Corporate Finance

HW#1 (Due November 13, 2022)

1. You are saving for a down payment on a house. You have $10,050 saved already ,and you can
afford to save an additional $5,000 per year at the end of each year. If you earn 7.25% per year
on your savings, how long will it take you to save $60,000?

2. Carla would like to start a business. She believes that her business will require an initial
investment of $1.5 million. after that, it will generate a cash flow of $150,000 at the end of one
year, and this amount will grow by 4% per year thereafter. What is the NPV of this investment
opportunity if the discount rate is 3.5%?

3. You would like to buy a car. The car costs $35 thousand. Your monthly budget for car payment is
$200 and you would like to borrow for 5 years. Could you buy the car if interest rate on car loans
are 4.5%? Do you need to pay a down payment to buy the car?

4. You are saving for retirement. Instead of splurging on 2 cappuccinos a day each of which costs 2
euros, you would drink water and save it for the future. You would open a brokerage account
and save each week. If yearly return on stock market index is 7% per year, and you save in that
index, how much money would you have in 10 years?

5. Assume problem #4 savings above. Add a lumpsum gift of 5000 euros that your grandma plan to
give you 5 years from now. How much will you have in 10 years, 20 years and 30 years assuming
the same returns?

6. Assume problem #5 savings above. Now you open an annuity account with the savings after 30
years and withdraw 12,000 euros each year. At what age will you run out of your savings,
assuming your opportunity cost is 7%?

7. Assume problem #4 savings above. Now you open a perpetuity account with the savings. Your
opportunity cost is 5% per year. How much you could withdraw each year from that account?

8. Assume problem #4 savings above. Now you open a perpetuity account with the savings, and
this perpetuity is tied to the stock market, and it grows at the rate of 7%. Your opportunity cost
is 10% per year. How much you could withdraw each year from that account?

9. What is the Yield curve of a government security?

10. Find the prices of a zero-coupon bond that pays 1000 $ in 5 years, if the YTM are 5%, 10%, 12%?
What did you learn?

11. Find the price of a coupon paying bond that has a coupon rate of 5% and pays 1000$ in 10 years,
and YTM is 6%. If YTM goes up by 5%, what price would you pay for this bond? If YTM goes
down by 3%, how much would you pay?

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 12. Consider the bond in #11 question. Also consider another bond that has a coupon rate of 7%
and pays 1000$ in 10 years, and YTM is 6%.

What is the % change in price of each bond if YTM increases by 3%. What did you learn?

13. Search for the Italian govt bond yield curve on the internet. Using this yield curve, compare the
yield to maturity for a three-year, zero-coupon bond; a three-year coupon bond with 4% annual
coupons; and a three-year coupon bond with 10% annual coupons. All of these bonds are
default free.

14. You are pricing an Italian corporate zero-coupon bond that pays 1000 euros in one year. There is
a 40% chance that the corporation will pay only 40% of its obligation. Because of this
uncertainty, the discount rate is 7%. What is the YTM of this bond? (Hint: use the yield curve in
question #13)

15. You are choosing one of the following projects. Which one would you pick without knowing
anything about the discount rate of the projects? Show at least 2 methods.

Projects and their

A - - 300000 900
10000

B - 22,222 50,000 - 28,000

C 9000 60000 1,056

D -4300 10,000 - 6,000

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 16. You know the following cashflows from two projects. Find the crossover point. Now pick one of
those based on the discount rate of 10% -- pick the project based on the crossover point only.

Proposal 0 1 2 3

A - 10000 5000 5000 5000

B - 15000 5000 9400 7000

17. An insurance product is offered to you. The product is structured as follows. You receive
$10,000 upfront. Then, you would receive $20, 000, each year for the next 5 years. You estimate
your opportunity cost to be 10%. How much would you be willing to pay for this product.
18. Plot the NPV profiles for each project. And select (or don’t select) the one you think is a good
one.

Projects and their

A - 600 - 300 700

B - 20,000 30,000 - 20,000

C 300 500 - 2,056

D - 4,000 11,000 - 4,000

19. Would you use IRR all the time in project valuation? Discuss.
20. Why bond prices change all the time if the coupon rate on bonds never changes?
21. Do you think the NPV rule is always valid?

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 22. Which one of these projects is the riskiest?

Projects and their

A - 1000 -4500 20000

B - 10,000 10,000 5,000

C 20,0000 500 - 20,056

D - 2,000 11,000 - 1,000

23. If project A in problem #22 above has a discount rate of 5%, what would be your estimates on
the discount rate for Projects B and C?
24. Based on your estimate in problem #23, what are the NPVs of each. Now select the project
based on NPV.
25. Consider problem #22 cash flows. Based on IRR, what project would you pick? Compare the
results of this problem with those of problem #24.