Corporate Finance

Exercises session #3
Block 8 (Alternative investment rules)

November 30th, 2018

Corporate Finance: Lectures and Seminars, HEC Liège (ULiège) 2018-2019 – Marie Lambert 1
 Q1
Your firm has recently reached an expansion phase and is seeking
possible new geographic regions to market a newly patented
chemical compound called “Glupto”. The five regional projections
are as follows:

Cash flows (in €millions)

Years from now: 0 1 2 3 4 5
Germany -95 15 20 25 30 30
France -75 15 20 20 25 30
Italy -60 10 15 20 20 25
Ireland -35 5 10 10 15 15
Spain -20 5 5 6 6 10
Zero-coupon yields (%) - 6.5 7 7 7.5 8

Corporate Finance: Lectures and Seminars, HEC Liège (ULiège) 2018-2019 – Marie Lambert 2
 Q1
• Questions
a) Which countries would be profitable to the firm? Which of the
five is the most profitable?
b) If current budgeting can support a €100 million expenditure in
year 0, which combination of regions is optimal?
c) Assume now that you can expand without regional saturation
(i.e. several times in the same country). With the budget
constraint in part b), which region is optimal?

Corporate Finance: Lectures and Seminars, HEC Liège (ULiège) 2018-2019 – Marie Lambert 3
 Q2
Investco, a South African research company, must decide on the level of
computer technology it will buy for its analysis department. Package A, a
mid-level technology, would cost €15 million for firm-wide installation,
while package B, a higher level technology, would cost €21 million.
Equipped with level A technology, the firm could generate a cash flow of
€9 million for two years before the technology would require
replacement; with level B technology, the firm could generate a cash flow
of €10.2 million for three years, after which the technology would require
replacement. Investco is interested in a six-year planning horizon. Assume
the following about discount rates:

Zero-coupon yields for year

1 2 3 4 5 6
5% 5.5% 6% 6% 6.5% 7%

Corporate Finance: Lectures and Seminars, HEC Liège (ULiège) 2018-2019 – Marie Lambert 4
 Q2
• Questions
a) What are the associated cash flows for each package or
sequence of packages?
b) What is the optimal decision, given Investco’s planning
horizon?

Corporate Finance: Lectures and Seminars, HEC Liège (ULiège) 2018-2019 – Marie Lambert 5
 Q3
A manufacturing company wants to launch a new product
specifically designed for the Chinese market. In that context, the
company has to choose between three different mutually exclusive
technologies (A, B, and C). Initial investment outlays/outflows as
well as inflows are as follows:
Cash flows (in €millions)
0 1 2 3 4 5
A -10.5 2 3 3.5 4 5
B -2.3 0.5 0.8 1 1.5 2
C -18 4.5 4.5 5 6.5 7

Corporate Finance: Lectures and Seminars, HEC Liège (ULiège) 2018-2019 – Marie Lambert 6
 Q3
• Questions
a) What is the Internal Rate of Return (IRR) of each technology?
b) If the required rate of return is 10%, in which technology
should the company invest?
c) If the company has a capital budget constraint of $15 million
and the projects are not scalable, in which technology should
the company invest?
d) If the company still has a budget constraint of $15 million and if
the projects are now scalable, in which technology should the
company invest? How many times?

Corporate Finance: Lectures and Seminars, HEC Liège (ULiège) 2018-2019 – Marie Lambert 7
 Q4
As the CFO of a company, you have to value four different mutually
exclusive projects (A, B, C and D). You estimate that the company's
WACC/cost of capital is 8.00%. Project A has a risk which is similar
to assets currently hold by the firm, Project B is less risky while
Project C and Project D are riskier than the current projects of the
company. Given the following information, which project should
you launch?

– Projects A and D have an IRR of 8.00%.

– Project B has a profitability index of 1.50 and a PV of
$3.00 million.
– Project C has a NPV of $2 million.

Corporate Finance: Lectures and Seminars, HEC Liège (ULiège) 2018-2019 – Marie Lambert 8
 Q5

project 1 = 8%, B = 12%

a) What is the IRR of Project A, Project B?
b) Assuming a 10% discount rate for both projects, in which project should you
invest? Why? In project B bcs its NPV is higher than project A
c) Assuming a 3% discount rate for both projects, in which project should you
invest? Why? You are indifferent between the two projects, as they have the same NPV
Corporate Finance: Lectures and Seminars, HEC Liège (ULiège) 2018-2019 – Marie Lambert 9
 Q6

a) Between Project A and Project B, which is the most risky? What is their
respective hurdle rate? Both projetcs have the same risk, their hurdle rate is 10%
b) Between Project A and Project B, in which project would you invest? Why?
B as it lies above the line SM
c) What is the NPV of A*? =0

Corporate Finance: Lectures and Seminars, HEC Liège (ULiège) 2018-2019 – Marie Lambert 10