RSM333final10

# RSM333final10 - UNIVERSITY OF TORONTO Faculty of Arts and...

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UNIVERSITY OF TORONTO Faculty of Arts and Science and Rotman School of Management Final Examinations, April 2010 RSM 333H1S – Introduction to Corporate Finance Duration: 2 hours Aids Allowed: Silent electronic calculator and one 1-sided 8 1 2 × 11” crib sheet Name: Student Number: Circle the section that you are registered in: Buti (Tue. 9a.m.–11a.m.) Buti (Tue. 11a.m.–1p.m.) Buti (Tue. 7p.m.–9p.m.) Farooqi (Mon. 11a.m.–1p.m.) Farooqi (Fri. 10a.m.–12p.m.) Farooqi (Fri. 12p.m.–2p.m.) Ganguly (Mon. 1p.m.–3p.m.) Ganguly (Tue. 1p.m.–3p.m.) Instructions 1. Write your answers on this examination paper. 2. Answer five out of six questions. Each question is worth 20 points. 3. Do not answer all six questions! In the table below, cross out the question that you choose not to answer. Question Marks 1 2 3 4 5 6 Total 1

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1. Firm XYZ is considering to enter a new line of business, where firm ABC is the market leader operating only in that field. The new project requires an initial investment of \$30 million today and a further outlay of \$75 million after one year. One of two possible states will occur after one year. If demand for the plant’s output is high, the present value of the future cashflows of the project at year 1 will be \$160 million; if it is low, it will be \$70 million. The probability that demand turns out to be high is 0.4. Firm XYZ has a debt-to-equity ratio equal to 2, and the beta of its equity is 1.3. Firm ABC has a debt-to-equity ratio equal to 1, and the beta of its equity is 1.1. Assume also that the risk-free rate is 8%/year and the market premium is 7%/year. The cost of debt for both firms is 9%/year and there are no taxes or other market imperfections. (a) For firm XYZ, what is the appropriate discount rate for the project? (4 marks) (b) Should XYZ start this project? (4 marks) (c) Suppose now that the management has the option to abandon the project after one year. If that is the case, the required outlay of \$75 million in year one will be saved.
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