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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