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Intermediate Corporate Finance 3023-001 Homework 1) You are hired as a manager for AT&T.

You are asked to make a presentation as to whether they should undertake the following project. For the purpose of this question, assume AT&T is all equity financed. a) First, you calculate that AT&T has a covariance with the market of .02, and that the standard deviation of the markets returns is .3. What is AT&Ts Beta? b) Treasury bills are currently yielding 1%. If you believe the market has a risk premium of 7%, what is the expected return to AT&T? c) AT&T is looking into constructing a new wireless network around San Antonio. The risk inherent in this project is similar to the overall risk of AT&T. Once built, you believe this project will provide cash flows of $10 million/year for the next 20 years. What is the most AT&T should be willing to pay to build this network?

2) Your company has a Beta of 1.75. a) If risk-free rates are 1% and the market has an expected return of 8%, what is your companys expected return? b) Assuming they are all equity financed, should they undertake a project with a 12% IRR? Why or why not?

3) Your company is financed with equity, debt, and convertible debt. Financing Source Stock Debt Convertible Debt Amount (millions) 150 50 50 Beta 1.2 0.1 0.6

What is the Beta of the companys assets (hint: this equals the beta of the companys liabilities)?

4) As manager of ACME industries, your company is 30% debt financed, 70% equity financed. Assuming the debt is risk-free, and assuming that your equity beta is 1.1, that treasury bills yield 1%, and that the market has an expected return of 8%, what is your weighted average cost of capital assuming a 35% tax rate? Should you invest in a new project with a 10% IRR?

5) Your midrange guess as to the amount of oil in a prospective field is 10 million barrels, but in fact there is a 50 percent chance that the amount of oil is 15 million barrels and a 50 percent chance of 5 million barrels. If the actual amount of oil is 15 million barrels, the present value of the cash flows from drilling will be $9 million. If the amount is only 5 million, the present value will be only $2 million. It costs $3 million to drill the well. Suppose that a seismic test that costs $200,000 can verify the amount of oil under the ground. Is it worth paying for the test? Use a decision tree to examine whether to drill and whether to test.

6) Dime a Dozen makes synthetic diamonds by treating carbon. Each diamond can be sold for $120. The materials cost for a standard diamond is $40. The fixed costs incurred each year for factory upkeep and administrative expenses are $200,000. The machinery costs $2 million and is depreciated straight-line over 10 years to a salvage value of zero. a) What is the accounting break-even level of sales in terms of number of diamonds sold? [That is, how many diamonds do you need to sell to have zero profit?] b) What is the economic break-even level of sales/year assuming a tax rate of 35%, a 10-year project life, and a discount rate of 12%?

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