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Sping2006MidtermSolutions-Makeup - The Wharton School...

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The Wharton School Professor Jeffrey Jaffe Spring 2006 Corporate Finance 100 Midterm Examination Make-up Instructions: Please read the exam instructions carefully. After you read the instructions please print your name and student ID and sign the exam at the bottom. Please do not open the exam until you are told to do so. The exam is administered under the University’s rules of academic conduct; the Code of Academic Integrity applies. To ensure the fairest possible chance for everyone, the following procedure will be used: a) No one may leave the room during the last 10 minutes of the examination period. b) When time expires, remain seated and silent. Pass your exam to the nearest aisle. c) Anyone seen writing after time expires will forfeit 20 points. Only the front sides of pages will be graded; the backsides of pages may be used for ungraded scratch paper. THE BACKSIDE OF PAGES WILL NOT BE COUNTED; DO NOT WRITE YOUR ANSWERS THERE. Answers will not receive full credit unless you show correct supporting work including any necessary assumptions. The exam is closed book, but you may use a calculator and both sides of an 8.5” x 11” inch sheet of notes. No other notes, books, or aids are allowed. Answer all questions for a possible 100 points. You have 2 hours. Only written re-grade requests submitted with a completely unaltered exam paper can be considered. If you use your calculator, please provide inputs so that we may provide partial credit where appropriate. Please Enter the First 3 Letters of your Last Name: Your Name: ______________________________________________________________ Your Student ID Number: __________________________________________________ Signature: ________________________________________________________________ Good Luck!!!!!!!
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The Wharton School Professor Jeffrey Jaffe Spring 2006 Question 1 (20 points) The date is 12/31/05. Assume that all cash flows occur at the end of each calendar year. The Marsh Company (Marsh) is considering a 10-year investment in commercial real estate. The purchase price is $20MM (Million), payable today, and Marsh will rent the property for 10 years beginning in 2006. After ten years it will have a resale value of $7MM in real terms. The company uses straight line depreciation. Assume that, for tax purposes, assets are depreciated to zero by the end of year 10. Marsh will rent the property for a real value of $5MM in 2006, and then increase the rent by 1.5% per year in real terms for the next ten years. Maintenance fees will be $3MM per year in real terms. The income tax rate is 35% for both ordinary income and capital gains, and the opportunity cost of capital for this type of investment is 11% in real terms. The annual inflation rate will be 6% for the next ten years. The company is currently profitable. a) Calculate the Net Present Value of the project. (15 points) b) Now assume that Marsh wants to change the yearly rental fee so that the investment exactly breaks even (i.e. NPV = 0). If the rent still grows by 1.5% per year in real terms, by what amount will the first year’s rent have to change so that the NPV equals zero? (5 points) Solution a) Calculations NPV = PV( -Purchase Price + Rental Revenue – Maintenance Fees
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