2011 Midterm - BUSFIN 1311: Corporate Finance Spring 2011:...

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Unformatted text preview: BUSFIN 1311: Corporate Finance Spring 2011: Professor Thomas Midterm Exam: 3/3/2011 Name The exam ends in one hour and 20 minutes. You can receive partial credit for incorrect answers to problems if you show your work. No credit will be granted for any answer to a numerical question without accompanying work. The amount of partial credit will depend on the clarity, legibility, and organization of your work. Please be complete but concise in response to discussion questions. Maximum of 130 points. Multiple—choice questions are worth five points each. 1. mp0??? 5” W? QWWU OW camp - Circle the letter corresponding to the answer choice that is most correct. Which of the following is most correct? The US. SEC is considering adopting new rules to prevent financial firms from masking the risks they take by temporarily lowering debt levels before reporting quarterly results to investors. Requiring firms to also report average or maximum debt levels over the period would reduce the incentives that these firms have to engage in “window dressing” at the end of the period. Managers of financial firms that temporarily lower debt levels prior to reporting can argue that, at a minimum, these actions indicate that the firms are capable of reducing their debt to the reported levels if desired. A and B are correct. All of the above are correct. Which of the following is most correct? A firm’s sustainable growth rate will equal its internal growth rate if the firm has no debt in its capital structure. If a restaurant firm that had not previously used franchising began franchising, then the firm’s actual sales growth would likely exceed its sustainable growth rate. Suppose a firm has a debt-equity ratio of two. Under the assumptions of the sustainable growth rate, for every dollar that the firm’s profit retained (net income minus dividends) increases the firm will have three total additional dollars of financing to purchase additional assets to support greater sales. A and B are correct. A and C are correct. B and C are correct. All of the above are correct. . Which of the following is most correct? It is appropriate to ignore interest expense when estimating the cash flows associated with a project (even if debt will be used to finance the project) provided that the discount rate used in the NPV calculation includes the after—tax cost of debt. At the very beginning of a project, there are no sunk costs. When evaluating mutually exclusive projects with different useful lives, it is appropriate to ignore that the projects have different lives because calculating the projects’ respective NPVs will provide a valid basis for comparing the projects. A and B are correct. B and C are correct. All of the above are correct. 4. B.R.O. Corp. makes undergarments. Currently B.R.O. makes cash sales only; however, management is considering offering credit and has estimated the following: _ m. .- t What is the minimum quantity sold that will make offering credit the preferred alternative? A. 400 B. 526 C. 667 D. 712 E. Not enough information to answer the question. T—A— 5 . If you quote your customers terms of 2/cash due at purchase, Net 30, (i.e., 2% discount for cash purchases and 30 days to pay for credit purchases) then what annualized interest rate are you charging them for the loan to buy your products? Assume that there are 360 days in a year. 0.0% 2.0% 27.4% 41.7% 44.7% Not enough information to answer the question. TUFHUOPU? ?> FUDGE“ F5901”? F1308“? Pennypacker Corp. purchases equipment at the start of a project for $100. The equipment will be depreciated on a straight line basis over four years. Suppose the project will end after three years. It is estimated that the equipment can be sold at the end of three years for $20. Pennypacker Corp. faces a 20% tax rate. What is the appropriate cash flow associated with the sale of the equipment at the end of year three? $20 assuming the firm is profitable, has been profitable in the recent past, or will be profitable in the future or $21 assuming the firm is not profitable, has not been profitable, and won’t be profitable for the foreseeable future. $21 assuming the firm is profitable, has been profitable in the recent past, or will be profitable in the future or $20 assuming the firm is not profitable, has not been profitable, and won’t be profitable for the foreseeable future. $19 assuming the firm is profitable, has been profitable