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a.

Revenues 15000000

- Production Cost 3000000

- Payroll 2000000

- Depreciation 6250000 ! This includes depreciation on sunk cost, since this acctg

- Allocated Advertising 1375000 ! This is based on allocation, again because this is a incom

Operating Income 2375000

- Taxes 950000

Operating Income after taxes 1425000

b.

Initial Investment = 30000000 ! Includes capitalized market testing expen

Ending Salvage Value = 5000000 ! Assumes market testing expenses are not amortized

Average Book Value = 17500000 ! If market testing not capitalized, this will be 15,000,000

Return on Capital = 8.14% ! If market testing not capitalized, this would be 12%

(If you ignore the sunk costs, the return on capital is 12%)

Depending upon your definition of starting and ending book value, and whether you included working capital,

averages ranged from $ 13.5 million to $ 18 million. I gave full credit for all of the alternatives

c.

The most direct way to do this is to do the operating income from scratch, using only incremental amounts

Revenues 15000000

- Production Cost 3000000

- Payroll 2000000

- Depreciation 5000000 ! The depreciation on testing is not increme

- Incremental Advertising 2500000 ! Focus on incremental advertising expense

Operating Income 2500000

- Taxes 1000000

Operating Income after taxes 1500000

+ Depreciation 5000000

ATCF 6500000

You can also get there from the operating income in part a.

Operating Income after taxes 1425000

+ Depreciation 6250000

ATCF 7675000

- Tax Benefit from Sunk Deprec'n 500000 ! This is the Depreciation on Testing Expense * Tax Rate

- Additional Adv. Cost (1-t) 675000 ! ($2.5 million - 1.375 million) * (1-t)

ATCF 6500000

d.

Year 0 1 2 3 4

Investment in Equipment $25,000,000

Investment in Working Capital $1,500,000

ATCF $6,500,000 $6,500,000 $6,500,000 $6,500,000

Salvage Value $6,500,000

Total ATCF ($26,500,000) $6,500,000 $6,500,000 $6,500,000 $13,000,000

PV of Total ATCF ($26,500,000) $5,772,647 $5,126,684 $4,553,006 $8,087,044

Cost of Capital = 12.60% ! Use the beta of software firms (and assumed an equity risk premium of 5.5%;

pre-2000 quizzes, it was not given but had to be estimated)

NPV = ($2,960,620)

IRR = 7.71%

Salvage Value includes $ 5 million from equipment and $1.5 million from working capital.

Problem 1 Alternatively,

Revenues 250 Revenues 250

- COGS 100 - COGS 100

- Deprecn 40 - Deprecn 50

- Variable OH 20 - Overhead 50

EBIT 90 EBIT 50

- Taxes 27 - Taxes 15

EBIT (1-t) 63 EBIT (1-t) 35

+ Deprecn 40 + Incr Deprecn 47 ! Only the after-tax portion of incr deprecn added back

- Cap Maint. 25 + Non-incr OH 21 ! Non-incremental portion (1 - tax rate)

- Chg in WC 20 - Chg in WC 20

ATCF 58 - Cap Maint 25

= ATCF 58

Problem 2

Annual cost of lease = 750 (APV,10%,6) = $172.21

Annual cost of buying = 1200 (APV,8%,15) = $140.20

Annual after-tax maintenance cost = $32.01

Annual maintenance cost (pre-tax) = $53.35

Problem 3

Cost of Equity = 5% + 1.8 (5.5%) = 0.149

NPV of project = -400 + 80 (PVA< 14.9%,5) = ($131.19)

Number of years the project would have to continue:

n PV of $ 80 million

5 268.808578

6 303.575786

The project will have to last 5 years beyond the fifth year for the project to have a positive NPV.

- 400 + 80 (PV of Annuity, 14.9%, n) and solve for n

n is approximately 10 years, yielding the same answer that the previous approach provided.

Problem 1

1 2 3 4 5

Existing 70% 0.77 0.847 0.9317 1.02487

New 20% 0.22 0.242 0.2662 0.29282

Total 90% 99% 109% 120% 132%

After-tax $ 24.00 $ 22.80 $ 21.66 $ 20.58 $ 19.55

PV $ 21.82 $ 18.84 $ 16.27 $ 14.05 $ 12.14

Opportunity Cost = 16.27 - 12.14 = $ 4.14 ! Assumed that systems get replaced in year in which capacity runs out

Problem 2

! I am assuming that $13 million is the expected payment next year. If I had assumed that it was last year's amount, I would have used 13 (1.05) in the solution

PV of 13 million(1-t) growing at 5% a year for 5 years = $ (32.37)

Equivalent annual cost of leasing = 32.37*(APV, 10%, 5 years) = $ (8.54) which would give me an answer of 33.89.

