Clould you please explain with details because I want to learn by following your

Question

Clould you please explain with details because I want to learn by following your solution steps.

2) Annual expenses for two alternatives have been estimated as follows: Alternative A Alternative B Annual Expenses Estimated inAnnual Expenses Estimated in End of Year Actual Dollars (S) 109,000 113,000 113,000 116,000 Real Dollars (S) 107,000 109,500 109,000 113,000 a) If the average general price inflation rate is expected to be (10 pts) 3.1% per year and the real rate of interest is 7.3% per year what is the value of the market interest rate? b) What is the PW of alternative A? c) What is the PW of alternative B? (5 pts) d) Which alternative will be selected? (4 pts)

Explanation / Answer

1. Market interest rate= real rate+ inflation = 7.3 + 3.1= 10.4%

2. The present value of alternatives

For Alternative A we need to do the discounting by market interest rate=

109000/(1.104)+ 113000/(1.104)^2..+n = 98731.8+ 92712.93+ 83979.10+ 78088.18= 353512.016$

Present value of alternative B=

107000/1.073 + 109500/(1.073)^2+...n=

99720.41+ 95107.48+ 88232.24+ 85250.85= 368310.97 $

Note: for Alternative B discounting is done by real rate as annual expenses are given on Real terms.

3. We will select the alternative having lower present value of expenses. WhIch is A.

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