in the recent past, or will be profitable in the future or $21 assuming the firm is not profitable, has not been profitable, and won’t be profitable for the foreseeable future. $19 regardless of the firm’s current, past, or future profitability. $25 regardless of the firm’s current, past, or future profitability. A firm is considering a new project. The project will require an initial investment in net working capital (NWC) of $300. The balances in NWC at the end of each ear of the project are as follows: Year 1 Year 2 Year 3 $400 $250 $0 The correct cash flows associated with NWC for this project are: -$300 at t=0, —$100 at t=1, $150 at t=2, and $250 at t=3 $300 at t=0, -$400 at t=1, -$250 at t=2, and $0 at t=3 $0 at t=0, -$400 at t=1, —$250 at t=2, and $0 at t=3 $0 at t=0, $400 at t=1, -$250 at t=2, and $650 at t=3 $300 at t=0, $400 at t=1, $250 at t=2, and $950 at t=3 Suppose a manager routinely evaluates mutually exclusive non-normal projects of differing risk by adjusting discount rates in a manner that is appropriate for evaluating normal projects. All else equal, over time, the risk of his firm will likely: Increase. Decrease. Increase initially and then decrease later. Decrease initially and then increase later. Impossible to determine given the information provided. 9. A. (10 points) Complete the spreadsheet forecast below by inserting formulas where necessary. A B C 1 Input Data: _2_ 2010 Sales 100 3 2011 Sales Growth 10% 4 Expenses/ Sales 0.70 5 Interest Rate 0.10 6 Tax Rate 0.30 7 Dividends/Net Income 0.20 8 Current Assets/Sales 0.50 _J 9 Fixed Assets/ Sales 0.50 Current Liabilities/ Sales 0.25 Long-Term Debt 25 L Common Stock 15 13 2010 Retained Earnings 5 __1_4__ Notes Payable Plug Figure 15 16 17 2011 Income Statement 18 Sales =C2*(1+C3) 19 Expenses =C18 *C4 EBIT =C18-C19 21 Interest Expense (Income) 22 l EBT =c20-021 23 Taxes =C22*C6 24 Net Income =C22-C23 25 Dividends =C24*C7 26 Profit Retained 27 28 2011 Balance Sheet: 29 Excess Cash 30 Current Assets =C8*C18 31 Fixed Assets =C9*C18 32 Total Assets 33 34 Current Liabilities =C18 *C10 35 Notes Payable — 36 Long-Term Debt =C1 1 3 7 Retained Earnings I 3 8 Common Stock =C12 l 39 Total Liabilities and Equity Trial Assets Trial Liabilities Plug: Notes Payable (Excess Cash) B. (5 points) Many of the spreadsheet forecasts prepared by students for the Body Shop Case showed the Body Shop accumulating greater and greater amounts of excess cash as sales grew. Would this forecast also lead to such an outcome? Briefly explain why or why not. 10. (5 points) In assessing the corporate governance practices of Jackson Industries (the firm from the first case assignment), several groups noted that the firm leased its headquarters building from the CEO of the firm. This was not always the case. The firm undertook a “sale—leaseback” transaction in which the firm sold its headquarters building to the CEO with an agreement that the CEO would lease the building back to the firm. If you were comparing Jackson Industries fixed asset turnover ratio (sales/fixed assets) for the year before this transaction was undertaken with the ratio from the first full year after this transaction was undertaken, then how would you expect this ratio to change all else equal? Briefly explain why? 1 1. (6 points) An auto firm currently has two existing plants that are each capable of manufacturing one type of vehicle, i.e., one can produce minivans and the other can produce sedans. Both of these plants now operate near full capacity and are generally expected to do so for the foreseeable future. While the firm expects overall demand for vehicles to grow, the firm is uncertain whether the increase in demand will come from largely an increase in the demand for one type of vehicle or the other or an increase in demand for both types of vehicles. Thus, the firm is evaluating the merits of constructing a new plant that will be capable of producing minivans or sedans, i.e., the plant can, with minimal adjustment switch its output from minivans to sedans and vice versa. True, False, or Uncertain and briefly WHY? All else equal, a manager would be justified in using a discount rate somewhat less than the auto firm’s current weighted average cost of capital (WACC) to calculate the NPV of the new plant? 