Equivalent annual cost = $ (8.62)

Equivalent annual cost = $ (7.57)

Problem 3

NPV of cashflows for first 3 years = 10/1.12 + 15/1.12^2 + 20/1.12^3 = $ 35.12

If initial investment is $ 120 million

PV of terminal value has to be = 120 - 35.12 $ 84.88

Terminal value has to be = 84.88 (1.12^3) = $ 119.25

20(1+g)/(.12-g) = 119.25

Solving for g,

g = ( .12*119.25-20)/(20+119.25) = -4.09% ! Growth rate has to be negative (and it can be)

Problem 1

Market Value of Equity = 250 * 20 = 5000

Market Value of Debt

Interest bearing debt = $ 1,000

PV of Operating Leases= $ 1,230 ! PV of $ 300 million at 7% for 5 years

Total $ 2,230

Debt to Equity Ratio = (2230/5000) = 44.60%

Debt to Capital Ratio = (2230/7230) = 30.84%

Cost of Equity for this project = 6.5% + 1.33 (6%) = 14.48%

Cost of Capital for this project = 14.48% (.6916) + 7% (1-.4)(.3084) = 11.31%

Grading

1. Used unlevered beta to compute cost of equity (-1 point): Would have given you a cost of equity which is too low

2. Used firm's beta to compute cost of equity for the project (-1 point)

3. Did not consider operating leases at all, or just took one year's lease commitment (-1 point)

4. Computed the present value of operating leases using after-tax cost of debt (-1/2 point)

5. In computing cost of capital, used pre-tax cost of debt (-1/2 point)

6. Reported cost of equity as the cost of capital (-1.5 points)

Problem 2

EBIT (1-t) 100 Alternatively, EBIT = 100/(1-.4) = 166.666667

+ Depreciation 50 + Total G& A = 240

+ Fixed G&A (1-t) 108 - Variable G& A = 60

Cash Flow 258 Correct EBIT = 346.666667

EBIT (1-t) = 208

+ Depreciation 50

Cash Flow = 258

Problem 3

Current usage Database Total Usage Cost of Usage PV

1 66.00% 30% 96.00% $ -

2 72.60% 30% 102.60% $ 5.20 $ 4.38

3 79.86% 30% 109.86% $ 19.72 $ 15.23

4 87.85% 30% 117.85% $ 35.69 $ 25.29

5 96.63% 30% 126.63% $ 53.26 $ 34.62

Present Value of Costs associated with excess capacity = $ 79.51

Present Value of Benefits = PV of $ 25 million a year for 5 years= $ 97.24

NPV of Project = $ 17.74

Spring 2001

1. Estimating Incremental after-tax cash flows

1 2 3 4 5

Investment Cash Flows

Investment ($1,000) $250

Working Capital ($180) $180

Operating Cash Flows

Revenues $1,800 $1,800 $1,800 $1,800 $1,800

EBITDA $450 $450 $450 $450 $450

Incremnetal S,G&A $20 $20 $20 $20 $20

Depreciation $150 $150 $150 $150 $150

EBIT $280 $280 $280 $280 $280

EBIT(1-t) $168 $168 $168 $168 $168

+ Depreciation $150 $150 $150 $150 $150

Cash flow $318 $318 $318 $318 $318

Effect of the computer purchase: Spend $ 200 (1-.4) = - $ 120 in year 2

Save $200 (1-.4) in year 5

Incremental cash flow in year 2 = 198

Incremental cash flow in year 5 = 438

2. NPV of project

Initial investment = 1180

Salvage Value = 430

Opportunity Cost = -$24.66 ! Cost of buying the computer earlier rather than later (-120/1.1^2 + 120/1.1^5)

NPV = -1180 + 318 (PVA, 10%,5 years) + 430 /1.1^5 -24.66= $267.80

Straight line Depreciation = $150.00 10%

Tax benefit each year = $60.00

PV of tax benefit = $227.45

Accelerated Depreciation 1 2 3 4 5

Depreciation $300.00 $190.00 $104.00 $78.00 $78.00

Tax Savings $120.00 $76.00 $41.60 $31.20 $31.20

PV $109.09 $62.81 $31.25 $21.31 $19.37 $243.84

Effect on NPV = $243.84 - $ 227.45 = $16.39

(I will assume that cap ex = depreciation, with infinite life)

Cash flow each year = 168

NPV =-1180+168/.1 - 24.66 = $475.34 ! You would get the same answer if you put this in year 5 and then discounted

and added it back to the present value of cash flows over the first 5 years.

