Page 284 - Krugmans Economics for AP Text Book_Neat

Tackle the Test: Multiple-Choice Questions
1. Suppose, for simplicity, that a bank uses a single interest rate 3. If the interest rate is 10%, the present value of $1 paid to you
for loans and deposits, there is no inflation, and all unspent one year from now is
money is deposited in the bank. The interest rate measures a. $0.
which of the following? b. $0.89.
I. the cost of using a dollar today rather than a year c. $0.91.
from now d. $1.
II. the benefit of delaying the use of a dollar from today e. more than $1.
until a year from now
4. If the interest rate is 5%, the amount received one year from now
III. the price of borrowing money calculated as a percentage
as a result of lending $100 today is
of the amount borrowed
a. $90.
a. I only
b. $95.
b. II only
c. $100.
c. III only
d. $105.
d. I and II only
e. $110.
e. I, II, and III
5. What is the present value of $100 realized two years from now if
2. If the interest rate is zero, then the present value of a dollar
the interest rate is 10%?
received at the end of the year is
a. $80
a. more than $1.
b. $83
b. equal to $1.
c. $90
c. less than $1.
d. $100
d. zero.
e. $110
e. infinite.
Tackle the Test: Free-Response Questions
1. a. Calculate the net present value of each of the three 2. a. What is the amount you will receive in three years if you loan
hypothetical projects described below. Assume the interest $1,000 at 5% interest?
rate is 5%. b. What is the present value of $1,000 received in three years if
Project A: You receive an immediate payoff of $1,000. the interest rate is 5%?
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.
b. Which of the three projects would you choose to undertake
based on your net present value calculations? Explain.

Answer (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.

242 section 5 The Financial Sector