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Version 1 1
Student name:__________
1) Capital budgeting analysis is very important, because it
A) involves, usually expensive, investments in capital assets.
B) has to do with the productive capacity of a firm.
C) will determine how competitive and profitable a firm will be.
D) all of the options
2) Tiger Towers, Inc. is considering an expansion of their existing business, student
apartments. The new project will be built on some vacant land that the firm has just contracted to
buy. The land cost $1,000,000 and the payment is due today. Construction of a 20-unit office
building will cost $3 million; this expense will be depreciated straight-line over 30 years to zero
salvage value; the pretax value of the land and building in year 30 will be $18,000,000. The
$3,000,000 construction cost is to be paid today. The project will not change the risk level of the
firm. The firm will lease 20 office suites at $20,000 per suite per year; payment is due at the start
of the year; occupancy will begin in one year. Variable cost is $3,500 per suite. Fixed costs,
excluding depreciation, are $75,000 per year. The project will require a $10,000 investment in
net working capital.
rdebt = 10.0%
rWACC = 11.20%
What is the unlevered after-tax incremental cash flow for year 0?
A) −$3,660,000
B) −$5,100,000
C) −$4,000,000
D) −$4,010,000
Version 1 2
3) Tiger Towers, Inc. is considering an expansion of their existing business, student
apartments. The new project will be built on some vacant land that the firm has just contracted to
buy. The land cost $1,000,000 and the payment is due today. Construction of a 20-unit office
building will cost $3 million; this expense will be depreciated straight-line over 30 years to zero
salvage value; the pretax value of the land and building in year 30 will be $18,000,000. The
$3,000,000 construction cost is to be paid today. The project will not change the risk level of the
firm. The firm will lease 20 office suites at $20,000 per suite per year; payment is due at the start
of the year; occupancy will begin in one year. Variable cost is $3,500 per suite. Fixed costs,
excluding depreciation, are $75,000 per year. The project will require a $10,000 investment in
net working capital.
rdebt = 10.0%
rWACC = 11.20%
What is the unlevered after-tax incremental cash flow for year 2?
A) −$4,610
B) $102,300
C) $202,300
D) $255,000
4) Tiger Towers, Inc. is considering an expansion of their existing business, student
apartments. The new project will be built on some vacant land that the firm has just contracted to
buy. The land cost $1,000,000 and the payment is due today. Construction of a 20-unit office
building will cost $3 million; this expense will be depreciated straight-line over 30 years to zero
salvage value; the pretax value of the land and building in year 30 will be $18,000,000. The
$3,000,000 construction cost is to be paid today. The project will not change the risk level of the
firm. The firm will lease 20 office suites at $20,000 per suite per year; payment is due at the start
of the year; occupancy will begin in one year. Variable cost is $3,500 per suite. Fixed costs,
excluding depreciation, are $75,000 per year. The project will require a $10,000 investment in
net working capital.
rdebt = 10.0%
rWACC = 11.20%
What is the unlevered after-tax incremental cash flow for year 30?
A) $12,432,300
B) $12,225,390
C) $12,332,300
D) $12,485,000
Version 1 3
5) Tiger Towers, Inc. is considering an expansion of their existing business, student
apartments. The new project will be built on some vacant land that the firm has just contracted to
buy. The land cost $1,000,000 and the payment is due today. Construction of a 20-unit office
building will cost $3 million; this expense will be depreciated straight-line over 30 years to zero
salvage value; the pretax value of the land and building in year 30 will be $18,000,000. The
$3,000,000 construction cost is to be paid today. The project will not change the risk level of the
firm. The firm will lease 20 office suites at $20,000 per suite per year; payment is due at the start
of the year; occupancy will begin in one year. Variable cost is $3,500 per suite. Fixed costs,
excluding depreciation, are $75,000 per year. The project will require a $10,000 investment in
net working capital.
rdebt = 10.0%
rWACC = 11.20%
Assume that the firm will partially finance the project with a $3,000,000 interest-only 30-year
loan at 10.0 percent APR with annual payments.
What is the levered after-tax incremental cash flow for year 0?
A) −$1,010,000
B) −$1,000,000
C) −$660,000
D) −$2,100,000
6) Tiger Towers, Inc. is considering an expansion of their existing business, student
apartments. The new project will be built on some vacant land that the firm has just contracted to
buy. The land cost $1,000,000 and the payment is due today. Construction of a 20-unit office
building will cost $3 million; this expense will be depreciated straight-line over 30 years to zero
salvage value; the pretax value of the land and building in year 30 will be $18,000,000. The
$3,000,000 construction cost is to be paid today. The project will not change the risk level of the
firm. The firm will lease 20 office suites at $20,000 per suite per year; payment is due at the start
of the year; occupancy will begin in one year. Variable cost is $3,500 per suite. Fixed costs,
excluding depreciation, are $75,000 per year. The project will require a $10,000 investment in
net working capital.
rdebt = 10.0%
rWACC = 11.20%
Version 1 4
Assume that the firm will partially finance the project with a $3,000,000 interest-only 30-year
loan at 10.0 percent APR with annual payments.
What is the levered after-tax incremental cash flow for year 1?
A) $4,300
B) −$202,610
C) −$95,700
D) $57,000
7) Tiger Towers, Inc. is considering an expansion of their existing business, student
apartments. The new project will be built on some vacant land that the firm has just contracted to
buy. The land cost $1,000,000 and the payment is due today. Construction of a 20-unit office
building will cost $3 million; this expense will be depreciated straight-line over 30 years to zero
salvage value; the pretax value of the land and building in year 30 will be $18,000,000. The
$3,000,000 construction cost is to be paid today. The project will not change the risk level of the
firm. The firm will lease 20 office suites at $20,000 per suite per year; payment is due at the start
of the year; occupancy will begin in one year. Variable cost is $3,500 per suite. Fixed costs,
excluding depreciation, are $75,000 per year. The project will require a $10,000 investment in
net working capital.
rdebt = 10.0%
rWACC = 11.20%
Assume that the firm will partially finance the project with a $3,000,000 interest-only 30-year
loan at 10.0 percent APR with annual payments.
