ECON 202 Decision Making: Short-term Vs. Long-term

| March 14, 2016

Decision Making: Short-term Vs. Long-term

Robin Briggs, a wealthy private investor, had been approached by Union Finance Company on the previous day. It seemed that Union Finance was interested in loaning money to one of its large clients, but the client’s demands were such that Union could not manage the whole thing. Specifically, the client wanted to obtain a loan for $385,000, offering to repay Union Finance $100,000 per year over seven years. Union Finance made Briggs the following proposition. Since it was bringing Briggs business, its director argued, they felt that it was only fair for Briggs to put up a proportionately large share of money. If Briggs would put up 60% of the money ($231,000), then Union would put up the remaining 40% ($154,000). They would split the payments evenly, each getting $50,000 at the end of each year for the next seven years.

Questions

1. Union Finance can usually earn 19% on its money. Using this interest rate, what is the net present value of the client’s offer to Union?

2. Robin Briggs does not have access to the same investments as Union. In fact, the best available alternative is to invest in a security earning 11% over the next seven years. Using this interest rate, what is Briggs’s net present value of the offer made by Union? Should Briggs accept the offer?

3. What is the net present value of the deal to Union if Briggs participates as proposed?

4. The title of this case study is “The Value of Patience.” Which of these two investors is more patient? Why? How is this difference exploited by them in coming to an agreement?

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