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Description

Individual Assignment
Instructions
Due Date: 11:00 pm on
Tuesday, April 13th
(via Blackboard)
Each student should submit his or her own answers on Blackboard, and these answers should be
derived individually without consulting other students. Since this assignment is done on an
individual basis rather than in groups, it is particularly important that you have an opportunity to
clarify the interpretation of each question and make sure that the setup of the problem is perfectly
clear.
You only need to submit an Excel file with ALL your calculations. The Excel file should be wellorganized and presentable. If you choose to work with a calculator, you can submit a .pdf or Word
file showing ALL your calculations.
THE TITLE OF THE FILE SHOULD INCLUDE YOUR FULL NAME.
For example: GiannisAntetokounmpo.xlsx
There will be a 20 points penalty if the title of the file does not include your name.
If you need help with interpreting the information in any problem, please feel free to contact me via
email. If you need help with reviewing a general concept or a topic area to prepare for this
assignment, please do not hesitate to schedule an appointment with me or with the TA. Good luck!
Problem 1
You are evaluating a project to produce a movie and are wondering how much you can afford to
pay the actors.
Actors’ Compensation
The shooting of the movie will commence in month 5 and will take 12 months to complete. Actors
are paid on a monthly basis, and their salary grows by 1% each month.
The first salary payment to actors will occur at the end of month 5 and the remaining 11 payments
will occur at the end of each of the next eleven months.
The Movie
After the movie is released, it will be shown in theaters for 5 months, producing cash inflows at the
end of each month. The first cash inflow, to be received at the end of month 18, is estimated to be
$25 million. For the remaining four months, the inflow will decrease at a monthly rate of 10%, as
the viewership gradually declines and the picture moves to budget theaters.
The Decision
You are now negotiating with several famous actors and wonder about the following question: what
is the maximum amount of the first monthly payment to the actors so that the movie creates at least
$20 million in present value terms? Assume that the actors’ salary is the only expense in the movie
production, that there are no taxes in this particular example, and that the annual discount rate is
24% APR with monthly compounding. This discount rate reflects the high risk and uncertainty
associated with producing a movie.
Problem 2
Payday lenders are firms that make short-term (often one- to two-week) loans to consumers. The
intent is to provide households with some extra cash in advance of the next paycheck. An
example of such a lender is Check`n Go (https://www.checkngo.com). The loan terms of these
loans are attached in the last page of this problem set.
According to the loan terms of Check‘n Go, if you obtain a two-week loan of $500, in two weeks
(i.e., 14 days), you have to repay $555 (not $555.50 as stated in the loan terms).
(a) What is your two-week interest charge expressed as a percentage of the loan received? (i.e., your
periodic interest rate over the 14-day period)?
(b) If the interest is compounded every 14 days, how many compounding periods do you have in
one year (assuming 365 days in a year)?1 Using this number of compounding periods and the
periodic rate for the 14-day loan you found in (a), show how Check‘n Go arrived at the APR that
the firm reported for the $500 loan.
(c) Using the number of compounding periods and the APR that you found in (b), find the Effective
Annual Rate (EAR) on this borrower-friendly loan. As in (b), interest is compounded every 14 days
and there are 365 days in a year. Why is this rate higher/lower than APR?
(d) Suppose Check’n Go charges the same APR as it does right now for a $500 loan, but changes its
compounding frequency to daily. Assuming daily compounding (365 days in a year) and the APR
stated in (b), what would be the EAR on this loan?
Problem 3
You are asked to evaluate the following statements about capital budget criteria. Please state
whether each statement below is true or false and briefly explain your answer. A statement is
considered true when it is unambiguously correct; otherwise, the statement is false. For all
statements, assume that the company is profitable, that the tax rate is greater than zero, and that the
discount rate is greater than zero. You can also assume that all the discount rates and cash flows
have been accurately estimated for each project. A typical investment project is a project that
requires a cash outflow at time zero and provides positive cash inflows for the rest of its life. If it is
indicated that a company is not capital-constrained (part e), it means that the firm has enough
money to implement any combination of its projects (all of them, some, or none at all).
a) For all investment projects, increasing the discount rate will reduce the NPV.
b) For typical investment projects, increasing the discount rate will shorten the discounted payback
period.
1
Please do not round the number of periods to an integer; retain two digits after the decimal point.
c) If a company has to select one project from three mutually exclusive typical investment projects
that are all profitable, it will create the most value for the shareholders by choosing the project with
the highest profitability index.
d) One advantage of the IRR is that it can be used to rank typical investment projects according to
their investment attractiveness without knowing their discount rates.
e) If a company is not capital-constrained and has several typical independent projects with known
discount rates and known IRRs but with a different scale (different size of the initial investment),
the IRR criterion will yield the same accept/reject decision for each project as the NPV.
f) Since depreciation is a non-cash expense, the choice of depreciation method (straight-line vs.