(Technicially,there will be other computer purchases further down the road, but the item seems small enough to ignore)

Spring 2002

Problem 1

a. Book value of debt = 750

Annual interest expenses = 40

Maturity of the debt = 5

Market interest rate = 7.20%

Market value of debt = $692.90

Market value of equity = 2000

D/E ratio = 0.3464516628

levered beta = 0.9662967981

Cost of equity = 10.20%

After-tax cost of debt = 4.32%

Debt Ratio = 25.73%

Cost of capital = 8.68%

Problem 2

Effect of Working capital

Increase in initial investment = -250 ! 10% of revenues

Increase in salvage value = 250 ! Recover 100% at end

NPV effect = - 250 + 250/1.12^3 = -72.054938047

Effect of expensing

Tax benefit shown in analysis = 1200 ! Shown today

Depreciation each year = 1000

Tax benefit each year = 400

PV of tax benefits over 3 years = 960.73250729

Difference in PV = -239.26749271

Spring 2003

Problem 1

a. Cost of capital calculation Common Errors

Levered beta for software = 1.725 ! Use software company beta: 1.5 (1 + (1-.4)(200/800)) 1. Forgot to lever beta: -0.5

Cost of equity = 11.90% 2. Math error in levering beta: -0.5

After-tax cost of debt 4.20% ! (5% +2%) (1-.4) 3. Wrong cost of debt: -0.5

Cost of capital = 10.36% ! 11.9% (.8) + 7% (1-.4) (.2) 4. Forgot (1-t) in cost of debt: -0.5

b. Incremental cashflows

0 1 2 3 4

Initial investment -5

Revenues 6 6 6 6

- Operating Expenses 3.6 3.6 3.6 3.6

- Depreciation 1 1 1 1 ! No deprecn from sunk investment

EBIT 1.4 1.4 1.4 1.4

- Taxes 0.56 0.56 0.56 0.56 Any error in incr CF statement: 1 point off

EBIT (1-t) 0.84 0.84 0.84 0.84 1. Forgot taxes

+ Depreciation 1 1 1 1 2. Forgot to add back depreciation

Cashflow after taxes 1.84 1.84 1.84 1.84 3. Did strange things with allocated G&A

Salvage Value 1

Cashflow to firm -5 1.84 1.84 1.84 2.84 Forgot salvage value: -0.5

PV -5 1.6672707503 1.5107563884 1.3689347485 1.9145714252 Errors in NPV calculation: -0.5

c. NPV = $1.46

Problem 2

Levered beta for computers= 1.035 This project is not a software project. You have to revert back to the unlevered beta of computer businesses: -1

Cost of equity = 9.1400%

Cost of capital = 8.15% You cannot compare the NPVs of two mutually exclusive projects with different lives: -1

Using IRR and profitability indices are only partial solutions to this problem.

NPV for 8 year project = $3.43

Equivalent annuity = $0.60

Spring 2004

Problem 1

Levered beta for project = 1.265 ! 1.10 (1 +(1-.4)*(20/80)): Use the marginal tax rate and the unlevered beta of educational service companies

Cost of equity = 10.10% Common Errors

Cost of capital = 8.80% ! 10.10(.8)+6%(1-.4)(.2) 1. Used company's beta instead of educational service beta (-1)

2. Forgot to lever educational service beta (-1)

Problem 2 3. Used effective tax rate (-1/2)

Year 0 Year 1-3 Year 3 4. Used wrong debt to equity ratio or wrong debt to capital ratio (-1/2)

Revenues $10.00

EBITDA & G&A $3.00

- Depreciation $1.50 Common Errors

- Incremental G&A $0.50 1. Started with revenues instead of EVBITA & G&A (-1)

- Incremental cleaning expenses $0.15 2. Used allocated G&A instead of incremental and did not correct (-1)

EBIT $0.85 3. Showed change in working capital each year instead of only in year 0 (-1)

- Taxes $0.34 4. Used effective tax rate (-1/2)

After tax operating income $0.51 5. Used wrong depreciation number (-1/2)

+ Depreciation $1.50

- Change in WC $0.00

After-tax Cashflow $2.01

Investment in working capital -$1.00 $1.00

-$8.50 $4.00

Problem 3

Net Present Value = -$0.29 ! -8.5 + 2.01(PV of annuity, 3 years, 8.80%) + 4 (PV of FV, 3 years, 8.80%) ! Forgot to salvage working capital or fixed assets . (-1/2)

Forgot initial investment (-1/2)

Problem 4 Mechanical errors (-1/2)

After-tax cashflow starting in yr 4= $0.51 ! Assume capital maintenance will be equal to depreciation in perpetuity

Terminal value = $5.80 Common Errors

1. Used CF from part 2 without adjusting for any capital maintenance (-1)

Net present value = $1.11 ! Use 5.11 as terminal value instead of salvage of 4.00 2. Too little capital maintenance. If your capital maintenance is set < depreciation, you

will have a problem since you will run out of book value to depreciate (-1/2 to -1 point)

