2 hours from now (5:30 eastern u.s. new york time)
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hello, another expert referred me to you. i will need help in approximately 2 hours from now. i will have four questions about corporate finance that i will need help solving. i do not have the questions, but i have sample questions similar to the ones i will have later. i have included them here for you to review, not to solve, just for you to see. i was going to pay the other expert $50. do you want this job?
1. you are a manager at percolated fiber, which is considering expanding its operations in synthetic fiber manufacturing. your boss comes into your office, drops a consultant’s report on your desk, and complains, “we owe these consultants $1 million for this report, and i am not sure their analysis makes sense. before we spend the $25 million on new equipment needed for this project, look it over and give me your opinion.” you open the report and find the following estimates (in thousands of dollars):
all of the estimates in the report seem correct. you note that the consultants used straightline depreciation for the new equipment that will be purchased today (year 0), which is what the accounting department recommended. the report concludes that because the project will increase earnings by $4.875 million per year for 10 years, the project is worth $48.75 million. you think back to your halcyon days in finance class and realize there is more work to be done!
first, you note that the consultants have not factored in the fact that the project will require $10 million in working capital upfront (year 0), which will be fully recovered in year 10. next, you see they have attributed $2 million of selling, general and administrative expenses to the project, but you know that $1 million of this amount is overhead that will be incurred even if the project is not accepted. finally, you know that accounting earnings are not the right thing to focus on!
a. given the available information, what are the free cash flows in years 0 through 10 that should be used to evaluate the proposed project?
b. if the cost of capital for this project is 14%, what is your estimate of the value of the new project?
2. you are deciding between two mutually exclusive investment opportunities. both require the same initial investment of $10 million. investment a will generate $2 million per year (starting at the end of the first year) in perpetuity. investment b will generate $1.5 million at the end of the first year and its revenues will grow at 2% per year for every year after that.
a. which investment has the higher irr?
b. which investment has the higher npv when the cost of capital is 7%?
c. in this case, for what values of the cost of capital does picking the higher irr give the
correct answer as to which investment is the best opportunity?
3. bill clinton reportedly was paid $10 million to write his book my life. the book took three years to write. in the time he spent writing, clinton could have been paid to make speeches. given his popularity, assume that he could earn $8 million per year (paid at the end of the year) speaking instead of writing. assume his cost of capital is 10% per year.
a. what is the npv of agreeing to write the book (ignoring any royalty payments)?
b. assume that, once the book was finished, it was expected to generate royalties of $5 million in the first year (paid at the end of the year) and these royalties were expected to decrease at a rate of 30% per year in perpetuity. what is the npv of the book with the royalty payments?
4. suppose that general motors acceptance corporation issued a bond with 10 years until maturity, a face value of $1000, and a coupon rate of 7% (annual payments). the yield to maturity on this bond when it was issued was 6%.
a. what was the price of this bond when it was issued?
b. assuming the yield to maturity remains constant, what is the price of the bond immediately before it makes its first coupon payment?
c. assuming the yield to maturity remains constant, what is the price of the bond immediately after it makes its first coupon payment?
1. you are a manager at percolated fiber, which is considering expanding its operations in synthetic fiber manufacturing. your boss comes into your office, drops a consultant’s report on your desk, and complains, “we owe these consultants $1 million for this report, and i am not sure their analysis makes sense. before we spend the $25 million on new equipment needed for this project, look it over and give me your opinion.” you open the report and find the following estimates (in thousands of dollars):
all of the estimates in the report seem correct. you note that the consultants used straightline depreciation for the new equipment that will be purchased today (year 0), which is what the accounting department recommended. the report concludes that because the project will increase earnings by $4.875 million per year for 10 years, the project is worth $48.75 million. you think back to your halcyon days in finance class and realize there is more work to be done!
first, you note that the consultants have not factored in the fact that the project will require $10 million in working capital upfront (year 0), which will be fully recovered in year 10. next, you see they have attributed $2 million of selling, general and administrative expenses to the project, but you know that $1 million of this amount is overhead that will be incurred even if the project is not accepted. finally, you know that accounting earnings are not the right thing to focus on!
a. given the available information, what are the free cash flows in years 0 through 10 that should be used to evaluate the proposed project?
b. if the cost of capital for this project is 14%, what is your estimate of the value of the new project?
2. you are deciding between two mutually exclusive investment opportunities. both require the same initial investment of $10 million. investment a will generate $2 million per year (starting at the end of the first year) in perpetuity. investment b will generate $1.5 million at the end of the first year and its revenues will grow at 2% per year for every year after that.
a. which investment has the higher irr?
b. which investment has the higher npv when the cost of capital is 7%?
c. in this case, for what values of the cost of capital does picking the higher irr give the
correct answer as to which investment is the best opportunity?
3. bill clinton reportedly was paid $10 million to write his book my life. the book took three years to write. in the time he spent writing, clinton could have been paid to make speeches. given his popularity, assume that he could earn $8 million per year (paid at the end of the year) speaking instead of writing. assume his cost of capital is 10% per year.
a. what is the npv of agreeing to write the book (ignoring any royalty payments)?
b. assume that, once the book was finished, it was expected to generate royalties of $5 million in the first year (paid at the end of the year) and these royalties were expected to decrease at a rate of 30% per year in perpetuity. what is the npv of the book with the royalty payments?
4. suppose that general motors acceptance corporation issued a bond with 10 years until maturity, a face value of $1000, and a coupon rate of 7% (annual payments). the yield to maturity on this bond when it was issued was 6%.
a. what was the price of this bond when it was issued?
b. assuming the yield to maturity remains constant, what is the price of the bond immediately before it makes its first coupon payment?
c. assuming the yield to maturity remains constant, what is the price of the bond immediately after it makes its first coupon payment?
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