What is the levered after-tax incremental cash flow for year 30?
A) $9,027,390
B) $9,234,300
C) $9,134,300
D) $9,287,000
Version 1 5
8) Tiger Towers, Inc. is considering an expansion of their existing business, student
apartments. The new project will be built on some vacant land that the firm has just contracted to
buy. The land cost $1,000,000 and the payment is due today. Construction of a 20-unit office
building will cost $3 million; this expense will be depreciated straight-line over 30 years to zero
salvage value; the pretax value of the land and building in year 30 will be $18,000,000. The
$3,000,000 construction cost is to be paid today. The project will not change the risk level of the
firm. The firm will lease 20 office suites at $20,000 per suite per year; payment is due at the start
of the year; occupancy will begin in one year. Variable cost is $3,500 per suite. Fixed costs,
excluding depreciation, are $75,000 per year. The project will require a $10,000 investment in
net working capital.
rdebt = 10.0%
rWACC = 11.20%
Assume that the firm will partially finance the project with a subsidized $3,000,000 interest only
30-year loan at 8.0 percent APR with annual payments. Note that eight percent is less than the 10
percent that they normally borrow at.
What is the NPV of the loan?
A) $198,469
B) $53,979.83
C) $102,727.55
D) $1,334,851.09
9) Tiger Towers, Inc. is considering an expansion of their existing business, student
apartments. The new project will be built on some vacant land that the firm has just contracted to
buy. The land cost $1,000,000 and the payment is due today. Construction of a 20-unit office
building will cost $3 million; this expense will be depreciated straight-line over 30 years to zero
salvage value; the pretax value of the land and building in year 30 will be $18,000,000. The
$3,000,000 construction cost is to be paid today. The project will not change the risk level of the
firm. The firm will lease 20 office suites at $20,000 per suite per year; payment is due at the start
of the year; occupancy will begin in one year. Variable cost is $3,500 per suite. Fixed costs,
excluding depreciation, are $75,000 per year. The project will require a $10,000 investment in
net working capital.
rdebt = 10.0%
rWACC = 11.20%
Version 1 6
The firm's tax rate is 34 percent. The firm's pre-tax cost of debt is 8 percent; the firm's debt-to-
equity ratio is 3; the risk-free rate is 3 percent; the beta of the firm's common stock is 1.5; the
market risk premium is 9 percent.
What is the firm's cost of equity capital?
A) 33.33 percent
B) 10.85 percent
C) 13.12 percent
D) 16.5 percent
10) Tiger Towers, Inc. is considering an expansion of their existing business, student
apartments. The new project will be built on some vacant land that the firm has just contracted to
buy. The land cost $1,000,000 and the payment is due today. Construction of a 20-unit office
building will cost $3 million; this expense will be depreciated straight-line over 30 years to zero
salvage value; the pretax value of the land and building in year 30 will be $18,000,000. The
$3,000,000 construction cost is to be paid today. The project will not change the risk level of the
firm. The firm will lease 20 office suites at $20,000 per suite per year; payment is due at the start
of the year; occupancy will begin in one year. Variable cost is $3,500 per suite. Fixed costs,
excluding depreciation, are $75,000 per year. The project will require a $10,000 investment in
net working capital.
rdebt = 10.0%
rWACC = 11.20%
The firm's tax rate is 34 percent. The firm's pre-tax cost of debt is 8 percent; the firm's debt-to-
equity ratio is 3; the risk-free rate is 3 percent; the beta of the firm's common stock is 1.5; the
market risk premium is 9 percent.
What is the required return on assets?
A) 33.33 percent
B) 10.85 percent
C) 13.12 percent
D) 16.5 percent
Version 1 7
11) Today is January 1, 2009. The state of Iowa has offered your firm a subsidized loan. It
will be in the amount of $10,000,000 at an interest rate of 5 percent and have ANNUAL
(amortizing) payments over 3 years. The first payment is due today and your taxes are due
January 1 of each year on the previous year's income. The yield to maturity on your firm's
existing debt is 8 percent. What is the APV of this subsidized loan? If you rounded in your
intermediate steps, the answer may be slightly different from what you got. Choose the closest.
A) −$3,497,224.43
B) $417,201.05
C) $840,797
D) none of the options
12) Today is January 1, 2009. The state of Iowa has offered your firm a subsidized loan. It
will be in the amount of $10,000,000 at an interest rate of 5 percent and have ANNUAL
(amortizing) payments over 3 years. The first payment is due December 31, 2009 and your taxes
are due January 1 of each year on the previous year's income. The yield to maturity on your
firm's existing debt is 8 percent. What is the APV of this subsidized loan? Note that I did not
round my intermediate steps. If you did, your answer may be off by a bit. Select the answer
closest to yours.
A) −$3,497,224.43
B) $417,201.05
C) $840,797
D) none of the options
13) The required return on assets is 18 percent. The firm can borrow at 12.5 percent; firm's
target debt to value ratio is 3/5. The corporate tax rate is 34 percent, and the risk-free rate is 4
percent and the market risk premium is 9.2 percent.
What is the weighted average cost of capital? The firm has a beta of 2.11.
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A) 12.15 percent
B) 13.02 percent
C) 14.33 percent
D) 23.45 percent
14) Your firm is in the 34 percent tax bracket. The yield to maturity on your existing bonds is
8 percent. The state of Georgia offers to loan your firm $1,000,000 with a two year amortizing
loan at a 5 percent rate of interest and annual payments due at the end of the year.
The interest will be deductible at the time that you pay. What is the APV of this below-market
loan to your firm? I did not round any of my intermediate steps. You might be a little bit off.
Pick the answer closest to yours.
