:Help me with the following questions.

Suppose that the depreciation rate increases. In the Solow growth model, determine the effects of this on the quantity of capital per worker and on output per worker in the steady state. Explain the economic intuition behind your results.

You will demonstrate the importance of diminishing returns to capital in the Solow-Swan model. Draw a Solow-Swan diagram in which there are constant returns to capital. This would happen if the production function were Yt = AKt. Furthermore, assume that the sum of population growth and the depreciation rate is less than the saving rate. Does the economy converge to a steady state in this case? To answer this question, you should draw a Solow-Swan diagram in terms of output per person, as we did in class. Use this diagram to explain why the economy converges to a steady state or not.

(25) . has any effect SECTION A TRUE OR FALSE QUESTION (40 Marks) The following questions indicate if it's True or False. Each question carries 2 Marks. 1. Accounting Principle is general law or rule followed in the preparation of financial statements 2. Usefulness, objectivity and feasibility are the three basic norms generally found in accounting principles 3. The Cash book record only the cash payments 4. If a Cheque sent for collection is dishonored, the debit is given to customer's account 5. If a Cheque is issued by us is dishonored, the credit is given to supplier's account 6. Discount allowed column appears in debit side of the cash book 7. Discount Received Column appears in the credit side of the cash book 8. Cash books one of the Subsidiary books 9. When Bank column of a Cash Book shows a credit balance, it means overdraft or amount due to the bank 10. Overdraft balance as per Pass book is R11, 500. Interest on Overdraft R350 Debited by Bank but not recorded in the Cash Book. Overdraft Bank balance as per Cash Book is R11, 150 credit 11. The ledger is the book of original entry 12. The income statement shows either net profit or net loss for a particular period 13. The salary paid in advance is not an expense because it neither reduces assets or nor increase liabilities 14. All liabilities which become due for payment in one year are classified as long-term liabilities 15. The term current asset is used to designate cash and other assets or resources which are reasonably expected to be realized or sold or consumed within one year 16, An asset gives rise to expenditure when it is acquired and to an expense when it is consumed 17. Sales less cost of goods sold = gross profit 18. Depreciation account appear in the trial balance is taken only to profit and loss account 19. Depreciation is charged on all assets 20. Fixed assets are stated in the balance sheet at their written down value15. A foundation announces that it will be offering one MIT scholarship every year for an indefinite number of years. The first scholarship is to be offered exactly one year from now. When the scholarship is offered, the student will receive $20,000 annually for a period of four years, beginning from the date the scholarship is offered. This student is then expected to repay the principal amount received ($80,000) in 10 equal annual installments, interest-free, starting one year after the expiration of her scholarship. This implies that the foundation is really giving an interest-free loan under the guise of a scholarship. The current interest is 6% for all maturities and is expected to remain unchanged. (a) What is the PV of the first scholarship? (b) The foundation invests a lump sum to fund all future scholarships. Determine the size of the investment today. 16. You signed a rental lease for an office space in the Back Bay for five years with an annual rent of $1 million, paid at the beginning of each year of the lease. Just before you pay your first rent, the property owner wants to use the space for another purpose and proposes to buy back the lease from you. The rent for similar space is now $1.25 million per year. What would be the minimum compensation that you would ask from the property owner? Assume the interest rate to be 6%. Fall 2008 Page 3 of 66 17. The annual membership fee at your health club is $750 a year and is expected to increase at 5% per year. A life membership is $7,500 and the discount rate is 12%. In order to justify taking out the life membership, what would be your minimum life expectancy? 18. You are considering buying a car worth $30,000. The dealer, who is anxious to sell the car, offers you an attractive financing package. You have to make a down-payment of $3,500, and pay the rest over 5 years with annual payments. The dealer will charge you interest at a constant annual interest rate of 2%, which may be different from the market interest rate. (a) What is the annual payment to the dealer? (b) The dealer offers you a second option: you pay cash, but get a $2,500 rebate. Should you go for the loan or should you pay cash? Assume that the market annual interest rate is constant at 5%. Note: the tradeoff between the two options is that in the first case, you can finance your purchase at a relatively low rate of interest. In the second case, you receive a lump-sum cash rebate. 