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fin1ans05spr09 2

# fin1ans05spr09 2 - CARNEGIE MELLON UNIVERSITY Tepper School...

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CARNEGIE MELLON UNIVERSITY Tepper School of Business INTRO FINANCE – FIN 70-391 Prof. Spencer Martin Solutions Set 5: Firms and Wealth Creation A Multiple Choice Warmup 1. Which of the following cash flows should be treated as incremental flows when deciding whether to go ahead with production of a new car model? (Note: More than one answer is possible.) YES: The consequent reduction in the sales of the company’s existing models The expenditure on new plant and equipment The salvage value of plant and equipment at the end of the project’s life The reduction in the tax bill resulting from the depreciation charge NO: The value of tools that can be transferred from the company’s existing plants The cost of research and development undertaken on the model during the past three years The annual depreciation charge Interest Payments Dividend Payments A proportion of existing head office overhead expenses 2. A project has the following expected nominal cash flow: C 0 C 1 C 2 C 3 (80) 30 20 10 The opportunity cost of capital is 13.4%. What is the NPV? (31.13) 3. A machine lasts 3 years and has the following costs : C 0 C 1 C 2 C 3 30,000 8,000 8,000 8,000 If the cost of capital is 8%, what is the present value of the costs of operating a series of such machines in perpetuity? 1

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\$245,500 PV(cost of one machine) = 30 , 000 + 8 , 000 . 08 bracketleftBig 1 - 1 1 . 08 3 bracketrightBig = 50 , 616 . 78 Equivalent to how much per year? 50616 . 78 A 3 0 . 08 = 50616 . 78 2 . 5771 = 19 , 640 . 98 This much per year, forever, has a PV of: 19 , 640 . 98 . 08 = 245 , 512 . Alternate Calculation: A new machine is needed every 3 years, and the 3-year r is 1 . 08 3 - 1 = 25.9712% PV(cost of perpetuity of machines) = 50 , 616 . 78 + 50 , 618 . 78 . 259712 = 245 , 474 4. The Splurge Company is financed entirely by common stock. This has a beta of 1.4 and a total market value of \$160 million. Suppose the firm repurchases \$60 million of stock and replaces it with risk-free debt. What is the beta of the stock after the re-financing? Asssume there are no taxes.
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fin1ans05spr09 2 - CARNEGIE MELLON UNIVERSITY Tepper School...

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