A) $64,157.38
B) $417,201.05
C) $840,797
D) none of the options
15) The firm's tax rate is 34 percent. The firm's pre-tax cost of debt is 8 percent; the firm's
debt-to-equity ratio is 3; the risk-free rate is 3 percent; the beta of the firm's common stock is 1.5;
the market risk premium is 9 percent. Calculate the weighted average cost of capital.
A) 33.33 percent
B) 8.09 percent
C) 9.02 percent
D) 16.5 percent
Version 1 9
16) Consider a project of the Cornell Haul Moving Company, the timing and size of the
incremental after-tax cash flows (for an all-equity firm) are shown below in millions:
The firm's tax rate is 34 percent; the firm's bonds trade with a yield to maturity of 8 percent;
the current and target debt-equity ratio is 2; if the firm were financed entirely with equity, the
required return would be 10 percent.
Using the weighted average cost of capital methodology, what is the NPV? I didn't round my
intermediate steps. If you do, you're not going to get the right answer.
A) −$1,406,301.25
B) $12,494,643.75
C) $36,580,767.55
D) $108,994.618.20
17) Consider a project of the Cornell Haul Moving Company, the timing and size of the
incremental after-tax cash flows (for an all-equity firm) are shown below in millions:
The firm's tax rate is 34 percent; the firm's bonds trade with a yield to maturity of 8 percent;
the current and target debt-equity ratio is 2; if the firm were financed entirely with equity, the
required return would be 10 percent.
What is the levered after-tax incremental cash flow for year 2?
A) $185,796,000
B) $215,152,000
C) $267,952,000
D) $284,848,000
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18) Consider a project of the Cornell Haul Moving Company, the timing and size of the
incremental after-tax cash flows (for an all-equity firm) are shown below in millions:
The firm's tax rate is 34 percent; the firm's bonds trade with a yield to maturity of 8 percent;
the current and target debt-equity ratio is 2; if the firm were financed entirely with equity, the
required return would be 10 percent.
What is the levered after-tax incremental cash flow for year 4?
A) $281,704,000
B) $465,152,000
C) −$194,848,000
D) $460,796,000
19) Consider a project of the Cornell Haul Moving Company, the timing and size of the
incremental after-tax cash flows (for an all-equity firm) are shown below in millions:
The firm's tax rate is 34 percent; the firm's bonds trade with a yield to maturity of 8 percent;
the current and target debt-equity ratio is 2; if the firm were financed entirely with equity, the
required return would be 10 percent.
Using the flow to equity methodology, what is the value of the equity claim?
A) −$1,540,000
B) $446,570,866.00
C) $36,580,767.55
D) $470,953,393.70
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20) Consider a project of the Cornell Haul Moving Company, the timing and size of the
incremental after-tax cash flows (for an all-equity firm) are shown below in millions:
The firm's tax rate is 34 percent; the firm's bonds trade with a yield to maturity of 8 percent;
the current and target debt-equity ratio is 2; if the firm were financed entirely with equity, the
required return would be 10 percent.
Using the APV method, what is the value of this project to an all-equity firm?
A) −$46,502,288.10
B) $12,494,643.75
C) $36,580,767.55
D) −$67,163,445.12
21) Consider a project of the Cornell Haul Moving Company, the timing and size of the
incremental after-tax cash flows (for an all-equity firm) are shown below in millions:
The firm's tax rate is 34 percent; the firm's bonds trade with a yield to maturity of 8 percent;
the current and target debt-equity ratio is 2; if the firm were financed entirely with equity, the
required return would be 10 percent.
Using the APV method, what is the value of the debt side effects?
A) $239,072,652.70
B) $66,891,713.66
C) $59,459,301.03
D) $660,000,000
Version 1 12
22) Consider a project of the Cornell Haul Moving Company, the timing and size of the
incremental after-tax cash flows (for an all-equity firm) are shown below in millions:
The firm's tax rate is 34 percent; the firm's bonds trade with a yield to maturity of 8 percent;
the current and target debt-equity ratio is 3; if the firm were financed entirely with equity, the
required return would be 10 percent.
Using the weighted average cost of capital methodology, what is the NPV? I didn't round my
intermediate steps. If you do, you're not going to get the right answer.
A) −$1,406,301.25
B) $12,494,643.75
C) $36,580,767.55
D) $108,994.618.20
23) Consider a project of the Cornell Haul Moving Company, the timing and size of the
incremental after-tax cash flows (for an all-equity firm) are shown below in millions:
The firm's tax rate is 34 percent; the firm's bonds trade with a yield to maturity of 8 percent;
the current and target debt-equity ratio is 3; if the firm were financed entirely with equity, the
required return would be 10 percent.
What is the levered after-tax incremental cash flow for year 2?
A) $185,796,000
B) $215,152,000
C) $267,952,000
D) $284,848,000
Version 1 13
24) Consider a project of the Cornell Haul Moving Company, the timing and size of the
incremental after-tax cash flows (for an all-equity firm) are shown below in millions:
The firm's tax rate is 34 percent; the firm's bonds trade with a yield to maturity of 8 percent;
the current and target debt-equity ratio is 3; if the firm were financed entirely with equity, the
required return would be 10 percent.
What is the levered after-tax incremental cash flow for year 4?
A) −$281,704,000
B) $465,152,000
C) −$194,848,000
D) $460,796,000
25) Consider a project of the Cornell Haul Moving Company, the timing and size of the
incremental after-tax cash flows (for an all-equity firm) are shown below in millions:
The firm's tax rate is 34 percent; the firm's bonds trade with a yield to maturity of 8 percent;
the current and target debt-equity ratio is 3; if the firm were financed entirely with equity, the
required return would be 10 percent.
Using the flow to equity methodology, what is the value of the equity claim?
