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Unformatted text preview: FNAN 301 Solutions to test bank problems – relevant cash flows and NPV analysis Some answers may be slightly different than provided solutions due to rounding 1. Blizzard Inc. is evaluating a 1year project that would involve an initial investment of $1,000,000 and an expected cash flow of $1,210,000 in 1 year. The project has a cost of capital of 10 percent. If Blizzard used $1,000,000 in cash that was in its bank account, the net present value (NPV) of the project would be $100,000. Blizzard has no cash in its bank account and would need to borrow $1,000,000. If Blizzard borrows the money, the interest rate on the loan would be 15 percent. Blizzard would receive $1,000,000 at the start of the project and would pay $1,150,000 one year later. Which of the following assertions is true? A. The NPV of the project assuming Blizzard borrows the money would be greater than $100,000 B. The NPV of the project assuming Blizzard borrows the money would be less than $100,000 C. The NPV of the project assuming Blizzard borrows the money would be equal to $100,000 D. It is not clear whether the NPV of the project assuming Blizzard borrows the money would be greater than, less than, or equal to $100,000 Answer: C. The NPV of the project assuming Blizzard borrows the money would be equal to $100,000 Projects should be evaluated solely on cash flows expected to be produced by assets. It does not matter if funds are borrowed to pay for the project or whether new stock is issued or whether the firm uses cash it already has. Ignore any and all cash flows associated with debt and equity including debtissuance proceeds, debt payments, equityissuance proceeds, dividends, and stock buybacks. Therefore, the NPV computed based on the assumption that Blizzard used $1,000,000 in cash that was in its bank account would be the same as the NPV computed based on the assumption that Blizzard borrowed the $1,000,000. 1 FNAN 301 Solutions to test bank problems – relevant cash flows and NPV analysis 2. Blizzard Inc. is evaluating a 1year project that would involve an initial investment of $1,000,000 and an expected cash flow of $1,210,000 in 1 year. The project has a cost of capital of 10 percent. If Blizzard used $1,000,000 in cash that was in its bank account, the net present value (NPV) of the project would be $100,000. Blizzard has no cash in its bank account and would need to issue $1,000,000 worth of shares of common stock to raise $1,000,000. If Blizzard issues stock shares, the expected return on the stock would be 25 percent. Which of the following assertions is true? A. The NPV of the project assuming Blizzard issues stock shares would be greater than $100,000 B. The NPV of the project assuming Blizzard issues stock shares would be less than $100,000 C. The NPV of the project assuming Blizzard issues stock shares would be equal to $100,000 D. It is not clear whether the NPV of the project assuming Blizzard issues stock shares would be greater than, less than, or equal to $100,000...
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This note was uploaded on 02/03/2011 for the course FINANCE 301 taught by Professor Murray during the Spring '09 term at George Mason.
 Spring '09
 MURRAY

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