10 Problems From Chapter 1 through 10
BHU MBA 671 Corporate Finace
Professor Mensah Dartey
April 14, 2013
Chapter 1, Problem 6 (pp. 6 ~ 8)
You are a shareholder in a C corporation. The corporation earns $2 per share before taxes. Once it has paid taxes it will distribute the rest of its earnings to you as a dividend. The corporate tax rate is 40% and the personal tax rate on (both dividend and non-dividend) income is 30%. How much is left for you after all taxes are paid?
Profit after corporate taxes=corporate earnings*(1-corporate tax rate)
Profit after personal taxes=profit after corporate ...view middle of the document...
C is best because we are able to receive all the cash flow today
Chapter 4, Problem 44 (pp.110~116)
You are thinking of making an investment in a new plant. The plant will generate revenues of $1 million per year for as long as you maintain it. You expect that the maintenance cost will start at $50,000 per year and will increase 5% per year thereafter. Assume that all revenue and maintenance costs occur at the end of the year. You intend to run the plant as long as it continues to make s positive cash flow (as long as the cash generated by the plant exceeds the maintenance costs). The plant can be built and become operational immediately. If the plant costs $10 million to build, and the interest rate is 6% per year, should you invest in the plant?
0 | 1 | 2 | N |
-10,000,000 | 1,000,000 | 1,000,000 | 1,000,000 |
| -50,000 | -50,000(1.05) | -50,000(1.05)ⁿ¯¹ |
The plant will not be continued when
a. 62 years annuity of 1,000,000 with interest rate of 6%
PV of annuity=c*(1-1/(1+r)ⁿ)/r (n=62)
b. 62 years growing annuity of 50,000 increasing at 5% per year with interest rate of 6%
**g – growing rate
PV of growing annuity=c*1/(r-g)*(1-(1+g/1+r)ⁿ)
Total PV of annuity=16,217,006-2,221,932=13,995,074
Since NPV is positive, the opportunity will be taken.
Chapter 5, Problem 22 (pp.133~139)
You need a new car and the dealer has offered you a price of $20,000, with the following payment options: a) pay cash and receive $2,000 rebate, or b) pay a $5,000 down payment and finance the rest with a 0% APR loan over 30 months. But having just quit your job and started an MBA program, you are in debt and you expect to be in debt for at least the next 2½ years. You plan to use credit cards to pay your expenses; luckily you have one with a low (fixed) rate of 15% APR (monthly). Which option is best for you?
PV=monthly payment * 1/r * (1-1/(1-r)ⁿ),
r=15/12=1.25%, monthly payment=15,000/30=500, n=30
PV=500 * 1/0.125 * (1-1/(1+0.0125)ⁿ)
=500 * 1/0.0125 * (1-1/1.45)
=500 * 1/0.0125 * 0.45/1.45=500*24.82=12,413
It is better taken loan from dealer.
Chapter 6, Problem 29 (pp171~174)
Natasha’s Flowers, a local florist, purchases fresh flowers each day at the local flower market. The buyer has a budget of $1000 per day spend. Different flowers have different profit margins, and also a maximum amount the shop can sell. Based on past experience, the shop has estimated the following NPV of purchasing each type:
| NPV per bunch | Cost per bunch | Maximum bunches | Profitability Index per...