A) −$1,540,000
B) $446,570,866.00
C) $36,580,767.55
D) $30,716,236.13
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26) Consider a project of the Cornell Haul Moving Company, the timing and size of the
incremental after-tax cash flows (for an all-equity firm) are shown below in millions:
The firm's tax rate is 34 percent; the firm's bonds trade with a yield to maturity of 8 percent;
the current and target debt-equity ratio is 3; if the firm were financed entirely with equity, the
required return would be 10 percent.
Using the APV method, what is the value of this project to an all-equity firm?
A) −$46,502,288.10
B) $12,494,643.75
C) $36,580,767.55
D) −$67,163,445.12
27) Consider a project of the Cornell Haul Moving Company, the timing and size of the
incremental after-tax cash flows (for an all-equity firm) are shown below in millions:
The firm's tax rate is 34 percent; the firm's bonds trade with a yield to maturity of 8 percent;
the current and target debt-equity ratio is 3; if the firm were financed entirely with equity, the
required return would be 10 percent.
Using the APV method, what is the value of the debt side effects?
A) $239,072,652.70
B) $66,891,713.66
C) $59,459,301.03
D) $660,000,000
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28) Your firm's existing bonds trade with a yield to maturity of eight percent. The state of
Missouri has offered to loan your firm $10,000,000 at zero percent for five years. Repayment
will be of the form of $2,000,000 per year for five years; the first payment is due in one year.
What is the value of this offer?
A) $4,729,622.75
B) $2,014,579.93
C) $0
D) $196,929.88
29) What proportion of the firm is financed by debt for a firm that expects a 15 percent return
on equity, a 12 percent return on assets, and a 10 percent return on debt?
The tax rate is 25 percent.
A) 20 percent
B) 1/3
C) 60 percent
D) 2/3
30) The required return on equity for an all-equity firm is 10.0 percent. They are considering
a change in capital structure to a debt-to-equity ratio of ½ the tax rate is 40 percent, the pre-tax
cost of debt is 8 percent. Find the new cost of capital if this firm changes capital structure.
A) 14.93 percent
B) 8.67 percent
C) 7.40 percent
D) none of the options
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31) The required return on equity for an all-equity firm is 10.0 percent. They currently have a
beta of one and the risk-free rate is 5 percent and the market risk premium is 5 percent. They are
considering a change in capital structure to a debt-to-equity ratio of ½ the tax rate is 40 percent,
the pre-tax cost of debt is 8 percent. Find the beta if this firm changes capital structure.
A) 1.12
B) 1
C) 7.4 percent
D) none of the options
32) What is the expected return on equity for firm in the 40 percent tax bracket with a 15
percent expected return on assets that pays 12 percent on its debt, which totals 25 percent of
assets?
A) 24 percent
B) 15.60 percent
C) 16 percent
D) 20 percent
33) Assume that XYZ Corporation is a leveraged company with the following information:
Kl = cost of equity capital for XYZ = 13%
i = before-tax borrowing cost = 8%
t = marginal corporate income tax rate = 30%
Calculate the debt-to-total-market-value ratio that would result in XYZ having a weighted
average cost of capital of 9.3 percent.
A) 35 percent
B) 40 percent
C) 45 percent
D) 50 percent
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34) Today is January 1, 2009. The state of Iowa has offered your firm a subsidized loan. It
will be in the amount of $10,000,000 at an interest rate of 5 percent and have ANNUAL
(amortizing) payments over 3 years. The first payment is due today and your taxes are due
January 1 of each year on the previous year's income. The yield to maturity on your firm's
existing debt is 8 percent. What is the NPV of this subsidized loan?
Note that I did not round my intermediate steps. If you did, your answer may be off by a bit.
Select the answer closest to yours.
A) $406,023.10
B) $840,797
C) $64,157.38
D) $20,659.77
35) Today is January 1, 2009. The state of Iowa has offered your firm a subsidized loan. It
will be in the amount of $10,000,000 at an interest rate of 5 percent and have ANNUAL
(amortizing) payments over 3 years. The first payment is due today and your taxes are due
January 1 of each year on the previous year's income. The yield to maturity on your firm's
existing debt is 8 percent.
What is the €-denominated NPV of this project? I did not round my intermediate steps, if you
did, select the answer closest to yours.
A) €5,563.23
B) €2,270.79
C) €7,223.14
D) €3,554.29
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36) The spot exchange rate is ¥125 = $1. The U.S. discount rate is 10 percent; inflation over
the next three years is 3 percent per year in the U.S. and 2 percent per year in Japan. Calculate
the dollar NPV of this project.
I did not round my intermediate steps, if you did, select the answer closest to yours.
A) $267,181.87
B) $14,176.67
C) $2,536.49
D) $2,137.46
37) In the context of the capital budgeting analysis of an MNC that has strong foreign
competitors, "lost sales" refers to
A) the cannibalization of existing projects by new projects.
B) the entire sales revenue of a new foreign manufacturing facility representing the
incremental sales revenue of the new project.
C) Both A & B are correct.
D) none of the options
38) Which of the following statements is false about "borrowing capacity"?
A) It is an especially important point in international capital budgeting analysis because
of the frequency of large concessionary loans.
B) It creates tax shields for APV analysis regardless of how the project is actually
financed.
C) It is synonymous to the "project debt."
D) It is based on the firm's optimal capital structure.
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39) The adjusted present value (APV) model that is suitable for an MNC is the basic net
present value (NPV) model expanded to
A) distinguish between the market value of a levered firm and the market value of an
unlevered firm.
B) discern the blocking of certain cash flows by the host country from being legally
remitted to the parent.
C) consider foreign currency fluctuations or extra taxes imposed by the host country on
foreign exchange remittances.
D) all of the options
40) Given the following information for a levered and unlevered firm, calculate the
difference in the cash flow available to investors. Assume the corporate tax rate is 40 percent.
(Hint: Calculate the tax savings arising from the tax deductibility of interest payments).
