A person is thinking about borrowing $100 from the bank at 7% pa and investing it in shares with an expected return of 10% pa. One year later the person intends to sell the shares and pay back the loan in full. Both the loan and the shares are fairly priced.
What is the Net Present Value (NPV) of this one year investment? Note that you are asked to find the present value (##V_0##), not the value in one year (##V_1##).
The US firm Google operates in the online advertising business. In 2011 Google bought Motorola Mobility which manufactures mobile phones.
Assume the following:
- Google had a 10% after-tax weighted average cost of capital (WACC) before it bought Motorola.
- Motorola had a 20% after-tax WACC before it merged with Google.
- Google and Motorola have the same level of gearing.
- Both companies operate in a classical tax system.
You are a manager at Motorola. You must value a project for making mobile phones. Which method(s) will give the correct valuation of the mobile phone manufacturing project? Select the most correct answer.
The mobile phone manufacturing project's:
Bonds X and Y are issued by different companies, but they both pay a semi-annual coupon of 10% pa and they have the same face value ($100), maturity (3 years) and yield (10%) as each other.
Which of the following statements is true?
A project has the following cash flows:
Project Cash Flows | |
Time (yrs) | Cash flow ($) |
0 | -400 |
1 | 200 |
2 | 250 |
What is the Profitability Index (PI) of the project? Assume that the cash flows shown in the table are paid all at once at the given point in time. The required return is 10% pa, given as an effective annual rate.
Value the following business project to manufacture a new product.
Project Data | ||
Project life | 2 yrs | |
Initial investment in equipment | $6m | |
Depreciation of equipment per year | $3m | |
Expected sale price of equipment at end of project | $0.6m | |
Unit sales per year | 4m | |
Sale price per unit | $8 | |
Variable cost per unit | $5 | |
Fixed costs per year, paid at the end of each year | $1m | |
Interest expense per year | 0 | |
Tax rate | 30% | |
Weighted average cost of capital after tax per annum | 10% | |
Notes
- The firm's current assets and current liabilities are $3m and $2m respectively right now. This net working capital will not be used in this project, it will be used in other unrelated projects.
Due to the project, current assets (mostly inventory) will grow by $2m initially (at t = 0), and then by $0.2m at the end of the first year (t=1).
Current liabilities (mostly trade creditors) will increase by $0.1m at the end of the first year (t=1).
At the end of the project, the net working capital accumulated due to the project can be sold for the same price that it was bought. - The project cost $0.5m to research which was incurred one year ago.
Assumptions
- All cash flows occur at the start or end of the year as appropriate, not in the middle or throughout the year.
- All rates and cash flows are real. The inflation rate is 3% pa.
- All rates are given as effective annual rates.
- The business considering the project is run as a 'sole tradership' (run by an individual without a company) and is therefore eligible for a 50% capital gains tax discount when the equipment is sold, as permitted by the Australian Tax Office.
What is the expected net present value (NPV) of the project?
Question 345 capital budgeting, break even, NPV
Project Data | ||
Project life | 10 yrs | |
Initial investment in factory | $10m | |
Depreciation of factory per year | $1m | |
Expected scrap value of factory at end of project | $0 | |
Sale price per unit | $10 | |
Variable cost per unit | $6 | |
Fixed costs per year, paid at the end of each year | $2m | |
Interest expense per year | 0 | |
Tax rate | 30% | |
Cost of capital per annum | 10% | |
Notes
- The firm's current liabilities are forecast to stay at $0.5m. The firm's current assets (mostly inventory) is currently $1m, but is forecast to grow by $0.1m at the end of each year due to the project.
At the end of the project, the current assets accumulated due to the project can be sold for the same price that they were bought. - A marketing survey was used to forecast sales. It cost $1.4m which was just paid. The cost has been capitalised by the accountants and is tax-deductible over the life of the project, regardless of whether the project goes ahead or not. This amortisation expense is not included in the depreciation expense listed in the table above.
Assumptions
- All cash flows occur at the start or end of the year as appropriate, not in the middle or throughout the year.
- All rates and cash flows are real. The inflation rate is 3% pa.
- All rates are given as effective annual rates.
Find the break even unit production (Q) per year to achieve a zero Net Income (NI) and Net Present Value (NPV), respectively. The answers below are listed in the same order.
Discounted cash flow (DCF) valuation prices assets by finding the present value of the asset's future cash flows. The single cash flow, annuity, and perpetuity equations are very useful for this.
Which of the following equations is the 'perpetuity with growth' equation?
A firm wishes to raise $10 million now. They will issue 6% pa semi-annual coupon bonds that will mature in 3 years and have a face value of $100 each. Bond yields are 5% pa, given as an APR compounding every 6 months, and the yield curve is flat.
How many bonds should the firm issue?
Question 546 income and capital returns, interest only loan, no explanation
Which of the following statements about the capital and income returns of an interest-only loan is correct?
Assume that the yield curve (which shows total returns over different maturities) is flat and is not expected to change.
An interest-only loan's expected:
This question is about the Balance of Payments. Australia's current account as a percent of nominal gross domestic product (GDP) per annum is shown in the graph below.
Assume that all foreign and domestic assets are either debt which makes interest income or equity which makes dividend income, and vice versa for liabilities which cost interest and dividend payments, respectively.
Which of the following statements is NOT correct?