solnpproblec2 - CARNEGIE MELLON UNIVERSITY Tepper School of...

Info iconThis preview shows pages 1–2. Sign up to view the full content.

View Full Document Right Arrow Icon

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: CARNEGIE MELLON UNIVERSITY Tepper School of Business Finance Summer 2009 Practice Problems Topic 2 Solution 1. The solution to the quiz is in Brealey, Myers and Allen. 2. The following table summarizes the NPV and return of each project. INVESTMENT NPV RETURN 1- 10 + 20/1.2 = $6,667 (20 - 10)/10 = 1.0 or 100% 2- 5 + 12/1.2 = $5,000 (12 - 5)/5 = 1.4 or 140% 3- 5 + 5.5/1.2 = -$417 (5.5 - 5)/5 = 0.10 or 10% 4- 2 + 5/1.2 = $2,167 (5-2)/2 = 1.5 or 150% (a) Investment 1, because it has the highest NPV. (b) Investment 1, because it maximizes shareholders wealth. 3. Calculate NPV of each alternative. (a) NPV = & $2 ; 000 ; 000 + [$2 ; 000 ; 000(1 : 05)] = (1 : 05) = 0 : (b) NPV = & $900 ; 000 + [$900 ; 000(1 : 07)] = (1 : 10) = & $24 ; 545 : 45 The correct discount rate is 10% because it represents the appropriate risk of Norman&s nephew&s restaurant. The NPV is negative because Norman will not earn enough to oset the risk. (c) NPV = & $2 ; 000 ; 000 + [$2 ; 000 ; 000(1 : 12)] = (1 : 12) = 0 : (d) NPV = & $1 ; 000 ; 000 + [$1 ; 100 ; 000] = (1 : 12) = & $17 ; 857 : 14 Norman should invest in either risk free government securities or the risky stock market based on his tolerance for risk. Correctly priced securities always have NPV = 0....
View Full Document

Page1 / 3

solnpproblec2 - CARNEGIE MELLON UNIVERSITY Tepper School of...

This preview shows document pages 1 - 2. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online