Levered
Unlevered
Revenue
$
250
$
250
Operating cost
−$
100
−$
100
Interest expense
−$
20
$
0
A) $8
B) $18
C) $78
D) $90
41) As of today, the spot exchange rate is €1.00 = $1.25 and the rates of inflation expected to
prevail for the next year in the U.S. is 2 percent and 3 percent in the euro zone. What is the one-
year forward rate that should prevail?
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A) €1.00 = $1.2379
B) €1.00 = $1.2139
C) €1.00 = $0.9903
D) $1.00 = €1.2623
42) As of today, the spot exchange rate is €1.00 = $1.25 and the rates of inflation expected to
prevail for the next three years in the U.S. is 2 percent and 3 percent in the euro zone. What spot
exchange rate should prevail three years from now?
A) €1.00 = $1.2379
B) €1.00 = $1.2139
C) €1.00 = $0.9903
D) $1.00 = €1.2623
43) Your firm is based in southern Ireland (and thereby operates in euro, not pounds) and is
considering an investment in the United States.
The project involves selling widgets: you project a sales volume of 50,000 widgets per year,
sales price of $20 per widget with a contribution margin of $15 per widget.
The project will last for 5 years, require an investment of $1,000,000 at time zero (which will be
depreciated straight-line to $10,000 over the 5 years). Salvage value for the equipment is
projected to be $10,000. The project will operate in rented quarters: $300,000 rent is due at the
start of each year.
The corporate tax rate is 12½ percent in Ireland and 40 percent in the U.S.
For simplicity, assume that taxes are paid like sales taxes: immediately.
The spot exchange rate is $1.50 = €1.00. The cost of capital to the Irish firm for a domestic
project of this risk is 8 percent. The U.S. risk-free rate is 3 percent; the Irish risk-free rate is 2
percent.
What is CF0 in dollars?
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44) Your firm is based in southern Ireland (and thereby operates in euro, not pounds) and is
considering an investment in the United States.
The project involves selling widgets: you project a sales volume of 50,000 widgets per year,
sales price of $20 per widget with a contribution margin of $15 per widget.
The project will last for 5 years, require an investment of $1,000,000 at time zero (which will be
depreciated straight-line to $10,000 over the 5 years). Salvage value for the equipment is
projected to be $10,000. The project will operate in rented quarters: $300,000 rent is due at the
start of each year.
The corporate tax rate is 12½ percent in Ireland and 40 percent in the U.S.
For simplicity, assume that taxes are paid like sales taxes: immediately.
The spot exchange rate is $1.50 = €1.00. The cost of capital to the Irish firm for a domestic
project of this risk is 8 percent. The U.S. risk-free rate is 3 percent; the Irish risk-free rate is 2
percent.
What is CF1 in dollars?
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45) Your firm is based in southern Ireland (and thereby operates in euro, not pounds) and is
considering an investment in the United States.
The project involves selling widgets: you project a sales volume of 50,000 widgets per year,
sales price of $20 per widget with a contribution margin of $15 per widget.
The project will last for 5 years, require an investment of $1,000,000 at time zero (which will be
depreciated straight-line to $10,000 over the 5 years). Salvage value for the equipment is
projected to be $10,000. The project will operate in rented quarters: $300,000 rent is due at the
start of each year.
The corporate tax rate is 12½ percent in Ireland and 40 percent in the U.S.
For simplicity, assume that taxes are paid like sales taxes: immediately.
The spot exchange rate is $1.50 = €1.00. The cost of capital to the Irish firm for a domestic
project of this risk is 8 percent. The U.S. risk-free rate is 3 percent; the Irish risk-free rate is 2
percent.
What is CF5 in dollars?
46) Your firm is based in southern Ireland (and thereby operates in euro, not pounds) and is
considering an investment in the United States.
The project involves selling widgets: you project a sales volume of 50,000 widgets per year,
sales price of $20 per widget with a contribution margin of $15 per widget.
The project will last for 5 years, require an investment of $1,000,000 at time zero (which will be
depreciated straight-line to $10,000 over the 5 years). Salvage value for the equipment is
projected to be $10,000. The project will operate in rented quarters: $300,000 rent is due at the
start of each year.
The corporate tax rate is 12½ percent in Ireland and 40 percent in the U.S.
For simplicity, assume that taxes are paid like sales taxes: immediately.
The spot exchange rate is $1.50 = €1.00. The cost of capital to the Irish firm for a domestic
project of this risk is 8 percent. The U.S. risk-free rate is 3 percent; the Irish risk-free rate is 2
percent.
What is the NPV of the U.S.-based project to the Irish firm?
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47) Your firm is based in southern Ireland (and thereby operates in euro, not pounds) and is
considering an investment in the United States.
The project involves selling widgets: you project a sales volume of 50,000 widgets per year,
sales price of $20 per widget with a contribution margin of $15 per widget.
The project will last for 5 years, require an investment of $1,000,000 at time zero (which will be
depreciated straight-line to $10,000 over the 5 years). Salvage value for the equipment is
projected to be $10,000. The project will operate in rented quarters: $300,000 rent is due at the
start of each year.
The corporate tax rate is 12½ percent in Ireland and 40 percent in the U.S.
For simplicity, assume that taxes are paid like sales taxes: immediately.
The spot exchange rate is $1.50 = €1.00. The cost of capital to the Irish firm for a domestic
project of this risk is 8 percent. The U.S. risk-free rate is 3 percent; the Irish risk-free rate is 2
percent.
What is the dollar-denominated IRR?
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48) Your firm is based in southern Ireland (and thereby operates in euro, not pounds) and is
considering an investment in the United States.
The project involves selling widgets: you project a sales volume of 50,000 widgets per year,
sales price of $20 per widget with a contribution margin of $15 per widget.
The project will last for 5 years, require an investment of $1,000,000 at time zero (which will be
depreciated straight-line to $10,000 over the 5 years). Salvage value for the equipment is
projected to be $10,000. The project will operate in rented quarters: $300,000 rent is due at the
start of each year.