The more precise answer 3. Discounted back terminal value 4 years instead of 3. You use year 4 cashflow to get

After-tax cashflow starting in yr 1= $0.51 ! Assumes that you can't wait until year 4 to start capital mainte terminal value, it is in year 3. (-1/2 point)

PV of cashflows = $5.80 4. Also counted salvage value (-1)

NPV of project = -$2.70

(If you decide to make this a perpetual project, you should start investing in capital maintenance right away and not wait until year 4)

Spring 2005

Problem 1 Common Errors

Revenues 28 1. Computing the cashflow after interest expenses (Usin

- Operating Expenses 12 the tax benefit from interest. (The cost of capital already

- Depreciation 5 2. Adding back the entire non-incremental G&A, instead

- Allocated G&A 4 3. Using actual taxes paid of $ 1.2 million instead of re

EBIT 7

- Interest Expenses 3 ! -1 point for subtracting out interest expenses or using

EBT 4 !-1 point for not correctly dealing with G&A expenses

- Taxes 1.2

Net Income 2.8

Revenues 28

- Operating Expenses 12

- Depreciation 5

- Incremental G&A 1

EBIT 10

Taxes 3

EBIT (1-t) 7

+ Depreciation 5

FCFF 12

There is a book value of $ 10 million at the end of the project. If this i

NPV = $7.80 NPV = $11.02

Problem 2

a. NPV of liquor license = -65.91379608 ! The initital investment is a capital expense. You cannot

is no need to depreciate. If you did depreciate, I still gav

b. Annual cashflow needed to c 19.6631104923 ! Your cashflows from the restaurant have to have a NPV o

Revenue needed 32.7718508205 give you this present value is computed. Dividing by 0.6

! -65.91 = PMT (PVA, 15%,5 years)

Problem 3

Cost of equity = 11.00%

NPV of option 1 = 416.473833532 ! Used riskless rate since cashflow is guaranteed ! You cannot compare NPVs when projects have different lives, as these do.

Annual benefit = 96.1949596257 ! Converted into annuity You have to either replicate or convert into annuities.

! -1.5 points for not using annuity

NPV of option 2 = 484.312053407 ! Used cost of equity=5% + 1.5*4% = 11% ! -1 point for using risk adjusted discount rate to discount first option

Annual benefit = 74.5972713595 ! Converted back into annuity ! -1 point for not computing risk adjusted rate right

Spring 2007

Problem 1 Comments

Interest bearing debt = $300.00 1. Ignored leases altogether: -1

PV of lease commitments= $216.47 2. Took nominsl value of leases: -1

Total debt outstanding = $516.47 3. Computed present value of leases using wrong r: -0.

Equity = $2,000.00 4. Used book value for debt or equity: -1

D/E Ratio = 25.82% 5. Error in levering beta: -0.5

Levered Beta = 0.9240 6. Error in CAPM equation: -0.5

1. Forgot to after-tax debt : -0.5

Cost of capital = 7.47% ! 8.62% (2000/2516.47) + 5% (1-.4)(516/47/2516.47) 2. Weights don't add up to one: -0.5

3. Math errors: -0.5

Problem 2

0 Yrs 1-5 Salvage

Investment in facility 500000 100000

Investment in Inventory 50000 50000

- Food cost 500000 1. Subtracted change in working capital every year: -1

- Employee Expenses 200000 2. Error in computing depreciation: -0.5

- Advertising 40000 3. Used revenues for restaurant instead of service: -1

- Depreciation 80000 4. Forgot to add back depreciation: -0.5

Operating Income 180000

Taxes 72000

After-tax Operating Income 108000

+ Depreciation 80000

Cash flow to firm 188000 1. Ignored working capital in salvage with no tax effect: -0.5

2. Forgot working capital in initial investment: -0.5

NPV= $154,781.67 ! -550000+ 188000 (PV of annuity, 15%,5)+ PV of Salvage 3. Errors in computation: -0.5

Revenues lost in restaurant 200000 1. Forgot expenses associated with revenues: -0.5

- Variable costs 100000 2. Forgot taxes: -0.5

Operating Income 100000 3. Other errors: -0.5

Taxes 40000

After-tax Operating Income 60000 I gave full credit for two alternative interpretations

1. Using the after-tax operating margin for the restaur

PV of Cashflows from lost sales = $201,129 2. Keeping variable costs fixed (the problem was a litt

Adjusted NPV = -$46,348

Spring 2008

Problem 1

a. After-tax cash flow Grading

Rental revenue 100000 Math error: -.5

Maintenance cost & property taxes 20000 Added back maintenance: -.5

Depreciation 40000 Double counted tax benefits on maintenance: -.5

Operating income 40000

Taxes 16000

Income after taxes 24000

+ Depreciation 40000

After-tax cashflow 64000

b.

