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Question 1:

Consider the following investment opportunity which offers the following sure real cash
flows:

The cash flows are all real and the capital investment is depreciated at 3 years straight line.
How much is the project worth?
Assume: 1. Taxes are paid immediately (i.e. in Sep 15 for the Sep-15 Profits). The tax code
where you are doing this project allows you to carry forward any tax losses your firm may
incur.
2. The corporate tax rate is 40%.
3. Assume that the nominal rate of interest is 10%
4. Assume that the rate of inflation is 0%
Real Interest Rate

= (Nominal Interest Rate Inflation)/(1 + inflation rate)


= 10%

------------------------------------------------------------------------------------------------------------------------------------------------------Question 2
Consider now the case in which the investment requires an amount of working capital equal
to 10 and must be maintained at this level for the life of the project. At the end of the project
all of the working capital is sold.
(a) What is working capital? Give an example of working capital. Discuss the difference
between the stock of working capital and the flow of working capital.
(b) You determine that the following real cash flows apply as a result of this new information.
How much is the project worth now?
Working capital is amyou need

------------------------------------------------------------------------------------------------------------------------------------------------------Question 3:
After a little while you decide that the previous scenario was a little bit unrealistic. You
determine that the inflation rate for the life of the project is going to 5% per annum. How
much is the project worth now? Below are the same real cash flows from before.

Assume:
1. Taxes are paid immediately (i.e. in Sep 15 for the Sep-15 Profits). The tax code where you
are doing this project allows you to carry forward any tax losses your firm may incur.
2. The corporate tax rate is 40%.
3. Assume that the nominal rate of interest is 10%
4. Assume that the rate of inflation is 5%
5. Assume that the working capital must be held constant in real terms.
Real Interest Rate
= (Nominal Interest Rate Inflation)/(1 + inflation rate)
= (10% - 5%) / (1 + 5%)
= 4.8%

------------------------------------------------------------------------------------------------------------------------------------------------------Question 4
As you examine the project more deeply, you discover that taxes are paid on a 1 year lag.
With the same assumptions as question 3, how much is the project worth? And with the
assumptions of question 2?

------------------------------------------------------------------------------------------------------------------------------------------------------Question 5:
Someone tells you that he read an article that talks about depreciation affecting how much a
project is worth. He also says that he is thinking about increasing the life of his assets from 6
years to 10 years. Assuming that nothing else has changed since question 3 and 4
(combined) except that you decide to depreciate your capital over 10 years (Straight line)
instead of 3 years, how much is the project worth? Would you make this change in
accounting policy for your firm?

------------------------------------------------------------------------------------------------------------------------------------------------------Question 6
Company would have more payables hence WC would decrease.