The corporate tax rate is 12½ percent in Ireland and 40 percent in the U.S.
For simplicity, assume that taxes are paid like sales taxes: immediately.
The spot exchange rate is $1.50 = €1.00. The cost of capital to the Irish firm for a domestic
project of this risk is 8 percent. The U.S. risk-free rate is 3 percent; the Irish risk-free rate is 2
percent.
What is the euro-denominated IRR?
49) Your firm is based in southern Ireland (and thereby operates in euro, not pounds) and is
considering an investment in the United States.
The project involves selling widgets: you project a sales volume of 50,000 widgets per year,
sales price of $20 per widget with a contribution margin of $15 per widget.
The project will last for 5 years, require an investment of $1,000,000 at time zero (which will be
depreciated straight-line to $10,000 over the 5 years). Salvage value for the equipment is
projected to be $10,000. The project will operate in rented quarters: $300,000 rent is due at the
start of each year.
The corporate tax rate is 12½ percent in Ireland and 40 percent in the U.S.
For simplicity, assume that taxes are paid like sales taxes: immediately.
The spot exchange rate is $1.50 = €1.00. The cost of capital to the Irish firm for a domestic
project of this risk is 8 percent. The U.S. risk-free rate is 3 percent; the Irish risk-free rate is 2
percent.
Find the break-even price (in dollars) and break-even quantity for the U.S. project.
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50) Your firm is based in southern Ireland (and thereby operates in euro, not pounds) and is
considering an investment in the United States.
The project involves selling widgets: you project a sales volume of 50,000 widgets per year,
sales price of $20 per widget with a contribution margin of $15 per widget.
The project will last for 5 years, require an investment of $1,000,000 at time zero (which will be
depreciated straight-line to $10,000 over the 5 years). Salvage value for the equipment is
projected to be $10,000. The project will operate in rented quarters: $300,000 rent is due at the
start of each year.
The corporate tax rate is 12½ percent in Ireland and 40 percent in the U.S.
For simplicity, assume that taxes are paid like sales taxes: immediately.
The spot exchange rate is $1.50 = €1.00. The cost of capital to the Irish firm for a domestic
project of this risk is 8 percent. The U.S. risk-free rate is 3 percent; the Irish risk-free rate is 2
percent.
Repeat the above project analysis assuming that the Irish firm could replicate the project in
Ireland. (i.e. cash flow out the project in Ireland and find break-even price (in €), quantity, NPV,
IRR (in euro not dollars).
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51) Consider the following international investment opportunity. It involves a gold mine that
can be opened at a cost, then produces a positive cash flow, but then requires environmental
clean-up.
{MISSING IMAGE}
The current exchange rate is $1.60 = €1.00. The inflation rate in the U.S. is 6 percent and in the
euro zone 2 percent. The appropriate cost of capital to a U.S.-based firm for a domestic project of
this risk is 8 percent.
Find the euro-zone cost of capital to compute is the dollar-denominated NPV of this project.
52) Consider the following international investment opportunity. It involves a gold mine that
can be opened at a cost, then produces a positive cash flow, but then requires environmental
clean-up.
{MISSING IMAGE}
The current exchange rate is $1.60 = €1.00. The inflation rate in the U.S. is 6 percent and in the
euro zone 2 percent. The appropriate cost of capital to a U.S.-based firm for a domestic project of
this risk is 8 percent.
Find the dollar cash flows to compute the dollar-denominated NPV of this project.
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53) Consider the following international investment opportunity. It involves a gold mine that
can be opened at a cost, then produces a positive cash flow, but then requires environmental
clean-up.
{MISSING IMAGE}
The current exchange rate is $1.60 = €1.00. The inflation rate in the U.S. is 6 percent and in the
euro zone 2 percent. The appropriate cost of capital to a U.S.-based firm for a domestic project of
this risk is 8 percent.
What is the dollar-denominated IRR of this project?
54) Consider the following international investment opportunity. It involves a gold mine that
can be opened at a cost, then produces a positive cash flow, but then requires environmental
clean-up.
{MISSING IMAGE}
The current exchange rate is $1.60 = €1.00. The inflation rate in the U.S. is 6 percent and in the
euro zone 2 percent. The appropriate cost of capital to a U.S.-based firm for a domestic project of
this risk is 8 percent.
What is the euro-denominated IRR of this project?
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55) Consider the following international investment opportunity. It involves a gold mine that
can be opened at a cost, then produces a positive cash flow, but then requires environmental
clean-up.
{MISSING IMAGE}
The current exchange rate is $1.55 = €1.00. The inflation rate in the U.S. is 6 percent and in the
euro zone 2 percent. The appropriate cost of capital to a U.S.-based firm for a domestic project of
this risk is 8 percent.
Find the euro-zone cost of capital to compute is the dollar-denominated NPV of this project.
56) Consider the following international investment opportunity. It involves a gold mine that
can be opened at a cost, then produces a positive cash flow, but then requires environmental
clean-up.
{MISSING IMAGE}
The current exchange rate is $1.55 = €1.00. The inflation rate in the U.S. is 6 percent and in the
euro zone 2 percent. The appropriate cost of capital to a U.S.-based firm for a domestic project of
this risk is 8 percent.
Find the dollar cash flows to compute the dollar-denominated NPV of this project.
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57) Consider the following international investment opportunity. It involves a gold mine that
can be opened at a cost, then produces a positive cash flow, but then requires environmental
clean-up.
{MISSING IMAGE}
The current exchange rate is $1.55 = €1.00. The inflation rate in the U.S. is 6 percent and in the
euro zone 2 percent. The appropriate cost of capital to a U.S.-based firm for a domestic project of
this risk is 8 percent.
What is the dollar-denominated IRR of this project?