12. (6 points) The vast majority of corporate investment projects include the option to abandon the project. Typically, a traditional NPV analysis of a project reflects the value of the option to abandon the project at the end of the proj ect’s useful life through after-tax salvage values, recovery of net working capital, and the recovery of opportunity costs, etc. True, False, or Uncertain and BRIEFLY WHY? By assuming that the project can only be abandoned at the end of its useful life, traditional NPV analysis likely understates the true value of the option to abandon. 13. The Pickzar Corporation is considering creating a new animated movie. Prior to starting production of the movie, the firm will develop some sketches of the characters in the script and conduct test marketing of the sketches. The test marketing will indicate whether or not potential audiences find the characters interesting. The test marketing will cost $1 million to complete (at t=0). The marketing group estimates that potential audiences will find the characters interesting with a probability of 5%. They also estimate that it will cost $10 million (at t=1) to complete the movie and market the movie regardless of the outcome of the test. The present value of all ticket and DVD sales will be realized at t=2. The present value (at t=2) of future ticket and DVD sales in the event of a successful test is expected to be $50 million. The present value (at t=2) of future ticket and DVD sales in the event of an unsuccessful test is expected to be $1 million. The managers of Pickzar will initially use a 10% discount rate for all phases of the project. A. (4 points) What is the NPV at t=1 if the test marketing is successful? What is the NPV at t=1 of investing if the test marketing is unsuccessful? B. (4 points) Supposing (unrealistically) that Pickzar would be forced to complete the movie regardless of the test marketing results, what is the NPV of the project at t=0? Should Pickzar develop the sketches and conduct the test marketing? C. (4 points) Now suppose (more realistically) that Pickzar can choose to invest based on the outcome of the test marketing. What is the NPV of the project at t=0? Should Pickzar develop the sketches and conduct the test marketing? Why or Why not? D. (4 points) From the calculations above, provide a ballpark estimate for the value of the option to abandon in this project, i.e., compare the NPVS from part B and C and very briefly discuss why they are different. E. (5 points) The option to abandon clearly adds value to the project by increasing expected cash flows. The option to abandon also adds value to this project in another way. Briefly describe how? Cite specific evidence in your response. F. (6 points) Would you evaluate this project differently if you knew the Pickzar Corporation could obtain other scripts and develop sketches and test market those, i.e., this project is part of a portfolio of projects the firm might undertake with each individual project having an outcome that is independent of the outcomes of other projects? Briefly explain why or why not. 13. Continued (For your convenience, the information for question 13 is reproduced below.) The Pickzar Corporation is considering creating a new animated movie. Prior to starting production of the movie, the firm will develop some sketches of the characters in the script and conduct test marketing of the sketches. The test marketing will indicate whether or not potential audiences find the characters interesting. The test marketing will cost $1 million to complete (at t=0). The marketing group estimates that potential audiences will find the characters interesting with a probability of 5%. They also estimate that if the test marketing is successful, then it will cost $10 million (at t=1) to complete the movie and market the movie and then they will realize the present value of ticket and DVD sales (at t=2). The present value of future ticket and DVD sales in the event of a successful test is expected to be $50 million. The present value of future ticket and DVD sales in the event of an unsuccessful test is expected to be $1 million. The managers of Pickzar will initially use a 10% discount rate for all phases of the project. . (6 points) Suppose that Pickzar not only has the rights to the script for the initial movie, but has also secured the exclusive rights to the use of the characters in a subsequent film for five years. Using the terminology of real options, describe the development rights to a subsequent film. H. (6 points) Suppose that when the executives at Pickzar added a branch to their decision tree (for the first movie) to include the possibility of a sequel, they forecasted a smaller expenditure on marketing and a smaller range of possible ticket and DVD sales revenues relative to the initial movie. Briefly