Question

No need for explanation

You are trying to compare two six year investment ideas; both ideas require a $12,500 investment today (T-0). Investment A will grow to $50,000 at the end of year 6 (T-ó), while Investment B will grow to $25,000 at the end of year 6 (T=6). Estimate the annualized return for each investment using the Rule of 72, Next, find the Compound Annual Growth Rate (i.e. geometric average) for each investment, which we learned is more precise that the Rule of 72. You can use the timeline below to help answer problems 1-2: YEAR Investment A Investment B 0 2 $12,500) $50,000 $25,000 $ (12,500) 1. The Rule of 72 estimates the return on Investment A will be closest to: a. 12.0% per year b. 12.2% per year c. 24.0% per year d. 26.0% per year e. 50.0% per year 2. Compare the Rule of 72 to the CAGRs for each investment. Based on your observations, which of the following statements is most accurate: a. The Rule of 72 does a better job of estimating the annualized return of Investment B than InvestmentA; b. The Rule of 72 does a better job of estimating the annualized return of Investment c. The Rule of 72 does a better job of estimating the annualized return of Investment B than InvestmentA; d. The Rule of 72 does a better job of estimating the annualized return of Investment e. The Rule of 72 does a better job of estimating the annualized return of Investment B than InvestmentA; The Rule of 72 underestimates the actual return on Investment B by 20% The Rule of 72 overestimates the actual return on Investment A by 2.0% The Rule of 72 overestimates the actual return on nvestment B by 0.2% The Rule of 72 overestimates the actual return on investment A by 0.2% The Rule of 72 underestimates the actual return on Investment A by 20% 3. Assume a discount rate of 10.0% per year. Using the concept of discount factors to compare receiving $20 today (T-0) to receiving $20 20 years from now (T-20). Which of the following statements is the most accurate: a. The $20 received 20 years from now is worth only 5% of the value today b. The $20 received 20 years from now is worth only 10% of the value today c. The $20 received 20 years from now is worth only 15% of the value today d. The $20 received 20 years from now is worth only $4 today e. The $20 received 20 years from now is worth only $6 today 4. In the 5-Stage DuPont ROE formula, which of the following stages is considered to be a relative measurement of how much long term debt there is on the balance sheet (i.e. a solvency ratio): a. NI SE, or the return on equity b. NI / Sales, or the profit margin c. EBIT Sales, or the operating margin d. EBIT Interest, or the times interest earned ratio e. TA / SE or the leverage ratio

Answer 1

Case study - Question 1 and 2

Question 1: The rule of 72 says how may years it takes for the money to double itself

Investment A of 12,500 increased four times to 50,000 in 6 years. So, it doubled in 3 years. So, the rate of return on investment A as per rule 72 is 72/3 = 24% (Option C)

Question 2:

The actual return of Investment A = (50000/12500)^(1/6) -1 = 26%. So rule of 72 underestimates the actual return on investment A by 2% whereas it accurately estimates investment B

Answer : The rule of 72 does a better job of estimating the annualized return of Investment B than Investment A; The rule of 72 underestimates the actual return of investment A by 2% (Option E)

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