solnpproblec5 - CARNEGIE MELLON UNIVERSITY Tepper School of...

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Unformatted text preview: CARNEGIE MELLON UNIVERSITY Tepper School of Business Finance Summer 2009 Practice Problems Topic 5 Solution CONCEPT QUESTIONS 1. Quiz from Chapter 6 - Brealey, Myers and Allen. 2. See the table given below: We begin with cash &ows given in the table and utilize the following relationships. Real Cash Flow = Nominal Cash Flow/(1 + in&ation rate) Here the nominal rate is 20% , the expected rate of in&ation is 10% and the real rate is (1 + r nominal ) = (1 + r real ) (1+in&ation rate) 1 : 20 = (1 + r real )(1 : 1) r real = 0 : 909 = 9 : 09% As may be seen from the following table, the NPV is unchanged (to within a rounding error). 1 2 3 4 5 6 7 Net cash &ows - Nominal-12,600-1,484 2,947 6,323 10,534 9,985 5,757 3,269 Net cash &ows - Real-12,600-1,349 2,436 4,751 7,195 6,200 3,250 1,678 NPV of real cash &ows at 9.09% = $3,803. 3. Unfortunately, there is no simple adjustment to the discount rate that will take care of taxes. Mathematically, C 1 1 : 10 6 = C 1 = (1 & : 34) 1 : 15 and C 2 1 : 10 2 6 = C 2 = (1 & : 34) 1 : 15 2 4. Even when the capital budgeting calculations are done in real terms, an in&ation forecast is needed because: (a) Some real &ows depend on the the in&ation rate, e.g. real taxes and real proceeds from collecting receivables; and, 1 (b) Real discount rates are often estimated by starting with nominal rates and &taking out ination. 5. If the $50,000 is expensed at the end of year 1, the value of the tax shield is: : 35 & 50 ; 000 1 : 05 = $16 ; 667 If it is capitalized and then depreciated, the value of the tax shield is: [ : 35 & 50 ; 000] & : 20 1 : 05 1 + : 32 1 : 05 2 + : 192 1 : 05 3 + : 1152 1 : 05 4 + : 1152 1 : 05 5 + : 0576 1 : 05 6 = $15 ; 287 Not surprisingly, the tax shield is larger if the cost can be expensed....
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This note was uploaded on 01/20/2012 for the course INVESTMENT 101 taught by Professor Unknown during the Spring '08 term at Carnegie Mellon.

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solnpproblec5 - CARNEGIE MELLON UNIVERSITY Tepper School of...

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