Midterm_FINA_306_Fall_2004-2005_Solution-1

Midterm_FINA_306_Fall_2004-2005_Solution-1 - AMERICAN...

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AMERICAN UNIVERSITY OF BEIRUT The School of Business MBA-Fall 2004/2005 FINA 306-Midterm Exam November 27, 2004. You have 2 hours to answer all questions. PART A Problem 1. INVESTMENT APPRAISAL (21 Points) The Go-Around-Europe Bus Company is thinking of replacing part of its current fleet of buses that it purchased 8 years ago. At that time the projected life of the buses was 20 years. They cost $1,325,000 and were expected to have a salvage value of $230,000. They can currently be sold for $445,000. Maintenance costs for the old buses were $133,000 during the last year and are expected to grow at 5% per year. The new buses they are thinking of buying have a life of 15 years. They cost $1,640,000 and have an expected salvage value of $195,000. The maintenance costs are expected to be $96,000 during the first year and to grow at 4% thereafter. Both, the new and current buses, are expected to generate the same revenues. The firm has a tax rate of 37%. It has profitable ongoing operations and can offset all the costs for tax purposes. It uses straight-line depreciation. Assume all cash flows occur at the end of the year. The firm's discount rate for decisions of this type is 12%. Should Go- Around-Europe replace the buses? Problem 2. DECISION TREES AND NPV (22 Points) You have identified a countrywide market need and therefore; decided to set up a corporation called Bubble.com . This will manufacture and sell kits of liquid soap and wire frames that will allow children and adults to blow soap bubbles. There is a 60% chance that the demand will be high in the first year. If it is high, there is an 80% chance that it will remain high indefinitely. If demand is low in the first year, there is a 60% chance that it will continue low indefinitely. Bubble.com has two alternatives available large bubble kits and small bubble kits. The Small Bubble kit plant requires an initial investment of $180 Million while the Large Bubble kit plant cost $350 Million. If it happened that the demand was low in the first year you may choose to stop production, then the Small kit plant can be sold for $150 Million and the Large kit plant can be sold for $500 Million. Your applicable discount rate is 8%. Your business analyst prepared a decision tree (this is attached, Figure 4.1) where the probabilities and projected cash flows are shown correspondingly. (a) Ignoring the option to abandon, which Plant should you buy? (14 Points) 1
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(b) How much does the option to abandon add to the value of the Small Kit Plant? How much does it add to the value of the Large Kit plant? (8 Points) _________________________________________________________________ _ PART B Multiple Choice Problems The following information is needed to answer questions 1 to 4: Market Efficiency (12 Points) Macrohard is a major hardware company. It currently has 100 million shares outstanding with each share having a price of $40. It is developing new processors. Give the share
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Midterm_FINA_306_Fall_2004-2005_Solution-1 - AMERICAN...

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