58) Consider the following international investment opportunity. It involves a gold mine that
can be opened at a cost, then produces a positive cash flow, but then requires environmental
clean-up.
{MISSING IMAGE}
The current exchange rate is $1.55 = €1.00. The inflation rate in the U.S. is 6 percent and in the
euro zone 2 percent. The appropriate cost of capital to a U.S.-based firm for a domestic project of
this risk is 8 percent.
What is the euro-denominated IRR of this project?
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59) A French firm is considering a one-year investment in the United Kingdom with a pound-
denominated rate of return of i£ = 15%. The firm's local cost of capital is i€ = 10%. The project
costs £1,000 and will return £1,150 at the end of one year. The current exchange rate is €2.00 =
£1.00.
Suppose that the bank of England is considering either tightening or loosening its monetary
policy. It is widely believed that in one year there are only two possibilities:
S1 (€|£) = €2.20 per £
S1 (€|£) = €1.80 per £
Following revaluation, the exchange rate is expected to remain steady for at least another year.
Find the ex post IRR in euro for the French firm if they undertake the project today and then the
exchange rate falls to S1(€|£) = €1.80 per £.
60) A French firm is considering a one-year investment in the United Kingdom with a pound-
denominated rate of return of i£ = 15%. The firm's local cost of capital is i€ = 10%. The project
costs £1,000 and will return £1,150 at the end of one year. The current exchange rate is €2.00 =
£1.00.
Suppose that the bank of England is considering either tightening or loosening its monetary
policy. It is widely believed that in one year there are only two possibilities:
S1 (€|£) = €2.20 per £
S1 (€|£) = €1.80 per £
Following revaluation, the exchange rate is expected to remain steady for at least another year.
Find the ex post IRR in euro for the French firm if they undertake the project today and then the
exchange rate rises to S1(€|£) = €2.20 per £.
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61) A French firm is considering a one-year investment in the United Kingdom with a pound-
denominated rate of return of i£ = 15%. The firm's local cost of capital is i€ = 10%. The project
costs £1,000 and will return £1,150 at the end of one year. The current exchange rate is €2.00 =
£1.00.
Suppose that the bank of England is considering either tightening or loosening its monetary
policy. It is widely believed that in one year there are only two possibilities:
S1 (€|£) = €2.20 per £
S1 (€|£) = €1.80 per £
Following revaluation, the exchange rate is expected to remain steady for at least another year.
Find the IRR in euro for the French firm if they wait one year to undertake the project after the
exchange rate rises to S1(€|£) = €2.20 per £.
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62) A French firm is considering a one-year investment in the United Kingdom with a pound-
denominated rate of return of i£ = 15%. The firm's local cost of capital is i€ = 10%. The project
costs £1,000 and will return £1,150 at the end of one year. The current exchange rate is €2.00 =
£1.00.
Suppose that the bank of England is considering either tightening or loosening its monetary
policy. It is widely believed that in one year there are only two possibilities:
S1 (€|£) = €2.20 per £
S1 (€|£) = €1.80 per £
Following revaluation, the exchange rate is expected to remain steady for at least another year.
Find the NPV in euro for the French firm if they wait one year to undertake the project after the
exchange rate rises to S1(€|£) = €2.20 per £.
63) A French firm is considering a one-year investment in the United Kingdom with a pound-
denominated rate of return of i£ = 15%. The firm's local cost of capital is i€ = 10%. The project
costs £1,000 and will return £1,150 at the end of one year. The current exchange rate is €2.00 =
£1.00.
Suppose that the bank of England is considering either tightening or loosening its monetary
policy. It is widely believed that in one year there are only two possibilities:
S1 (€|£) = €2.20 per £
S1 (€|£) = €1.80 per £
Following revaluation, the exchange rate is expected to remain steady for at least another year.
Find the IRR in euro for the French firm if they wait one year to undertake the project after the
exchange rate falls to S1(€|£) = €1.80 per £.
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64) A French firm is considering a one-year investment in the United Kingdom with a pound-
denominated rate of return of i£ = 15%. The firm's local cost of capital is i€ = 10%. The project
costs £1,000 and will return £1,150 at the end of one year. The current exchange rate is €2.00 =
£1.00.
Suppose that the bank of England is considering either tightening or loosening its monetary
policy. It is widely believed that in one year there are only two possibilities:
S1 (€|£) = €2.20 per £
S1 (€|£) = €1.80 per £
Following revaluation, the exchange rate is expected to remain steady for at least another year.
Find the NPV in euro for the French firm if they wait one year to undertake the project after the
exchange rate falls to S1(€|£) = €1.80 per £.
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65) A French firm is considering a one-year investment in the United Kingdom with a pound-
denominated rate of return of i£ = 15%. The firm's local cost of capital is i€ = 10%. The project
costs £1,000 and will return £1,150 at the end of one year. The current exchange rate is €2.00 =
£1.00.
Suppose that the bank of England is considering either tightening or loosening its monetary
policy. It is widely believed that in one year there are only two possibilities:
S1 (€|£) = €2.20 per £
S1 (€|£) = €1.80 per £
Following revaluation, the exchange rate is expected to remain steady for at least another year.
The CFO who has a CFA notices the optionality in starting this project today. He asks you to
comment and outline your valuation strategy.
66) A French firm is considering a one-year investment in the United Kingdom with a pound-
denominated rate of return of i£ = 15%. The firm's local cost of capital is i€ = 10%. The project
costs £1,000 and will return £1,150 at the end of one year. The current exchange rate is €2.00 =
£1.00.
Suppose that the bank of England is considering either tightening or loosening its monetary
policy. It is widely believed that in one year there are only two possibilities:
S1 (€|£) = €2.20 per £
S1 (€|£) = €1.80 per £
Following revaluation, the exchange rate is expected to remain steady for at least another year.
Your banker quotes the euro-zone risk-free rate at i€ = 6% and the British risk free rate at i£ =
6%. Find the value of the option and thereby the project.