House price today = 1000000 ! Bt renting the house, you get a positive

NPV. Netting this out against the current

Cost of renovation 200000 ! Negative cash price gives you the PV of the future price

PV of after-tax cashflows (rental) = $242,610.35 ! Positive cash flow

PV of future house price = $957,389.65 Did not net out renovation cost: -1 point

FV of house price = $1,541,885.60 Forgot to take future value: -1 point

House has to sell for more thanthis value for the rental option to be be Sundry errors: -.5 point each

Problem 2

NPV computed by analyst = $10.00 ! Computed tax benefits incorrectly: -.5

- PV of depreciation over next 5 yea $31.94 ! $ 20 m (.4) (P ! Forgot salvage: -.5 to -1 point

+PV of depreciation over next 10 y $24.16 ! 8 m (.4) (PV o ! PV incorrect: -.5 to -1 point

+PV of salvage value $4.63 ! Salvage value discounted

Correct NPV = $6.85

Problem 3

PV of investing in year 2 $2,391,581.63 ! Did not convert to annuity: -1.5 points

PV of investing in year 5 $1,702,280.57 ! Did not take PV difference: -1 point

Cost of using excess capacity = $689,301.07 ! Math errors: -.5 point each

Annual revenues needed to break e $191,218.82

Spring 2009

Problem 1 Grading guidelines

Step 1: Compute debt ratios

Pre-tax cost of debt = 5% ! Did not compute PV o leases: -1 point

Annual lease commitment = 100 Used after-tax cost of cdebt as discount rate: -0.5 point

Number of years of lease commitm $646.32 Did not use the right beta: -1 point

Market Value of Equity = 2500 Did not lever beta: -0.5 point

Debt to Equity Ratio = 0.2585285104 Wrong cost of debt: -0.5 point

Debt to Capital Ratio = 0.2054212584 Did not compute after-tax cost of debt : -0.5 point

Step 2: Compute beta and cost of equity Math errors: -0.5 point

Unlevered beta for services = 0.8

Levered beta for services = 0.924093685

Cost of equity = 8.54%

Step 3: Compute cost of capital

Cost of equity = 8.54%

After-tax cost of debt = 3.00% ! Pre-tax cost (1- marginal tax rate)

Cost of capital = 7.41%

Problem 2

0 1 2 3

Investment in fixed assets 250 ! Did not adjust for fixed G&A: -1 point

Invvestment in Working Capital $22.50 Did not tax adjust the G&A: -0.5 point

Revenues $225 $300 $450 Used total working capital instead of change: -0.5 to -1 point

- Depreciatiion $75 $50 $25 Forgot salvage value of WC: -0.5 point

- Other Operating Expenses $100 $125 $175 Forgot salvage value of fixed assets : -0.5 poiint

- Allocated G&A $25 $25 $25 did not compute NPV: -1 point

Pre-tax Operating Income $25 $100 $225

- Taxes $10.0 $40.0 $90.0

After-tax Operating Income $15.0 $60.0 $135.0

+ Deprecistion $75 $50 $25

+ Fixed G&A (1-t) $15.0 $15.0 $15.0

- Change in Working Capital 7.5 15 0

Salvage of WC $45.00

Salvage of Fixed Assets $100

After-tax Cash Flow -$272.50 $97.50 $110.00 $320.00

PV at cost of capital -$273 $89 $91 $240

NPV = $147.47

Problem 3

1 2 3 4 5

Cash flows from long term offer $36,000 $36,000 $36,000 $36,000 $36,000 ! See below. Any PV errors; -0.5 points

Cash flow foregone (on reuglaro wor $0 $0 $60,000 $60,000 $60,000

Incremental Cash flow $36,000 $36,000 -$24,000 -$24,000 -$24,000

PV of cash flows $31,304 $27,221 -$15,780 -$13,722 -$11,932

Present value of cash flows = $17,091

Cashflows under status quo 75000 75000 150000 150000 150000

Present value 65217.39130435 56710.775047 98627.434865 85762.986839 74576.5102947

Total 380895.0983501

Cashflows under Long term offer $111,000 $111,000 $126,000 $126,000 $126,000

Present value $96,521.74 $83,931.95 $82,847.05 $72,040.91 $62,644.27

Total $397,985.91

Difference in present values $17,090.81

Spring 2010

Problem 1 ! PV of leases computed at wrong rate: -1 pt

Current market value of equity = $1,000.00 ! Math errors in PV: -0.5 pt

Present value of leases = $266.91 ! 50 (PV of annuity, 4 yrs, 5%) + 40 (PV of annuity, 3 years, 5%) (PF, 4 years, 5%)

