Problem Set 1 Solutions

# Problem Set 1 Solutions - NYU Stern School of Business...

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NYU Stern School of Business Corporate Finance B40.2302.11, .12 Fall 2001 Problem Set #1 Due in class, October 3 rd (.11 section) or 4 th (.12 section). Hard copy is strongly preferred, but if you can’t attend class, you can email solution by 6pm October 4 th to Keith Siilats [[email protected]]. Can work in teams of up to three students. Be sure to list all team members’ names. The questions are equal-weighted unless otherwise indicated. 1) List three advantages to organizing as a corporation. Possible answers include: corporations can live forever (so an investor can pass away or divest without upsetting operations); ownership is more easily transferred; can raise capital from a larger investor base; limited liability 2) What are the two reasons for discounting future cash flows? Time value of money: Dollar today is worth more than a dollar tomorrow. Risk: Safe dollar is worth more than a risky one. 3) State the NPV rule for capital budgeting. Accept projects with NPV>0. 4) The economy has three states: good, bad, and ugly (very bad). The first two states occur with probability .40 each, and ugly occurs with probability .20. You are considering an investment that pays off \$100 in the good state, \$50 in the bad state, and \$10 in the ugly state. The discount rate appropriate for these cash flows is 15%. What is the most you would be willing to pay for this project? You would be willing to pay the PV of the project, but no more. PV = (.4*100+.4*50+.2*10)/(1.15)=\$53.91. 5) You can borrow and lend at 10% per year. You have an income of \$90,000 this year (count it as today’s dollars) and \$120,000 next year (count it as one-year-away dollars).

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