Name:______
MAN 321 Corporate Finance
Midterm Examination II
Fall 2001
There are 5 problems on this examination. Answer the problems in the spaces provided on the exam. You have 90 minutes. Good luck!
Question 1 (20 points) (For this question, you can use the back of the page)
Consider the following two mutually exclusive projects:
Year /Net Cash Flows A
/ Net Cash Flows B0 / -50,000 / -50,000
1 / 15,990 / 0
2 / 15,990 / 0
3 / 15,990 / 0
4 / 15,990 / 0
5 / 15,990 / 100,560
- Find the NPV of the two projects if cost of capital is 8 percent.
- Find the IRR of the two projects.
- At what discount rate do projects A and B have the same NPV?
- Calculate modified IRR (MIRR) for the two projects when cost of capital is 5%.
- Which project should be chosen? Why?
Question 2: (20 points)
Virtual Markets is considering to open a new retail store in the suburbs of Urfa. The company estimates that the new store will cost €25 million. The expected cash flows from the store is €6 million per year for the next 10 years. The vice president in charge of financial affairs of Virtual thinks that their cost of capital is 12%.
a. Find the NPV of the project.
b. Although the expected cash flows are €6 million per year, the financial VP knows that the actual cash flows will depend on whether or not there is turmoil in Northern Iraq. The political situation in Iraq will be much clearer one year later. If there is stability in the region cash flows will be €9 million, otherwise they will be €3 million per year. The VP believes that the probability of stability is 50%. The company has to decide to open the new store this year or wait for one year until the political situation will be clear before making a decision. Should they wait or proceed with the project today?
c. Suppose that Virtual markets can sell the store to a local entrepreneur for €20 million one year later. How does this possibility affect your decision?
Question 3: (20 points)
Club Auto Parts’ last dividend, D0, was $2.00, and the company expects to experience no growth for the next two years (t1 and t2). However Club will grow at an annual rate of 5 percent in the third and fourth years (t3 and t4), and after that it should attain a 10 percent growth rate which it will sustain thereafter. Club has a required rate of return of 18 percent.
a. Calculate the current price (P0) of the company’s common stock.
b. What will be the price of Club stock at the end of the second year (P2)?
Question 4: (20 points)
Vanderheiden Inc. is considering two average risk alternative ways of producing its patented polo shirts. Process S has a cost of €8,000 and will produce net cash flows of €5,000 per year fro two years. Process L will cost €11,500 and will produce cash flows of €4,000 per year for four years. The company has a contract that requires it to produce the shirts for four years, but the patent will expire after four years, so the shirts will not be produced after four years. Annual inflation is expected to be 5% over the next four years. Vanderheiden expects that all revenues and costs, including the costs of the processes S and L, will keep up with inflation. Vanderheiden’s nominal cost of capital is 15 percent. Which process should the company select?
Question 5: (20 points)
The president of Real Time Inc. has asked you to evaluate the proposed acquisition of a new computer. The computer’s price is $40,000 and it will be depreciated towards a zero salvage value according the to schedule given below. The purchase of the computer would require an increase in net working capital of $2,000. The computer will increase the firm’s revenues by $22,000 per year but will also increase operating costs by $5,000 per year. The computer is expected to be used for three years and then be sold for $25,000. The firm’s marginal tax rate is 40%, and its cost of capital is 14%.
a. What is the net investment required at t=0?
b. What are the net cash flows in years 1, 2 and 3?
c. Find the NPV of the project.
Depreciation Schedule:
Year 1: 40%, Year 2: 30%, Year 3: 30%