the Ricardian equivalence result).