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ECO359-06MidA

# ECO359-06MidA - DEPARTMENT OF ECONOMICS UNIVERSITY OF...

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D EPARTMENT OF E CONOMICS U NIVERSITY OF T ORONTO ECO359 – Financial Economics II Summer 2006 Midterm: July 24 Solutions Instructions : This is a closed book examination. You are allowed one 4’’x6" crib card and the use of a calculator. Show all your work otherwise you will not get full credit . Only written re-grade requests submitted with a completely unaltered exam paper can be considered. You have 2 hours. Good Luck! NAME: _____________________________________________ ID#: _____________________________________________ 1 _______________ (10 points) 2 _______________ (15 points) 3 _______________ (15 points) 4 _______________ (15 points) 5 _______________ (20 points) Total _____________ (80 points)

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2 Problem 1: [15 points] A company is considering buying a new machine for one of its factories. The cost of the machine is \$60,000 and its expected life span is 5 years. The machine will save the cost of a worker estimated at \$22,500 annually. The book value of the machine at the end of year 5 is \$10,000 but the company estimates that the market value will be only \$5,000. Annual depreciation is calculated on a straight-line basis (i.e. \$10,000 a year). Calculate the NPV of the machine if the discount rate is 12% and the tax rate is 30%. 1. Figure out the cash flow for years 1-4: 8 points 2. … year 5: 5 points 3. 7 points to the PV and the overall makeup. . Machine cost 60,000 Machine book value, year 5 10,000 Annual depreciation 10,000<-- =(B2-B3)/5 Annual cost savings, before tax 22,500 Salvage value, year 5 5,000 Cash flow from salvage 6,500<-- =B7*(1-B10)+B10*B3 Tax rate 30% Discount rate 12% Year Cash flow 0 -60,000 1 18750 =(22500-10000)*.7=8750+10000 2 18750 3 18750 4 18750 5 25,250 11,277.83 <-- =NPV(B11,B15:B19)+B14
3 Problem 2: [15 points] 3. You and your friend have opened a security valuation business. You need to determine the weighted average cost of capital and the value of a client company’s stock. The company assets include: Bond: 40,000 bonds with 15 years till maturity with a par value of \$1000. The bonds carry an annual coupon of

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ECO359-06MidA - DEPARTMENT OF ECONOMICS UNIVERSITY OF...

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