FINANCIAL MANAGEMENT I FALL 2015

SEMINAR 2
1.

You are considering investing in a start-up company. The founder asked you for $200,000 today and you
expect to get $1,000,000 in nine years. Given the riskiness of the investment opportunity, your cost of capital is
20%. What is the NPV of the investment opportunity? Should you undertake the investment opportunity?
Calculate the IRR and use it to determine the maximum deviation allowable in the cost of capital estimate to
leave the decision unchanged.

2.

Bill Clinton reportedly was paid $10 million to write his book My Way. The book took three years to write. In
the time he spent writing, Clinton could have been paid to make speeches. Given his popularity, assume that he
could earn $8 million per year (paid at the end of the year) speaking instead of writing. Assume his cost of
capital is 10% per year.
a.

WhatiseNPVgornfwbk(yaltpnms)?e

b.

uAmsetha,oncbkifdxpgeoratyls$5minhfd(petoyar)slixpcdtearof30%ynpiu.tWhseNPVfbokwyralnpmt?

3.

How many IRRs are there in part (a) of Problem 2? Does the IRR rule give the right answer in this case? How
many IRRs are there in part (b) of Problem 2? Does the IRR rule give the right answer in this case?

4.

Think of a project which has the following cash-flows:

C0
C1
C2
-100
225
-126
The sum of cash flows is negative. Is this enough to reject the project? Is there any value of the discount rate
which makes the project interesting? Plot the NPV profile of the project and find the IRR(s).

5.

A company is considering launching a new product. The investment project has the following characteristics:
Additional investments in the production line are estimated to be 1mln. These investments are to be linearly
depreciated during the next 12 years.
The company expects to close the project at the end of the 8th year and sell the equipment and the plant. The
estimated cash flow from this sale is 400.000.
In addition to CAPEX, the company will also have to invest in the working capital. The initial (time 0)
investment in the working capital is 300.000, and its expected to stay at 15% of sales each year (on top of the
the time 0 investments).
The first year sales are expected to be 5mln., with the sales growth rate decreasing linearly from 7% in the
second year to 1% in the 8th. Production costs are 85% of sales.
The new product is likely to compete with the existing main product of the company. As a result, the new
product is expected to reduce companys EBIT from the existing one by 80.000 a year. In the absence of the
project, these profits would have grown by 3% per year.
Companys profits are taxed at 35%. Assume that the cost of capital is 12.5%.
Calculate the NPV and IRR of the project.