19. Your brother-in-law asks you to lend him $100,000 as a second mortgage on his vacation home. He promises to make level monthly payments for 10 years, 120 payments in all. You decide that a fair interest rate is 8% compounded annually. What should the monthly payment be on the $100,000 loan? 20. Your cousin is entering medical school next fall and asks you for financial help. He needs $65,000 each year for the first two years. After that, he is in residency for two years and will be able to pay you back $10,000 each year. Then he graduates and becomes a fully qualified doctor, and will be able to pay you $40,000 each year. He promises to pay you $40,000 for 5 years after he graduates. Are you taking a financial loss or gain by helping him out? Assume that the interest rate is 5% and that there is no risk. 21. You are awarded $500,000 in a lawsuit, payable immediately. The defendant makes a counteroffer of $50,000 per year for the first three years, starting at the end of the first year, followed by $60,000 per year for the next 10 years. Should you accept the offer if the discount rate is 12%? How about if the discount rate is 8%? 22. You are considering buying a Back Bay two-bedroom apartment for $800,000. You plan to make a $200,000 down payment and take a $600,000 30-year mortgage for the rest. The interest rate on the mortgage is 6% monthly APR. Payments are due at the end of every month. (a) What is the effective annual rate? (b) What is the monthly payment?18. Digital Organics has been growing at a rate of 6 percent per year and is expected to continue to do so indefinitely. The next dividend is expected to be $5 per share. (a) If the market expects a 10 percent rate of return on Digital Organics, at what price must it be selling? (b) Next year Digital Organics earnings per share will be $8. What part of Digital Organicss value is due to assets in place, and what part to growth opportunities? 19. The Sloan Management Group expects to pay a dividend of $4.50 per share one year from now. After this payment, the annual dividend is expected to grow (in perpetuity) in real terms at 4% per year. The appropriate nominal discount rate for valuing the dividends is 9.5% per year. Inflation is expected to be 2% per year. Given these assumptions, what is the present value of the stream of future dividends paid by Sloan Management Group stock? Fall 2008 Page 30 of 66 20. Company Ts current return on equity (ROE) is 16%. It pays out one-quarter of earnings as cash dividends (payout ratio = .25). Current book value per share is $35. The company has 5 million shares outstanding. Assume that ROE and payout ratio stay constant for the next four years. After that, competition forces ROE down to 10% and the company increases the payout ratio to 60%. The company does not plan to issue or retire shares. The cost of capital is 9.5%. (a) What is stock T worth? (b) How much of stock Ts value is attributable to growth opportunities (PVGO)? 21. Now suppose the management of company T decides to increase the dividend payout ratio to 60% starting next year, at the same time maintaining the investment and growth rates that you calculated in answering pervious question. The company will cover any cash shortfall by issuing additional shares. (a) How many additional shares will Company T have to issue next year? (b) What is the effect on the (ex-dividend) value of stock T today? You can assume that the stock issue is made immediately after the dividend at year 1. The company can take out a short-term loan if necessary to cover the additional dividend at year 1. 22. Company XYZ is expected to pay a dividend of $5 a year from now. This dividend is expected to grow at 10% for the next two years and at 5% forever after. The return that investors expect on XYZ is 12%. XYZ's payout ratio is 0.3. (a) Determine XYZ's stock price. (b) Determine XYZ's PVGO. (c) Determine XYZ's P/E ratio. (d) What will be the P/E ratio of XYZ in one year from now? (e) To see how sensitive your conclusions are to the assumption about discount rates, re-compute your answers to previous questions assuming that the required rate of return on XYZ is either 10% or 14%. 23. Firm XYZ has two lines of business, organized as two divisions, A and B. Division A generates a risk-free cash flow. It will produce $2 million in free cash flow next year and it will grow at 2% each year thereafter forever. The second line of business, run by Division B, is risky. It expects to generate a cash flow of $2 million next year and will grow at a rate of 4%. Currently, the total market value of XYZ is $87 million. The term structure of interest rate is flat at 5%. (a) What is the cost of capital for the second line of business