describe the logic behind these choices as well as how these choices should also influence the discount rate used to calculate the NPV of the sequel at its inception, e.g., at t=3 in the expanded decision tree. l4.A firm owns a vacant lot that it wants to sell. The firm finds a buyer willing to pay $200,000 for the lot, but the firm must also provide the buyer with a put option to sell the lot back for $200,000 at the end of two years. Moreover, the firm agrees to pay the buyer $40,000 for a call option to repurchase the lot for $200,000 at the end of two years. A. (8 points) Very briefly characterize the payoffs that the firm will receive at the end of two years on its various positions. B. (7 points) In effect, the firm has borrowed money from the buyer. What is the amount of the loan and what is the annualized interest rate on the loan? C. (4 points) Suppose the volatility of real estate prices increases over the next year or so. In general, how will this affect the net value of the position that the firm holds? N ame BUSFIN 1311: Corporate Finance Spring 2011: Professor Thomas Midterm Exam: 3/3/2011 Key The exam ends in one hour and 20 minutes. You can receive partial credit for incorrect answers to problems if you show your work. No credit will be granted for any answer to a numerical question without accompanying work. The amount of partial credit will depend on the clarity, legibility, and organization of your work. Please be complete but concise in response to discussion questions. Maximum of 130 points. Multiple~choice questions are worth five points each. Circle the letter corresponding to the answer choice that is most correct. 1. A. D. 2. A. B. C. D. E. 2G Which of the following is most correct? The U.S. SEC is considering adopting new rules to prevent financial firms from masking the risks they take by temporarily lowering debt levels before reporting quarterly results to investors. . Requiring firms to also report average or maximum debt levels over the period would reduce the incentives that these firms have to engage in “window dressing” at the end of the period. . Managers of financial firms that temporarily lower debt levels prior to reporting can argue that, at a minimum, these actions indicate that the firms are capable of reducing their debt to the reported levels if desired. A and B are correct. All of the above are correct. Which of the following is most correct? A firm’s sustainable growth rate will equal its internal growth rate if the firm has no debt in its capital structure. If a restaurant firm that had not previously used franchising began franchising, then the firm’s actual sales growth would likely exceed its sustainable growth rate. Suppose a firm has a debt—equity ratio of two. Under the assumptions of the sustainable growth rate, for every dollar that the firm’s profit retained (net income minus dividends) increases the firm will have three total additional dollars of financing to purchase additional assets to support greater sales. A and B are correct. A and C are correct. B and C are correct. All of the above are correct. 3. Which of the following is most correct? A. B. C. (D) F. G. It is appropriate to ignore interest expense when estimating the cash flows associated with a project (even if debt will be used to finance the project) provided that the discount rate used in the NPV calculation includes the after—tax cost of debt. At the very beginning of a project, there are no sunk costs. ‘ When evaluating mutually exclusive projects with different useful lives, it is appropriate to ignore that the projects have different lives because calculating the projects’ respective NPVS will provide a valid basis for comparing the projects. A and B are correct. B and C are correct. All of the above are correct. 4. B.R.O. Corp. makes undergarments. Currently B.R.O. makes cash sales only; however, management is considering offering credit and has estimated the followin- Offer Credit 100 Price per unit Quantity sold Cost per unit Probability of payment Discount rate What is the minimum quantity sold that will make offering credit the preferred alternative? | £11 400 526 A. B. . 