MBA HEC Paris

Financial Markets Philippe Henrotte

Practice 2

NPV & Portfolio Theory

Question 1. (1 point) The annualized discount rate is 10%. Which proposition is the most
valuable?
A: USD 100 received in one year.
B: USD 200 received in five years.
C: USD 300 received in ten years.

Question 2. (1 point) What is the present value at the annualized discount rate of 8% of
receiving EUR 10, 000 every year in perpetuity with the first payment to start two years
from now? Give your answer rounded to the nearest Euro.

Question 3. (2 points) Your son is currently five years old. You anticipate that he will
be going to college in 13 years. You would like to have USD 100, 000 in a savings account
to fund his education at that time. If the account promises to pay a fixed interest rate
with an APR of 3% compounded quarterly, how much money do you need to put into the
account today to ensure that you will have USD 100, 000 in 13 years, assuming you make
no additional payment after your initial deposit? Give your answer rounded to the nearest
dollar.

Question 4. (1 point) The British government has a consol bond outstanding paying
GBP 100 per year forever. Assume the current annually compounded discount rate is 2.5%.
What is the value of the bond immediately before a payment is made, meaning that you
will receive the first payment immediately after you purchase the consol bond? Give your
answer rounded to the nearest pound.

Question 5. (2 points) You are head of a family endowment which has decided to fund
a school in perpetuity. Every five years, you will give USD 150, 000 to the school with the
first payment occurring five years from today. If the annualized discount rate is 6%, what
is the present value of your gift? Give your answer rounded to the nearest dollar.

1
 Problem 1. The Value of an MBA (5 points)

You just turned 26 years old and you plan to work to age 65. We assume that you receive
your salary at the end of the year, just before your birthday. Absent an MBA, you plan to
work 40 years with a starting salary of USD 45, 000 which you expect to grow every year
at a constant growth rate to reach a final level of USD 200, 000.

The MBA would take two years to complete, but your starting salary after these two
years would be USD 70, 000 and would grow 5% per year. Every year the MBA tuition is
USD 30, 000 and the books cost USD 3, 000, both paid at the beginning of the year. You
also plan that a summer job will pay you USD 8, 000 at the end of the first year of your
program. Assume no inflation, no retirement benefits, and a discount rate of 6%. For the
two questions in this problem, give your answer rounded to the nearest dollar.

Question 6. (2 points) What is the NPV of not doing an MBA?

Question 7. (3 points) What is the NPV of doing an MBA?

Problem 2. Leverage (4 points)

The risk free rate is 5%. A portfolio of stocks offers an expected return of 8% and has a
volatility of 18%. Your initial wealth is USD 300, 000. You seek to enhance the expected
return offered by the portfolio by using leverage. You borrow money at the risk free rate on
top of your initial wealth and invest the total in the portfolio, seeking to reach an expected
return of 12% on your initial wealth.

Question 8. (2 points) How much cash should you borrow? Give your answer rounded to
the nearest dollar.

Question 9. (1 point) What is the volatility of your leveraged position? Give your answer
as a number with 4 digit precision, for instance enter 0.1234 if your answer is 12.34%.

You find that the volatility level of the levered portfolio is unacceptably large. You wish
to set 36% as the target volatility for your levered portfolio.

Question 10. (1 point) How much cash should you borrow to reach this volatility target?
Give your answer rounded to the nearest dollar.