MACRS) for both accounting and tax purposes does not affect the value of the profitability index
for a typical investment project.
Problem 4
As an owner of a chocolate factory, you are considering an investment in the production of a new
candy bar called Coconut Freedom. The introduction of the candy bar requires an immediate
investment in 400 new machines costing $10,000 each. Installing the machines costs an additional
$2,000 per machine. The machines will be depreciated over the four years of project’s life based on
the following MACRS schedule: year 1: 33.33%; year 2: 44.45%; year 3: 14.81%; year 4: 7.41%.
The life of the project is estimated to be 4 years, after which each machine will be sold for $1,000 at
the end of year 4.
The project also requires an immediate investment in net working capital in the amount of
$500,000, which will be fully recovered at the end of year 4. To evaluate the appeal of Coconut
Freedom to consumers, you have already completed a pilot tasting experiment, which cost you
$100,000.
You expect to sell 2,000,000 chocolate bars each year during the project’s life at the price of $2.50
per bar. Production costs are estimated to be $0.50 per candy bar.
In addition to these variable costs, you expect to incur $1,000,000 per year in advertising
expenditures to support the sales of Coconut Freedom.
Finally, the results of your study indicate that the introduction of Coconut Freedom will cannibalize
the sales of other chocolate bars currently produced by your firm and erode their combined after-tax
cash flow by $200,000 per year. All cash flows occur at year-end.
If the discount rate is 15%, and the tax rate is 20%, please compute the NPV, the IRR, and the
regular payback period (in years and months) for this project. Should the company go ahead with
this investment?
Problem 5
You would like to buy a new home theater system, which costs $1,700 now. As a result of your
savings, you now have a sum equivalent to 60% of the system’s current price. Since this money is
not enough, you are planning to invest it so as to buy the home theater in the future. Moreover,
during the next 12 months, you are planning to save an additional $50 per month toward this
purchase (savings occur at the end of the month).2 You will earn an APR of 9% (compounded
monthly) on all your savings. During the next 12 months, the price of the home theater will also
increase at the rate of x% per month.
If your total savings will be exactly equal to the price of the theater in 12 months, what is the rate of
the monthly increase in the price of the home theater, x?
Problem 6
You are evaluating a project to build an oil pipeline in one of the emerging markets. Building the
pipeline will take 8 annual investments, each of which is paid at the beginning of the year, starting
immediately. The first of these investments is $20 million and the amount of the remaining 7
investments is expected to decrease by 3% per year. The pipeline will commence its operations in
year 9 and will transport 3,500,000 barrels of oil per year in perpetuity. As the pipeline owner, you
will collect an annual cash flow equal to 10% of the total value of transported oil, with cash flows
occurring at the end of each year.
If the discount rate is 12%, what is the minimum price of oil per barrel under which the
Profitability Index is 1.05? For simplicity, assume that oil prices are constant over time and that
the costs of running the pipeline are negligible.
2
In other words, at the end of each month we add $50 to our investment account, where we placed our initial
savings.
FLORIDA RETAIL PAYDAY LOANS
FINANCE CHARGE SCHEDULE
The Annual Percentage Rate (“APR”) calculation is based on a transaction with a 14-day term. Your APR may be different if your
transaction term is not 14 days. The APR of your transaction will be disclosed in the federal Truth-In-Lending Statement contained in your
contract.
ANNUAL
PERCENTAGE
RATE
The cost of your credit as a
yearly rate
(Assumes a 14-day term)
521.43%
434.52%
391.07%
365.00%
347.62%
335.20%
325.89%
318.65%
312.86%
308.12%
304.17%
300.82%
297.96%
295.48%
293.30%
291.39%
289.68%
288.16%
286.79%
FINANCE
CHARGE
The dollar amount the credit
will cost you
$10.00
$12.50
$15.00
$17.50
$20.00
$22.50
$25.00
$27.50
$30.00
$32.50
$35.00
$37.50
$40.00
$42.50
$45.00
$47.50
$50.00
$52.50
$55.00
State Law Disclosures (FL)(Retail), Version Date January 22, 2018
AMOUNT
FINANCED
TOTAL OF
PAYMENTS
The amount we pay to you
or on your behalf
The amount you will have
paid after you have made all
payments as scheduled
$50.00
$75.00
$100.00
$125.00
$150.00
$175.00
$200.00
$225.00
$250.00
$275.00
$300.00
$325.00
$350.00
$375.00
$400.00
$425.00
$450.00
$475.00
$500.00
$60.00
$87.50
$115.00
$142.50
$170.00
$197.50
$225.00
$252.50
$280.00
$307.50
$335.00
$362.50
$390.00
$417.50
$445.00
$472.50
$500.00
$527.50
$555.50
NUMBER OF
PAYMENTS
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1

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