Debt to capital ratio = 21.07% ! PV of leases/ (PV of leases + Market value of equity)

Cost of capital = 8.53% ! 10% (.7865) + 5% (1-.4) (.2135) ! Wrong cost of equity or debt: -0.5 pt

Problem 2

Opportunity cost of server = $1,554 ! After tax cost of server = 10000 (1-.4) (Expensed, not capitalize ! No tax benefit: -0.5 point

! 6000/1.15^2-6000/1.15^5 ! No netting out of savings: -0.5 pt

( I gave full credit if you did not show the

Now Yrs 1-5 savings in year 5 and stayed consistent all

Initial cost -25000 the way through)

Server opportunity cost -$1,554

Annual operating cost 15000 ! Did not who server cost in NPV: -0.5 pt

Depreciation 5000 ! Did not count initial investment: -0.5 pt

Operating income 10000 ! Math errors: -0.5 pt each

Taxes 4000

After-tax operating income 6000

+ Depreciation 5000

After-tax cash flow 11000

Net present value = $10,320 ! --25000 - 1554 + 11000 (PV of annuity, 5 years, 15%)

Problem 3

Now Yrs 1-5 Yr 5 only

Kitchen upgrade -50000 10000 ! Dont forget salvage in year 5)

Revenues 60000 (You can show the lost sales separately. If you do, your after tax cash flow will be

Direct costs 24000 $17,600 and your lost CF from cannibalization will be $ 3,000/year)

Incremental salary 12000 ! Allocation is irrelevant. Only the incremental salary counts

Lost profits at restaurant 5000 ! 10% of operating profits

Depreciation 8000

Operating income 11000 ! Showed allocated salary instead of incrmental: -1 point

Taxes 4400 ! Errors in computing value from lost restaurant business: -1 point

After-tax operating income 6600 ! No salvage value shown: -0.5 point

+ Depreciation 8000 ! Errors in computing cash flow: -1 point

After-tax cash flows 14600

Net present value $8,304 ! -50000 + 14600 (PV of annuity, 5 years, 12%) + 10000 (PV of CF, 5 years, 10%)

Spring 2011

Problem 1

Cost of capital in US$ = 10% ! Did not estimate cost of capital correctly: -1 point

Inflation rate in rupiah = 9% ! Error in computing NPV: -1 point

Inflation rate in US$ = 2%

Cost of capital in Rupiah = 17.55% ! (1+ Cost of capital in US$) (1+ inflation rate in Rupiah)/ (1+inflation rate in US$)

As an approximation, you can add the inflation rate difference of 7% to the $ cost of capital to get 17%. You get full credit.

0 1 2 3

Cash flow in rupiah -Rp1,000.00 Rp350.00 Rp450.00 Rp500.00

Present value -Rp1,000.00 Rp297.75 Rp325.67 Rp307.83

NPV = -Rp68.75

Problem 2

Initial investment -50000

Annual cash flow for break $14,916 ! PMT given PV = 50000

- Taxes $3,277.19 ! Solved for breakeven cash flow but did not go further: -1 point

After-tax operating income $4,916 ! Brought in existing revenue (non-incremental) into decision: -1 point

+ Depreciation 10000

After-tax cash flow $14,916

Initial investment = -$50,000.00

+ Depreciation tax benefit $13,408.62

Remaining cost to be recov -$36,591.38

Annuity needed to cover $10,915.78

Pre-tax CF needed $18,192.96 ! This is really EBITDA. If you did get this, though, I still gave you credit.

Subtracting the depreciation will give you the same answer as above.

Problem 3

PV of St, Louis offer $114.25 ! Use the cost of debt for St. Louis as discount rate

PV of Yankee offer $157.96 ! Use the cost of debt for Yankees as discount rate

! Used wrong discount rate: -1 point

Equivalent annuity = $27.12 ! Convert back into annuity ! Computed NPV incorrectly: -0.5 to -1 point

Equivalent annuity (Yankee $27.30 ! Did not compute annuity: -1 point

Some of you did try adding on to the shorter term offer to make the lives equivalent. If you did, you got 0.5 point.

