Question 3

Consider two projects, A and B, associated with the following expected cash flow sequences

Year	Project A	Project B
0	-950	-950
1	400	240
2	400	240
3	450	240
4	0	240
5	0	240
6	0	240

You are acting as the Chief Financial Officer of a firm. Suppose you face a capital rationing constraint such that you have a limit of 950 currency units in your budget. Your firms weighted average cost of capital (WACC) is 8%, and you assume that the cost of capital for each project A and B is also 8%. Address the following questions

1. Calculate the Internal Rates of Return of the projects, A and B. [20 marks]

2. Calculate the Net Present Values and Profitability Indices of the projects, A and B. [20 marks]

3. Which project would you recommend by way of an investment for your corporation? Why? [40 marks]

4. Is it reasonable to assume that both projects have the same WACC? [20 marks]

Question 4

1. Do financial derivative instruments have a role to play in corporate finance? If so, what is this role? [40 marks]

2. The put-call parity relation can be stated:

Call + PV (Exercise Price) = Put + Security Price

Can we have confidence that this relation is satisfied in any given capital market? How might knowledge of such a relation be useful to a Chief Financial Officer? [60 marks]