Practice

Free response question

Financial literacy · Hard · 20 marks

EO past paper: International Final, Part A

Section III (20 points). An entrepreneur has the option to deposit her 100,000 euros into a savings account that offers an annual interest rate of 4%. For this scenario, let's assume there are no taxes on the interest earned. Another option is to invest this money this year (i.e., in 2024) into a business project that will earn 35,000 euros in one year (i.e., in 2025), 35,000 euros in two years (i.e., in 2026), and 35,000 euros in three years (i.e., in 2027). Each return from this business project can then be deposited into the given savings account, which offers a 4% interest rate.

(a)Calculate and explain whether it is more profitable for the entrepreneur to undertake this investment or keep her money in the savings account using the net present value model.[10](b)Now consider that the investment scheme changes slightly. In the first year (i.e., in 2024), it is necessary to invest only 20,000 euros from the 100,000 euros, with the remaining 80,000 euros being invested in the second year (i.e., in 2025). The flow of returns (i.e., 35,000 euros each year from 2025 to 2027) remains the same as in the previous case. As before, each return from this business project can then be deposited into the given savings account, which offers a 4% interest rate. Using the net present value model, calculate and explain whether it is more profitable for the entrepreneur to undertake this investment or keep her money in the savings account.[10]

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