667 712 l -7 Not enough information to answer the question. x. log A: 0 YO * Q I M .. {\OO*7S)*QOO :. Lo‘ Q‘;7\\.L 5. If you quote your customers terms of 2/cash due at purchase, Net 30, (Le, 2% discount for cash purchases and 30 days to pay for credit purchases) then what annualized interest rate are you charging them for the loan to buy your products? Assume that there are 360 days in a year. ’13: 3:33.: 360/20 @27.4% v ‘00 - l D. 41.7% p 1 E. 44.7% F. Not enough information to answer the question. : Z7423 .0 .mp3 Increase. B. C. D. E. Pennypacker Corp. purchases equipment at the start of a project for $100. The equipment will be depreciated on a straight line basis over four years. Suppose the project will end after three years. It is estimated that the equipment can be sold at the end of three years for $20. Pennypacker Corp. faces a 20% tax rate. What is the appropriate cash flow associated with the sale of the equipment at the end of year three? $20 assuming the firm is profitable, has been profitable in the recent past, or will be profitable in the future or $21 assuming the firm is not profitable, has not been profitable, and won’t be profitable for the foreseeable future. $21 assuming the firm is profitable, has been profitable in the recent past, or will be profitable in the future or $20 assuming the firm is not profitable, has not been profitable, and won’t be profitable for the foreseeable future. $19 assuming the firm is profitable, has been profitable in the recent past, or will be profitable in the future or $21 assuming the firm is not profitable, has not been profitable, and won’t be profitable for the foreseeable future. $19 regardless of the firm’s current, past, or future profitability. $25 regardless of the firm’s current, past, or future profitability. mace-75" 22.5 ,wwzwfiw't ATsv : 2.0 "" (2.0 ‘13, *‘2‘ Z 20 «\—- [L Bficméx'h' A firm is considering a new project. The project will require an initial investment in net working capital (NWC) of $300. The balances in NWC at the end of each ear of the gnro’ect are as follows: Year 1 Year 2 Year 3 $400 $250 $0 The correct cash flows associated with NWC for this project are: —$300 at t=0, -$100 at t=1, $150 at t=2, and $250 at t=3 -$300 at t=0, -$400 at t=1, $250 at t=2, and $0 at t=3 $0 at t=0, $400 at t=1, -$250 at t=2, and $0 at t=3 $0 at t=0, $400 at t=1, —$250 at t=2, and $650 at t=3 —$300 at t=0, -$400 at t=1, -$250 at t=2, and $950 at t=3 Suppose a manager routinely evaluates mutually exclusive non-normal projects of differing risk by adjusting discount rates in a manner that is appropriate for evaluating normal projects. All else equal, over time, the risk of his firm will likely: Decrease. Kisk H\l\ Mex-ac.“ (5%“... "(WM Increase initially and then decrease later. Decrease initially and then increase later. Impossible to determine given the information provided. 9. A. (l0 points) Complete the spreadsheet forecast below by inserting formulas where necessary. WE Input Data: C _I 2010 Sales 2011 Sales Growth Expenses/ Sales Interest Rate Tax Rate Dividends/Net Income Current Assets/Sales OGQIQUI-war—A Fixed Assets/Sales Current Liabilities/Sales l 0.25 Long-Term Debt l 25 Common Stock l 15 2010 Retained Earnings l 5 Notes Payable Plug Figure 2011 Income Statement Sales =C2*(1+C3) Expenses =C18*C4 EBIT =C18-C19 Interest Expense (Income) 96 EBT =(C35+C36)*C5-C29*C5 =C20—C21 =C22*C6 =C22—C23 =C24*C7 =C24-C25 2011 Balance Sheet: Excess Cash * =IF(C43<O,-C43,0) Current Assets Fixed Assets Total Assets 9(- Current Liabilities Long—Term Debt Retained Earnings X'- Notes Payable it =C8*C18 =C9*C18 =C29+C30+C31 =C18*C10 =IF(C43>0,C43,0) =c11 =C13+C26 =C12 38 Common Stock 39 Total Liabilities and Equity )6 =C34+C35+C36+C37+C38 41 Trial Assets =C30+C31 42 Trial Liabilities 9% =C34+C36+C37+C38 43 Plug: Notes Payable (Excess Cash) 9(- =C41-C42 B. (5 points) Many of the spreadsheet forecasts prepared by students for the Body Shop Case showed the Body Shop accumulating greater and greater amounts of excess cash as sales grew. Would this forecast also lead to such an outcome? Briefly explain why or why not. no... cm not. Cow‘s} m a 2, OD Mus $ w.\\ mod“ lgowwow we. LTD+\'\O\A (*5 excess Cas\x $tw‘0i7l bCCo‘USC. ‘5“«25 ’i‘ 10. (5 points) In assessing the corporate governance practices of Jackson Industries (the firm from the first case assignment), several groups noted that the firm leased its headquarters building from the CEO of the firm. This was not always the case. The firm undertook a “sale—leaseback” transaction in which the firm sold its headquarters building to the CEO with an agreement that the CEO would lease the building back to the firm. If you were comparing Jackson Industries fixed asset turnover ratio (sales/fixed assets) for the year before this transaction was undertaken with the ratio from the first full year after this transaction was undertaken, then how would you expect this ratio to change all else