Advanced Corporate Finance Essay
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 …show more content…
The equipment to produce the new product costs $500,000. The $500,000 would be borrowed at a risk-free interest rate of 14 percent. However, the machine adds only $300,000 to the ﬁrm’s debt capacity in years 1, 2, and 3, and only $200,000 in years 4 and 5. Although net income includes the depreciation deduction, it does not include the interest deduction (that is, it assumes that the equipment is ﬁnanced with equity). The equipment can be depreciated on a straight-line basis over a ﬁve-year life at $100,000 per year. The equipment is expected to be sold for $100,000 in ﬁve years. Net working capital (NWC) required to support the new product is estimated to be equal to 10 percent of net sales of the new product. The NWC will be needed at the start of the year. This means that if sales were $1 in year 1, the NWC needed to support this one dollar of sales would be committed at the beginning of year 1. The company’s discount rate for the unlevered cash ﬂows associated with this new product is 18 percent and the tax rate is 40 percent. What is the net present value of this project?