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Unformatted text preview: ACTSC 372 Assignment 2 Solutions 1. [3 points] Pizza Planet Inc. is an all-equity firm with a beta of 0.85. The market risk premium is 8% and the risk-free rate is 3%. The company is considering a project that will generate annual after-tax cash flows of $210,000 at the end of each year for 4 years. The project requires an immediate investment of $800,000. (a) If the project has the same risk as the firm as a whole, should Pizza Planet undertake the project? (b) What is the smallest value for the annual after-tax cash-flow that would justify the project being undertaken? Solution: (a) The NPV is 210 , 000 a 4 e r- 800 , 000 where r = 0 . 03 + 0 . 85 . 08 = 0 . 098. Hence a 4 e r = (1- (1 + r )- 4 ) /r = 3 . 1836379, and therefore NPV =- 131 , 436 . 07. The NPV is negative, so the firm should not undertake the project. (b) Want x such that 800 , 000 = xa 4 e r . Therefore x = 800 , 000 / 3 . 1836 = 251 , 284 . 86. 2. [3 points] An all-equity firm is considering undertaking a project that requires an initial outlay of $500,000, and that generates after-tax cash-flows of $75,000 at the end of each year for 10 years. (a) What is the internal rate of return for this project? (b) If the risk-free rate is 5% and the market riskWhat is the internal rate of return for this project?...
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This note was uploaded on 09/18/2011 for the course ACTSC 372 taught by Professor Maryhardy during the Winter '09 term at Waterloo.
- Winter '09