RSM333mid11 SOLUTION

RSM333mid11 SOLUTION - UNIVERSITY OF TORONTO Joseph L....

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UNIVERSITY OF TORONTO Joseph L. Rotman School of Management Feb. 28, 2011 Buti/Farooqi RSM333 MID-TERM EXAMINATION Florence/Konukoglu SOLUTIONS 1. (a) The pay back period ( PP ) is the number of months needed to recover her investment of $90,000. Her monthly incremental $3 ; 000(= $5 ; 000 $1500 $500) ; so $3 ; 000 ± PP = $90 ; 000 PP = 30 months is the pay-back period. (b) Discounted pay back takes time value of money into account. The present value of 4 years (48 months) of $3,000/month, if the interest rate is 1%/month, is given by the formula: [$3 ; 000 =: 01][1 1 = (1 : 01) 48 ] = $113 ; 922 > $90 ; 000 So, she should proceed as the project will repay its initial cost within 4 years. (c) To compute the monthly IRR solve the following equation: $90 ; 000 + $3 ; 000 =r = 0 = ) r montly = : 0333 The annual IRR is computed as: r annual = (1 : 0333) 12 1 = : 4816 . (d) NPV = $90 ; 000 + $3 ; 000 =: 01 = $210 ; 000 : k 0 = r F + & 0 [ r M r F ] = : 06 + 1 ± ( : 14 : 06) = : 14 V U = EBIT (1 T C ) =k 0 = $20 m ± (1 : 40) =: 14 = $85 : 7142 m (b) NPV ( all equity ) = 90 m + 85 : 7142 m = $4 : 2857 m , the investment project would be rejected. V L = V U + PV ( tax shield ) = V U + T C D = $85 : 7142 m + : 40 ± $25 m = $95 : 7142 m 1
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NPV ( levered ) = $90 m + $95 : 7142 m = $5 : 7142 m > 0 (d) The value of levered equity is:
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RSM333mid11 SOLUTION - UNIVERSITY OF TORONTO Joseph L....

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