Module 1- Case: PRESENT VALUE
Assignment Overview
NOTE: This assignment is in two parts, one is quantitative problem, the other a short paper. You need to turn in both Part I and Part II to receive full credit for this assignment.
Part I: This part of the assignments tests your ability to calculate present value.
A. Suppose your bank account will be worth $15,000.00 in one year. The interest rate (discount rate) that the bank pays is 7%. What is the present value of your bank account today? What would the present value of the account be if the discount rate is only 4%?
B. Suppose you have two bank accounts, one called Account A and another Account B. Account A will be worth $6,500.00 in one year. Account B will be worth $12,600.00 in two years. Both accounts earn 6% interest. What is the present value of each of these accounts?
C. Suppose you just inherited an gold mine. This gold mine is believed to have three years worth of gold deposit. Here is how much income this gold mine is projected to bring you each year for the next three years:
Year 1: $49,000,000
Year 2: $61,000,000
Year 3: $85,000,000
Compute the present value of this stream of income at a discount rate of 7%. Remember, you are calculating the present value for a whole stream of income, i.e. the total value of receiving all three payments (how much you would pay right now to receive these three payments in the future). Your answer should be one number - the present value for this gold mine at a 7% discount rate but you have to show how you got to this number.
Now compute the present value of the income stream from the gold mine at a discount rate of 5%, and at a discount rate of 3%. Compare the present values of the income stream under the three discount rates and write a short paragraph with conclusions from the computations.
Part II: Read the following three sample business plans:
Ice Dreams
R J Wagner & Associates Realty
Interstate Travel Center
Which of these three projects do you think should have the highest risk from the point of view of investors (potential providers of funds) and would therefore be evaluated using the highest discount rate? Which one do you think should have the lowest? Write a paper explaining your reasoning.
In your assessment of the business plans consider the possible risk of each plan. Risk is one of the main considerations when deciding whether a plan should be evaluated and discounted to present value using a high or a low discount rate.
Note: you are not expected to fully analyze the numbers and financial statements in these business plans. There are only forecasts and projections. Nobody really believes them anyway. Use your intuition rather than calculations to assess risk and potential of each of these plans.
Assignment Expectations
Turn in both Part I and Part II in one Word document when completed. Part I should be two pages long and contain your calculations. Part II should be two pages long.
Module 2- Case: THE CAPITAL ASSET PRICING MODEL
Assignment Overview
1. For each of the scenarios below, explain whether or not it represents a diversifiable or an undiversifiable risk. Please consider the issues from the viewpoint of investors. Explain your reasoning.
a. There's a substantial unexpected increase in inflation.
b. There's a major recession in the U.S.
c. A major lawsuit is filed against one large publicly traded corporation.
2. Use the CAPM to answer the following questions:
a. Find the Expected Rate of Return on the Market Portfolio given that the Expected Rate of Return on Asset "i" is 12%, the Risk-Free Rate is 4%, and the Beta (b) for Asset "i" is 1.2.
b. Find the Risk-Free Rate given that the Expected Rate of Return on Asset "j" is 9%, the Expected Return on the Market Portfolio is 10%, and the Beta (b) for Asset "j" is 0.8.
c. What do you think the Beta (β) of your portfolio would be if you owned half of all the stocks traded on the major exchanges? Explain.
3. In one page explain what you think is the main 'message' of the Capital Asset Pricing Model to corporations and what is the main message of the CAPM to investors?
Assignment Expectations
The Case report should be a two-page report. Please show your work for quantitative questions.
Module 3- Case: APITAL BUDGETING WITH FUNDING SOURCES
Case Assignment
This case has two separate parts.
Part I: Capital Budgeting Practice Problems
a. Consider the project with the following expected cash flows:
|
Year
|
Cash flow
|
|
0
|
-$400,000
|
|
1
|
$100,000
|
|
2
|
$120,000
|
|
3
|
$850,000
|
• If the discount rate is 0%, what is the project's net present value?
• If the discount rate is 2%, what is the project's net present value?
• If the discount rate is 6%, what is the project's net present value?
• If the discount rate is 11%, what is the project's net present value?
• With a cost of capital of 5%, what is this project's modified internal rate of return?
Now draw (for yourself) a chart where the discount rate is on the horizontal axis (the "x" axis) and the net present value on the vertical axis (the Y axis). Plot the net present value of the project as a function of the discount rate by dots for the four discount rates. Connect the four points using a free hand 'smooth' curve. The curve intersects the horizontal line at a particular discount rate. What is this discount rate at which the graph intersects the horizontal axis?
[Look at the graph you draw and write a short paragraph stating what the graph 'shows']
b. Consider a project with the expected cash flows:
|
Year
|
Cash flow
|
|
0
|
-$815,000
|
|
1
|
$141,000
|
|
2
|
$320,000
|
|
3
|
$440,000
|
• What is this project's internal rate of return?
• If the discount rate is 1%, what is this project's net present value?
• If the discount rate is 4%, what is this project's net present value?
• If the discount rate is 10%, what is this project's net present value?
• If the discount rate is 18%, what is this project's net present value?
Now draw (for yourself) a chart where the discount rate is on the horizontal axis (the "x" axis) and the net present value on the vertical axis (the Y axis). Plot the net present value of the project as a function of the discount rate by dots for the four discount rates. Connect the four points using a free hand 'smooth' curve. The curve intersects the horizontal line at a particular discount rate. What is this discount rate at which the graph intersects the horizontal axis?
[Observe the graph and write a short paragraph stating what the graph 'shows']
c. Read the background materials. Then write a one-to-two page paper answering the following question:
Which method do you think is the better one for making capital budgeting decisions - IRR or NPV?
Part 2: Equity and Debt
Read the article below available in ProQuest:
American Superconductor switch ; Westboro company plans to raise money through a stock offering, Andi Esposito. Telegram & Gazette. Worcester, Mass.: Aug 26, 2003. pg. E.1
Abstract (Article Summary)
"AMSC's management and board of directors believe the decision to forgo a secured debt financing and to adopt an equity financing strategy under current market conditions is in the best interests of our shareholders," said Gregory J. Yurek, chief executive officer of AMSC. The 265-employee company has operations in Westboro and Devens and in Wisconsin.
Finally, the Northeast blackout "shined a lot of light on the problems we have been talking about as a company for three to four years," Mr. Yurek said. AMSC products, such as a system installed this year in the aging Connecticut grid and high temperature superconductor power cables and other devices bought by China for its grid, are designed to improve the cost, efficiency and reliability of systems that generate, deliver and use electric power. "We are a company with products out there solving problems today," he said.
After reading the background materials and doing your research, apply what you learned from the background materials and write a two to three page paper answering the following questions:
What are the advantages and disadvantages for AMSC to forgo their debt financing and take on equity financing? Do you agree with their decision? How can a company's cost of equity be determined? Is there a tax deduction from the use of debt financing? Please explain.
Explain your answers thoroughly. Be sure to support your opinions on these assignment questions with references to the background materials or to other articles in your paper.
Assignment Expectations
This assignment consists of a quantitative section (Part 1) and an essay section (Part 2) below. Upload both sections as one Word document by the end of the Module.