Advanced Corporate Finance

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Advanced Corporate Finance I SS 2012

Problem Set 1 Valuing Cash Flows

Problem Set 1
Valuing Cash Flows
Exercise 1 (Ex. 11.2 - 11.6 GT): Assume that Marriott’s restaurant division has the following joint distribution with the market return: Market Scenario Bad Good Great .25 .50 .25 Probability Market Return (%) -15 5 25 YR 1. Cash Flow Forecast $40 million $50 million $60 million

Assume also that the CAPM holds. 11.2 Compute the expected year 1 restaurant cash flow for Marriott. 11.3 Find the covariance of the cash flow with the market return and its cash flow beta. 11.4 Assuming that historical data suggests that the market risk premium is 8.4 percent per year and the market standard deviation is 40 percent per year, find the certainty equivalent of the year 1 cash flow. What are the advantages and disadvantages of using such historical data for market inputs as opposed to inputs from a set of scenarios, like those given in the table above exercise 11.2? 11.5 Discount your answer in exercise 11.4 at a risk-free rate of 4 percent per year to obtain the present value. 11.6 Explain why the answer to exercise 11.5 differs from the answer in Example 11.2.

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Advanced Corporate Finance I SS 2012

Problem Set 1 Valuing Cash Flows

Exercise 2 (Ex. 13.1 - 13.7 GT):) Exercises 13.1 - 13.7 make use of the following data: In 1985, General Motors (GM) was evaluating the acquisition of Hughes Aircraft Corporation. Recognizing that the appropriate WACC for discounting the projected cash flows for Hughes was different from General Motors’ WACC, GM assumed that Hughes was of approximately the same risk as Lockheed or Northrop, which had low-risk defense contracts and products that were similar to those of Hughes. Specifically, assume the Hamada model of debt interest tax shields and the inputs in the table at right. Comparision firm GM Lockheed Northrop βE 1.20 0.90 0.85 D/E 0.40 0.90 0.70

Target D/E for acquisition of Hughes = 1 Hughes’s expected unlevered cash...
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