Problem 4

NPV of project = $5.00

- PV of tax savings from d $25.67 ! Did not compute PV of tax benefits: -1 point

+ PV of tax savings from $40.00 ! Did not compute PV of immediate expensing: -1 point

New NPV $19.33 ! Brought in existing cash flows (non-incremental) into NPV: -1 point

Spring 2012

Problem 1

a. Market value of interest bearing debt

Interest expense = 10 ! Used after-tax cost of debt: -0.5 points

Book value of debt = 250 ! Math errors: -0.5 point

Pre-tax cost of debt = 7.50%

Estimated market value = $189.94

b. Market value of lease commitments ! Used after-tax cost of debt: -0.5 points

Lease commitment 20 ! Math errors: -0.5 point

Number of years 8

PV of of lease commitments $117.15

Debt = $307.09

Equity = 1200

D/E = 25.59%

Debt/Capital = 20.38%

Levered beta = 1.3843 ! Used wrong beta: -1 point

Cost of equity = 11.31% ! Did not lever beta: - 0.5 point

After-tax cost of debt = 4.50% ! Used effective tax rate: -0.5 point

Cost of capital = 9.92% ! Did not after-tax cost of debt: -0.5 point

Problem 2

Cost of shift to social media ! Ignored initial investment in analysis: -1.5 points

Initial investment = 25 ! Did not incorporate tax savings on depreciation: -1.5 points

Depreciation/year 5 ! Did not pre-tax savings: -0.5 points

Tax savings each year 2 ! Math errors: -0.5 point each

PV of tax savings $7.58

Net cost of shift = $17.42

Convert into annualized values

Annualized cost = $4.59

Pre-tax savings needed = $7.66

Initial investment -$80.00 ! Used company's discount rate of 10% to discount project cashflow

! Lease revenue from parking ignored/wrong: -0.5 point

Revenues $30.00 ! Fixed G&A counted/wrong: -0.5 point

- Direct Expenses $10.00 ! Did not offset depreciation in perpetuity: -1 point

- Incremental G&A $2.00 ! Counted salvage value in PV (you cannot have terminal value

- Lost lease revenue (from land) $1.00 and salvage value in the same PV

- Depreciation $7.00 ! Other math errors: -0.5 point

Operating income $10.00

- Taxes $4.00

After-tax operating income $6.00

+ Depreciation $7.00

- Capital maintenance $7.00

Cash flow $6.00

NPV = -$5.00

Acceptable variations

1. If you discounted the lost lease revenue separately using the company's cost of capital (instead of this project's cost of

capital), you should get full credit. In fact, the right discount right for lease revenues should be the pre-tax cost of debt of the

lessee.

2. If you estimated the cash flows for the first 10 years without a maintenance cap ex and introduced a cap ex after year 10, I

gave you full credit (even though I think you are starting too late). If you do this though, remember to bring your terminal

value back ten years. Your NPV will be as follows:

NPV = -80 + 13 (PVA, 10 years, 8%) + (6/.08) / 1.08^10

Spring 2013

Problem 1 Grading template

First, estimate the levered beta

Unlevered beta = 1.1 1. Used company's beta: -1 point

D/E ratio = 25% 2. Error on levering beta: -1/2 point

Tax rate = 35% 3. Did not adjust ERP for country risk: -1/2 point

Levered beta = 1.27875 4. Error on after-tax cost of debt: -1/2 point

5. Did not convert into Indian Rs: -1 point

Next, estimate the ERP & cost of equity 6. Error on conversion formula to Rs: -0.5 point

ERP = 8.500% 7. Error on D/E or D/C ratio: -0.5 point

Cost of equity = 13.8694% 8. Mistake in computing pre-tax cost of debt: -0.5 point

Cost of debt = 4.00%

After-tax cost of debt = 2.60%

Debt to capital = 20%

Cost of capital = 11.57550%

Inflation rate (INR) = 6% ( I gave full credit if you just added the differential inflation rate

Inflation rate (US $) = 2% of 4% to the US $ cost of capital)

Cost of capital in INR = 15.95% ! (1+ US $ Cost of capital) (1.06/1.02) -1

Problem 2

1 2 3

Revenues $50 $65 $70 1. Did not add back depreciation: -1/2 point

Depreciation $15 $12 $8 2. Improper adjustment for fixed G&A: -1/2 point

AllocatedG&A $10 $10 $10 3. Wrong taxes: -1/2 point

OtherOperatingExpenses $20 $22 $26 4. Change in WC wrong: -1/2 point

OperatingIncome $5 $21 $26

Operatingincome(1t) $3.00 $12.60 $15.60

+Depreciation $15 $12 $8

+FixedG&A(1t) $4.50 $4.50 $4.50

ChangeinWC $5.0 $1.50 $0.50 1. Forgot salvage value (either investment or WC): -1/2 point

AftertaxCashflow $17.50 $27.60 $27.60 2. Math error: -1/2 point

Costofcapital= 9%

Initialinvestment $45

SalvageValue $17 ! Book value of initial investment + BV of Working Capital

NPV= $28.72

Annualsidebenefits 7.5 ( I know that there are cases where you may wan 1. Wrong cost of capital: -1 point

Costofcapital(movies) 12% to apply the project's cost of capital to side benefi2. Math error: -1/2 point

PVover4years $18.01 but this does not seem to fit those parameters. If

IncreaseNPVbythisamount you can make a really good case, I will listen.)

