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UNIVERSITY OF TORONTO
Joseph L. Rotman School of Management
Feb. 28, 2011
Buti/Farooqi
RSM333
MIDTERM 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 payback 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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 Spring '11
 SabrinaButti

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