Corporate Finance a. An investment returns the following cash flows: In t=1: $32
ID: 2727840 • Letter: C
Question
Corporate Finance
a. An investment returns the following cash flows:
In t=1: $321,000
In t=2: $228,980
In t=3: $1,225,043
What is the net present value in t=0 if the interest rate is 7%?
b. Peter has two possible investments to choose from. Project 1 returns $120,000 in t=10. Project 2 returns $80,000 in t=4. Assume for now that capital markets are perfect.
i. At what interest rates does the second investment have a higher net present value?
ii. Assume the interest rate is r=6%. Which investment does Peter prefer?
iii. Peter wants to retire in t=7. Does that change your answer to ii.? Explain your answer and give the name of the theorem you invoke here.
iv. Now capital markets are not perfect. Borrowing money costs 10%, lending money gives 7%. Peter still wants to retire in t=7. How does this change your answer to ii.? Explain your answer.
v. A firm can finance its investments with equity or with debt. Explain using examples how these two can lead to different types of moral hazard by managers. No further copying, distribution or publication of this exam paper is permitted. By printing or downloading this exam paper, you are consenting to these restrictions.
Explanation / Answer
Ans1 NPV= PV of cash inflow- cash outflow 0=PV of cash inflow- cash outflow 0=1500000-cash outflow cash outflow=1500000 Calculation of PV of cash inflow Yr Cash flow PVAF 7% Value 1 321000 0.9346 300000 2 228980 0.8734 200000 3 1225043 0.8163 1000000 Total 1500000