Chapter 5 question 14
NPV = (Cash flows from year 1 / (1 + R) 1 ) + (Cash flows from year 2 / (1 + R) 2 ) – Initial investment
| Year | Project A | Project B | Project c | Rate | 1 / (1 +R ) 1 ) | Project A | Project B | Project C |
|
0 |
($10,000) |
$5,000 |
($15,000) |
0.12 |
1 |
($10,000) |
$5,000 |
($15,000) |
|
1 |
$8,000 |
$5,000 |
$10,000 |
0.12 |
1.12 |
$7,143 |
$4,464 |
$8,929 |
|
2 |
$7,000 |
($8,000) |
$10,000 |
0.12 |
1.2544 |
$5,580 |
($6,378) |
$7,972 |
Delegate your assignment to our experts and they will do the rest.
NPV for Project A = (7,143 + 5,580) – 10,000 = 2,723
NPV for project B = (5,000 + 4,464) – 6,378 = 3,087
NPV for project C = (8,929 + 7,972) – 15,000 = 1,901
All the three projects have positive NPV meaning that if they were independent, the three would be taken. However, for mutually exclusive projects, B would be the most preferred because it has the highest NPV.
The IRR for project A IS 32.75%, and for project C it is 21.52%. Project B does not have an IRR. Using IRR, the best investment is project A because it has the highest return.
Chapter 5 question 17
NPV = (Cash flows from year 1 / (1 + R) 1 ) + (Cash flows from year 2 / (1 + R) 2 ) – Initial investment
| Year | Cash flows | Discount rate (R) | 1 / (1 + R) 1 ) | Discounted Cash flows |
|
0 |
(15000) |
0.095 |
1 |
(15000) |
|
1 |
5000 |
0.105 |
1.105 |
4524.88688 |
|
2 |
5000 |
0.115 |
1.243225 |
4021.79815 |
|
3 |
10000 |
0.125 |
1.42382813 |
7023.31962 |
NPV = ( 4524.88688 + 4021.79815 + 7023.31962) – 15000 = 570
Net present value for the project = 570 meaning that the project is good for investment
IRR =rate at which (NPV year 1+ NPV year 2 + NPV year 3) – Initial investment = 0
| Year | Cashflows | Discount rate | 1 / (1 + R) 1 ) | Discounted Cashflows |
|
0 |
(15000) |
0.095 |
1 |
15000 |
|
1 |
5000 |
0.13941 |
1.13941 |
4388.23602 |
|
2 |
5000 |
0.1394 |
1.29823236 |
3851.39067 |
|
3 |
10000 |
0.1394 |
1.47920595 |
6760.38384 |
|
0.01 |
The IRR for the project is approximately 13.94%, and the project is worth investing in. This is because, the higher the rate of return, the more desirable the project is.
Chapter seven Question 6
Class A shares 50,000 with a two voting right each trading at $100 per share. Class B shares are 100,000 with a ½ voting right per share and trading at $90 a share
The firm has a 5 million debt in a bank which was taken recently.
Total shareholders’ equity = 50,000 X 100 + 100000 X 90 =5000000 + 9000000 = $14,000,000
Debt ratio = 5,000,000/14,000,000 = 0.35.71 or 35.71%
Why does it matter when the bank debt was taken on?
If the bank debt was taken a long time ago, it implies that the company was highly geared, and therefore the debt ratio will not demonstrate the actual status as the amount of loan taken will mostly be higher than the current value, therefore, giving a higher debt ratio.
Chapter 7 question 11
Calculated Expected return using CAPM
Beta =1.1
Risk less rate = 6.5%
Market risk premium 6%
Expected return using CAPM
R a = r f + ᵝa(rm – rf )
Ra = 0.065 + 1.1 X 0.06
= 0.131 or 13.1%
Why might you have a target rate greater than the expected return
An investor would like to receive the invested amount plus the profits from the investment. The investor works backward to determine their target return by picking an attainable performance and a period in which the targeted return can be reached.
