Assignment 1: Bus 312
You must provide complete answers that describe and demonstrate how you arrived at your solution. Numeric solutions alone are unacceptable. In addition, copying and pasting suggested solutions is not sufficient effort to earn a mark for this or any other assignment. Hand in a “hard copy” of your assignment to the marker box. No e-mail submissions. No late assignments, no exceptions.
1. (From Final Exam Summer 2009) ABC Company Ltd., is considering a possible business investment that requires a $350,000 expenditure today. Immediately after the $350,000 expenditure, the new venture’s market to book ratio (value to expenditure) is 1.6. Required: What is the new venture’s Net Present Value (NPV)? [pic]
2. (Former Midterm Exam Question) ABC Company is planning a real asset investment. ABC is a start-up firm, and therefore, it has no previous investments. Also, ABC has no other investments planned or contemplated other than the one described in this problem. For an investment of $I today, the expected cash flow to ABC in one year is $140,000. This cash flow is the profit on the investment, plus salvage, net of taxes and commissions, etc. The internal rate of return on the project is 40%. Currently, ABC has no debt in its financial structure and its book equity is zero. Book equity is the sum of share-capital and retained earnings. In order to undertake its investment, ABC needs to do some financing. They plan to sell ABC sells new shares to new shareholders in the amount of $I to finance their business investment. Immediately after the share issue and the required capital expenditure of $I, ABC’s market to book ratio for equity is 1.20 (there remains, nonetheless, one year before the expected cash flow benefit of $140,000 is received). Required: What is the financial market opportunity cost (expressed as a rate of return) facing the shareholders of ABC? (In other words, what is the discount rate?) [pic]
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