2011 Summer Midterm + Solutions

# 2011 Summer Midterm + Solutions - Midterm Exam Corporate...

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Midterm Exam Corporate Finance June 8, 2011 You have 60 minutes for this 3-question exam. You can use a calculator and your 1-sided formula sheet. Make sure to explain your work as needed. Good luck! 20% 1) Consider the following project. The cost of the investment (in year 0) is \$100m. The investment provides real cash flows of \$10m in year 1 and \$108m in year 2 (all after tax). The expected inflation rate is 4%. a) What is the IRR (Internal Rate of Return) of this investment? (Answer in real terms) b) You are told that the nominal discount rate for similar projects is 10%. Is this a worthwhile investment? Explain. 40% 2) Auto dealers have recently been offering “zero percent” financing. A typical plan offers a potential auto buyer the alternative between choosing a zero percent loan and a rebate on the car price. Here’s the way a loan works: Suppose Josephine Autobuyer is interested in buying a \$20,000 car. The dealer offers Josephine two alternatives (she can choose only one of them). She can pay the full manufacturer’s suggested retail price (MSRP) of \$20,000 and get a five-year loan at 0% (no interest). There are 60 monthly payments on the loan of 20,000/60= \$333.33; the loan’s first payment is at the time of the car purchase (month

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