equal? Briefly explain why? 11. (6 points) An auto firm currently has two existing plants that are each capable of manufacturing one type of vehicle, i.e., one can produce minivans and the other can produce sedans. Both of these plants now operate near full capacity and are generally expected to do so for the foreseeable future. While the firm expects overall demand for vehicles to grow, the firm is uncertain whether the increase in demand will come from largely an increase in the demand for one type of vehicle or the other or an increase in demand for both types of vehicles. Thus, the firm is evaluating the merits of constructing a new plant that will be capable of producing minivans or sedans, i.e., the plant can, with minimal adjustment switch its output from minivans to sedans and vice versa. True, False, or Uncertain and briefly WHY? All else equal, a manager i would be justified in using a discount rate somewhat less than the auto firm’s current weighted average cost of capital l (WACC) to calculate the NPV of the new plant? I! ' WOW-3» CASQ. sachmcto Him“ ’1 FlexfiJ-g Pfimb’ axiolds Can ow‘f PWOAUCQ ewe. o9 Vganle. qné is Pun. "HM. o'it‘lmzwi’yfie v2) \Mcflech é demaw (A lass msky X-o opgrqlve Plexxlol-e @\c.v"i‘ WACC. ,wQCXecA—s Lwlc op o?c.m<~..ir'\w\'cvix-aé cox—fulple—g 12. (6 points) The vast majority of corporate investment projects include the option to abandon the project. Typically, a traditional NPV analysis of a project reflects the value of the option to abandon the project at the end of the project’s useful life through after-tax salvage values, recovery of net working capital, and the recovery of opportunity costs, etc. True, False, or Uncertain and BRIEFLY WHY? By assuming that the project can only be abandoned at the end of its useful life, traditional NPV analysis likely understates the true value of the option to abandon. ' NPV firm/ma i/s/urJ 0/47ZZLM 74: agenda” as Evita/my» fill/L 0/0740?” N44" NZ (5 IV] Ac7l an flWx/ccn fll/x‘ O/AM Vow/Vt 0/ Amucqn p/flkw > Edna/cam a/24W,6// o e/s'c tiua/ 13. The Pickzar Corporation is considering creating a new animated movie. Prior to starting production of the movie, the firm will develop some sketches of the characters in the script and conduct test marketing of the sketches. The test marketing will indicate whether or not potential audiences find the characters interesting. The test marketing will cost $1 million to complete (at t=0). The marketing group estimates that potential audiences will find the characters interesting with a probability of 5%. They also estimate that it will cost $10 million (at t=1) to complete the movie and market the movie regardless of the outcome of the test. The present value of all ticket and DVD sales will be realized at t=2. The present value (at t=2) of future ticket and DVD sales in the event of a successful test is expected to be $50 million. The present value (at t=2) of future ticket and DVD sales in the event of an unsuccessful test is expected to be $1 million. The managers of Pickzar will initially use a 10% discount rate for all phases of the project. A. (4 points) What is the NPV at t=1 if the test marketing is successful? What is the NPV at t=1 of investing if the test marketing is unsuccessful? W/jiés/Isuacvss 3': "/0+ 77'” 7-"— B. (4 points) Supposing (unrealistically) that Pickzar would be forced to complete the movie regardless of the test marketing results, what is the NPV of the project at t=0? Should Pickzar develop the sketches and conduct the test marketing? (“9.09 (5,213.. Npggot ’/ 4‘ l'/ 4— /'/ »/ + (~78?) +1.69! ’7.Z4Ll AD “:33;- cowcivc’l Lcs’l" C. (4 points) Now suppose (more realistically) that Pickzar can choose to invest based on the outcome of the test marketing. What is the NPV of the project at t=0? Should Pickzar develop the sketches and conduct the test marketing? Why or Why not? 0 I 35.45- WflVéao : -/ +fl,95'/77 {’0’05 K /.I ’ fi’é/ , CWO/l/c7l 21657L D. (4 points) From the calculations above, provide a ballpark estimate for the value of the option to abandon in this project, i.e., compare the NPVs from part B and C and very briefly discuss why they are different. Maj/W0 0/50," 1 "7,24, WWW/OWL," = 0.9/ Vp/Mm ‘35 WflVu/ofi/qm - fl/flVu/o 0/5074 ’2: 7.85” E. (5 points) The option to abandon clearly adds value to the project by increasing expected cash flows. The option to abandon also adds value to this project in another way. Briefly describe how? Cite specific evidence in your response. @fso w/o/d/vtm,5ucwss : Aé// 4,1,,“ .—= O :2) 0"; L”. @2190 u/o 0/50.", Weave—Aw, Adm : 435' 2) on“? 