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UIUC FIN 321 - Assignment 2

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UNIVERSITY OF ILLINOIS AT URBANA-CHAMPAIGNCollege of BusinessD E P A R T M E N T O F F I N A N C EFinance 321 – Advanced Corporate Finance – Spring 2007Assignment 2 (20 points)Lectures 6-11Due March 1, 2007Problem sets are due at the beginning of class on the due date. Late assignments, which will automatically incur a 50% grade penalty, will be accepted only if the assignments have not been discussed in class or already graded. Students are allowed to collaborate with each other on any problem set, but the use of any unauthorized resource, including instructor and solution manuals, is prohibited. You are free to use any material included in the class textbook, including Appendix B – Answers to Quizzes. (2 points)1. Calculate the NPV based on a cost of capital of 12.5% for a project that costs $2,500,000 today (time 0) and has the following cash flows:Year Cash Flow1 1000002 3000003 5000004 5500005 6000006 6500007 7000008 7500009 50000010 250000.(2 points)2. Calculate the IRR for a project that costs $3,000,000 today (time 0) and has the following cash flows:Year Cash Flow1 5000002 6000003 7000004 8000005 7000006 6000007 5000008 4000009 30000010 200000(1 point)3. List one situation where IRR is clearly better than NPV for capital budgeting.(1 point)4. List one situation where NPV is clearly better than IRR for capital budgeting. (2 points)5. The correlation coefficient between a stock and the market portfolio is 0.8. The standard deviation of the stock is 35% and that of the market is 20%. Calculate the beta of the stock.(2 points)6. A project has an expected risky cash flow of $200 in year 1. The risk-free rate is 6%, the market rate of return is 16%, and the project's beta is 1.5. Calculate the certainty equivalent cash flow for year 1. (2 points)7. What type of risk is each of the following firms addressing?A. An airline hedges fuel costs with forward contracts.B. A firm hires an outside audit firm to conduct a review of its purchasing processes. (2 points)8. List two advantages for using debt as opposed to equity for financing a project.(6 points)9. Magna Charter (originally described on page 262 of the text) has refigured its numbers as follows:1. The turboprop will cost $500,000 to buy.2. The piston aircraft will cost $200,000 to buy at time 0.3. If the company decides to expand with a second piston plane, that will cost another $200,000.4. The risk free interest rate to use for discounting the certainty-equivalent cash flows is 5%.5. The probability of high demand in the first year is 50%. 6. If the demand is high in the first year, the probability of high demand in the secondyear is 75%.7. If the demand is low in the first year, the probability of high demand in the second year is 50%.8. All of the payoffs listed on Figure 10.7 remain the same.Draw the new decision tree for Magna Charter and fill in the payoffs and probabilities.A. What is the NPV of buying the turboprop at time 0?B. What is the NPV of buying the piston aircraft at time 0?C. What is the value, at time 0, of the option to expand?Fin 321 - Assignment 2 Answer Sheet Name_________________________(This sheet is for your answers only. Attach it to the front of your worksheets, graphs and any more detailed explanations that cannot fit here.)1. 2.3.4.5.6.7. A. B.8. 9. A. B.


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UIUC FIN 321 - Assignment 2

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