Problem3

Governmentcontract 1. Used risk adjusted rate on government contract: - 1 point

Riskfreerate= 3% 2 Used risk free rate for corporate contract: -1 point

1 2 3 3. Error on etimating risk adjusted discount rate: -0.5 point

Cash flow $60,000 $70,000 $75,000 4. NPV of share of profits contract wrong: -1/2 point

PV @ riskfree rate $58,252 $65,982 $68,636 5. Did not or error on converting govt contract to annuity: -1/2 point

NPV $192,870 6. Did not or error on converting share of profit contract to annuity: -1/2 point

Share of profits contract

Cost of equity = 9.00%

1 2 3 4 5

Total net profits $200,000 $250,000 $300,000 $350,000 $400,000

Share (20%) $40,000 $50,000 $60,000 $70,000 $80,000

PV @ 9% $36,697 $42,084 $46,331 $49,590 $51,995

NPV $226,697

! I gave full credit if you tax adjusted the latter, though I am not sure whose taxes you

To make them comparable, convert into annuities are netting out. If it the your (the consultant's) taxes, why would it not affect both contracts.

Annuity (Government contract) = $68,185.32 X Better Since net income is usually after corporate taxes, it should already be tax adjusted but I allowed

Annuity (Share of profits contract) = $58,281.97 for some leeway on this one.

Spring 2014

Problem 1 Grading template

Unlevered Beta = 0.9 1. Wrong risk free rate: -1/2 point

D/E ratio = 25% 2. Wrong unlevered beta: -1 point

Tax rate = 20% 3. Error in levering: -1/2 point

Levered Beta = 1.08 4. Wrong after-tax cost of debt: -1/2 point

5. Wrong debt ratio weights: -1/2 point

Risk free rate = 2.00% You cannot mix interest rates or costs of capital in different

ERP = 6.50% currencies and then try to take a weighted average. You can

Cost of equity = 9.0200% try to compute the cost of capital entirely in a different

Cost of debt = 3.500% currency and try to convert into your currency of choice, using

Afrte-tax cost of debt = 2.80% different inflation rates. Since the problem does not give you

Debt to capital = 20% those inflation rates, you can use interest rates as a proxy.

Cot of capital = 7.78%

Problem 2

Part a

Initial Investment -1000000 1. After-tax cash flow wrong: -0.5 to -1.5 points

2. Wrong discount rate: -1/2 point

Revenues 400000 3. Math errors: -1/2 point each

- Direct Expenses 150000

- Depreciation 200000

Operating Income 50000

-Taxes 20000

Operating Income after taxes 30000

+ Depreciation 200000

FCFF 230000

NPV (at 10%) -$128,119.04

Part b

Increase in sales = 400000 1. After-tax operating income wrong: -0.5 to -1 point

After-Tax Operating margin = 15% 2. Wrong discount rate: -1/2 point

incremental After-tax Operating In 60000 3. Math errors: -0.5 point each

To get the operating margin on equipment sales,

PV @12% $216,286.57 Current revenues from equipment = 2000000 (40% of $5 million)

NPV with synergy = $88,167.53 After-tax oper income from equip. sales 300000 (60% of 500000)

Prohect bcomes a good one, with synergy considered. Current after-tax oper margin = 15%

Problem 3

Licensing option

Initial pre-tax cash flow $200.00

PV of pre-tax CF at 4% = $1,667.76

PV (pre-tax) = $1,867.76 Use Amgen's cost of debt (Fixed & guaranteed by Amgen)

PV (after-tax) = $1,307.43 My answer

If you treated the initial cash flow $1,357.43 Full credit for this answer as well

In my infinite compassion, I also gave full credit if you Amgen's after-tax cost of debt (2.4%) in your discounting, though it mismatches taxes

PV of after-tax cash flows at 2.4% = $1,449.66

Do it yourself

Initial investment -$1,500.00 1. Wrong discount rate for licensing option: -1 point

2. Used EBITDA as cash flow in do-it-yourself option: -1 point

EBITDA $550.00 3. Error on computing cash flow from do it yourself options: -0.5 to 1 point

- Depreciation $100.00 4. Wrong discount rate for do it yourself: -1 point

EBIT $450.00 5. Math errors: -0.5 point

After-tax EBIT $315.00

+ Depreciation $100.00

ATCF $415.00

of Biozyte

< depreciation, you

ate (-1/2 to -1 point)

ar 4 cashflow to get

annuity: -1/2 point

ntract to annuity: -1/2 point

d it not affect both contracts.

ady be tax adjusted but I allowed

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