0/77’70W =9 [:53 Ila/C 23) Kamx o/Iscaunl Its/é :) A/fl/ fl LIA/4’17"" F. (6 points) Would you evaluate this project differently if you knew the Pickzar Corporation could obtain other scripts and develop sketches and test market those, i.e., this project is part of a portfolio of projects the firm might undertake with each individual project having an outcome that is independent of the outcomes of other projects? Briefly explain why or why not. fl/fl, /(a]cc/ Mc/J‘IL 44m: '70 C?" 0v S/zuaol—q/JM And/s o4 // yéoy/J ho/ 3e Zhoéx/A/Cew Pdoxecir '. $vanon‘l- (03%“ , ycpclnuna. sucuss =3>$l0 ebb-0,5/a C‘vium‘? bbéhtu: EOW’V) : -$L + Va {its} + S/ctoj 1—0.3: Would you 'j’alc.‘ ibmo'ycci" Wlmui‘ we 704 Men/‘- 4' Cam Ciqu [Mus-Yea} homo. {Mo + can Ac Pno‘ytci’ ‘h’xm ‘l'lmd EacL out-Come .s (“seawater :2) Emu has E(/w0y)<c> 13. Continued (For your convenience, the information for question 13 is reproduced below.) The Pickzar Corporation is considering creating a new animated movie. Prior to starting production of the movie, the firm will develop some sketches of the characters in the script and conduct test marketing of the sketches. The test marketing will indicate whether or not potential audiences find the characters interesting. The test marketing will cost $1 million to complete (at t=0). The marketing group estimates that potential audiences will find the characters interesting with a probability of 5%. They also estimate that if the test marketing is successful, then it will cost $10 million (at t=1) to complete the movie and market the movie and then they will realize the present value of ticket and DVD sales (at t=2). The present value of future ticket and DVD sales in the event of a successful test is expected to be $50 million. The present value of future ticket and DVD sales in the event of an unsuccessful test is expected to be $1 million. The managers of Pickzar will initially use a 10% discount rate for all phases of the project. . (6 points) Suppose that Pickzar not only has the rights to the script for the initial movie, but has also secured the exclusive rights to the use of the characters in a subsequent film for five years. Using the terminology of real options, describe the development rights to a subsequent film. 029/7m +0 a WWW “/ 5" /V‘/ 01/01" 7‘7be59/{5 A; 522‘»: / E; 6057(- o/fltoo/vory ,LM“! Sg/vc / fz'S’yar/ fa/p‘xwé 0/13” VOA—$7417 0/ fly/J?‘ fickvLSqIéJ o/Jyuc/S’ H. (6 points) Suppose that when the executives at Pickzar added a branch to their decision tree (for the first movie) to include the possibility of a sequel, they forecasted a smaller expenditure on marketing and a smaller range of possible ticket and DVD sales revenues relative to the initial movie. Briefly describe the logic behind these choices as well as how these choices should also influence the discount rate used to calculate the NPV of the sequel at its inception, e.g., at t=3 in the expanded decision tree. , /e$x M4b£¢£t7 IU/WMG/ g” 57“/ /4//6€€a/\/ Max/€044 M (7% / 24/») ' 5€fl*/5 44.»: ca "éw/IZ—m add/eha' =7) /c.¢5 Vex/97607: In DV/)+ 79614; 5941‘ QM» //1/746//4/41 14.A firm owns a vacant lot that it wants to sell. The firm finds a buyer willing to pay $200,000 for the lot, but the firm must also provide the buyer with a put option to sell the lot back for $200,000 at the end of two years. Moreover, the firm agrees to pay the buyer $40,000 for a call option to repurchase the lot for $200,000 at the end of two years. A. (8 points) Very briefly characterize the payoffs that the firm will receive at the end of two years on its various positions. bwn q call (m law A \«J/E = $100,000, Said c. pul- om in“; w/E :. $100,000 Max (S’EIO) —. max (Ergo) Max (S’ZOOpODfiDB —-— \Max (2.00,ooov~$,b) 7:) You W\‘\ Pay Buyeu. $100,000 M Zycaus («1/0 excalo‘i'lmn B. (7 points) In effect, the firm has borrowed money from the buyer. What is the amount of the loan and what is the annualized interest rate on the loan? ‘ QCCQW‘G $200000 pbow \avyvcw now I Pay bvyt.‘ $443,000 new gyml‘ iSlQO,ooO WI“ ()c-y buyew £200,000 in 7—year” w/o exm‘o‘irmvx 0 V f‘: 2600 0» L”l =ll30?o \(ooooo C. (4 points) Suppose the volatility of real estate prices increases over the next year or so. In general, how will this affect the net value of the position that the firm holds? NIH 600‘“, As w~ Vmivt. QC va- “mg c,__\\ May‘s/y OCCSex’ 0‘0" “V‘O‘H’W‘i‘ ...
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2011 Midterm - BUSFIN 1311: Corporate Finance Spring 2011:...

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