ACT349 F13 Assignment and Solutions for Sep 25 Tutorial v12

Solutions: ACT349 F13 Assignment for Sep 25, 2013 4:00pm Tutorial Brealey Myers Allen 11th Ed 'Principles of Corporate Finance' (North American or Global edition)

For Sep 25 ≥1Q on TT1 Chapter 5 1 a-e 3 5 7 8a-b 13 Chapter 6 1 3 21

1. (BMAGL11-XXX ;BMA11-Ch05-Q01 a, v00) C1

Solution Project

Payback period

A B C

3 yr 2 yr 3yr

(but C better than A)

(BMAGL11-XXX ;BMA11-Ch05-Q01 e, v00)

Solution True. Because it will be missing a lot of good long-term projects for which the payoff comes after more years

2. (BMAGL11-099 ;BMA11-Ch05-Q03v00)

Solution NPV = -6750 + 4,500/(1+i) + 18, 000/(1+i)2 i 0% 50% 100%

t 0 1 2 Tot

i ‐6750 4500 18000

0 ‐ 6750 4500 18000 15750

PV st time  0 at i i 0.5 1 ‐6750 ‐6750 3000 2250 8000 4500 4250 0

NPV 15,750 4,250 0: so IRR=100%

3. (BMAGL11-XXX ;BMA11-Ch05-Q05v00)

Solution: a): Two roots: solving a quadratic with b2 -4ac >0 so no problem with imaginary numbers. b) 0=75v2 -200v

+ 100

v = (200 +- sqrt(40,000 – 30,000))/(150) = (200 +_ 100)/(150) = 2 or 0.66666 Hence i= -50% or i+50% c) NPV (20%) >0 so, yes, an attractive project> A plot of NPV against i shows positive NPV if i within (-50%, +50%) Comment from Keith Sharp: This is assuming that the amazingly competent management can give a higher return on capital than the overall market can give. This gets pretty deep, and would involve considering e.g. that if the stockholder re-invests then he/she will be a ‘marginal’ investor whereas the first few dollars of investment get the factory electricity turned on and give a big return. Getting beyond ACT349, don’t worry about it.

4. (BMAGL11-XXX ;BMA11-Ch05-Q07v00)

Solution: The PI = NPV/Investment could be used as a guide. But it’s clear anyway that we don’t want to spend out whole $90,000 on the unrewarding project 3, with PI=1/9. Going for projects 1, 2, 4, 6 uses exactly 90,000 gives us a NPV=5000+5000+15,000+3000=28,000 and is fairly clearly going to give us the highest NPV of any use of the 90,000 or less.

5. (BMAGL11-XXX ;BMA11-Ch05-Q08a)-b) v00)

Solution:

Project A