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67) A French firm is considering a one-year investment in the United Kingdom with a pound-
denominated rate of return of i£ = 15%. The firm's local cost of capital is i€ = 10%. The project
costs £1,000 and will return £1,150 at the end of one year. The current exchange rate is €2.00 =
£1.00.
Suppose that the bank of England is considering either tightening or loosening its monetary
policy. It is widely believed that in one year there are only two possibilities:
S1 (€|£) = €2.20 per £
S1 (€|£) = €1.80 per £
Following revaluation, the exchange rate is expected to remain steady for at least another year.
Using the notion of a hedge ratio, make a recommendation vis-à-vis how to undertake the
project today without "buying" the option.
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68) An American Hedge Fund is considering a one-year investment in an Italian government
bond with a one-year maturity and a euro-denominated rate of return of i€ = 5%. The bond costs
€1,000 today and will return €1,050 at the end of one year without risk. The current exchange
rate is €1.00 = $1.50. U.S. dollar-denominated government bonds currently have a yield to
maturity of 4 percent. Suppose that the European Central Bank is considering either tightening or
loosening its monetary policy. It is widely believed that in one year there are only two
possibilities:
S1 ($|€) = €1.80 per €
S1 ($|€) = €1.40 per €
Following revaluation, the exchange rate is expected to remain steady for at least another year.
The hedge fund manager notices the optionality in starting this project today. He asks you to
comment and outline your valuation strategy.
69) An American Hedge Fund is considering a one-year investment in an Italian government
bond with a one-year maturity and a euro-denominated rate of return of i€ = 5%. The bond costs
€1,000 today and will return €1,050 at the end of one year without risk. The current exchange
rate is €1.00 = $1.50. U.S. dollar-denominated government bonds currently have a yield to
maturity of 4 percent. Suppose that the European Central Bank is considering either tightening or
loosening its monetary policy. It is widely believed that in one year there are only two
possibilities:
S1 ($|€) = €1.80 per €
S1 ($|€) = €1.40 per €
Following revaluation, the exchange rate is expected to remain steady for at least another year.
Your banker quotes the euro-zone risk-free rate at i€ = 5% and the U.S. risk free rate at i$ = 4%.
Find the value of the option and thereby the correct value of the bond to a U.S. investor.
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70) An American Hedge Fund is considering a one-year investment in an Italian government
bond with a one-year maturity and a euro-denominated rate of return of i€ = 5%. The bond costs
€1,000 today and will return €1,050 at the end of one year without risk. The current exchange
rate is €1.00 = $1.50. U.S. dollar-denominated government bonds currently have a yield to
maturity of 4 percent. Suppose that the European Central Bank is considering either tightening or
loosening its monetary policy. It is widely believed that in one year there are only two
possibilities:
S1 ($|€) = €1.80 per €
S1 ($|€) = €1.40 per €
Following revaluation, the exchange rate is expected to remain steady for at least another year.
Using your results to the last question, make a recommendation vis-à-vis when to buy the bond.
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71) An American Hedge Fund is considering a one-year investment in an Italian government
bond with a one-year maturity and a euro-denominated rate of return of i€ = 5%. The bond costs
€1,000 today and will return €1,050 at the end of one year without risk. The current exchange
rate is €1.00 = $1.50. U.S. dollar-denominated government bonds currently have a yield to
maturity of 4 percent. Suppose that the European Central Bank is considering either tightening or
loosening its monetary policy. It is widely believed that in one year there are only two
possibilities:
S1 ($|€) = €1.80 per €
S1 ($|€) = €1.40 per €
Following revaluation, the exchange rate is expected to remain steady for at least another year.
Using the notion of hedging, make a recommendation vis-à-vis how to undertake the project
today without "buying" the option.
72) The Strik-it-Rich Gold Mining Company is contemplating expanding its operations. To
do so it will need to purchase land that its geologists believe is rich in gold. Strik-it-Rich's
management believes that the expansion will allow it to mine and sell an additional 2,000 troy
ounces of gold per year. The expansion, including the cost of the land, will cost $500,000. The
current price of gold bullion is $425 per ounce and one-year gold futures are trading at $450.50 =
$425 × (1.06). Extraction costs are $375 per ounce. The firm's cost of capital is 10 percent.
Strik-it-Rich's management is, however, concerned with the possibility that large sales of gold
reserves by Russia and the United Kingdom will drive the price of gold down to $390 for the
foreseeable future. On the other hand, management believes there is some possibility that the
world will soon return to a gold reserve international monetary system. In the latter event, the
price of gold would increase to at least $460 per ounce. The course of the future price of gold
bullion should become clear within a year. Strik-it-Rich can postpone the expansion for a year by
buying a purchase option on the land for $25,000.
Compute the NPV at the current price of gold. Hint: think of the gold mine as a perpetuity.
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73) The Strik-it-Rich Gold Mining Company is contemplating expanding its operations. To
do so it will need to purchase land that its geologists believe is rich in gold. Strik-it-Rich's
management believes that the expansion will allow it to mine and sell an additional 2,000 troy
ounces of gold per year. The expansion, including the cost of the land, will cost $500,000. The
current price of gold bullion is $425 per ounce and one-year gold futures are trading at $450.50 =
$425 × (1.06). Extraction costs are $375 per ounce. The firm's cost of capital is 10 percent.
Strik-it-Rich's management is, however, concerned with the possibility that large sales of gold
reserves by Russia and the United Kingdom will drive the price of gold down to $390 for the
foreseeable future. On the other hand, management believes there is some possibility that the
world will soon return to a gold reserve international monetary system. In the latter event, the
price of gold would increase to at least $460 per ounce. The course of the future price of gold
bullion should become clear within a year. Strik-it-Rich can postpone the expansion for a year by
buying a purchase option on the land for $25,000.
Compute the NPV at the two possible prices of gold.
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Answer Key
Test name: chapter 18
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