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Class1 Solutions

This document contains the answer key for questions from a classwork on net present value calculations. It includes examples of calculating NPV for investment projects and determining if a project should be undertaken. It also covers examples of expected value, risk, and using capitalization rates and discount rates to determine the present value of stocks based on future dividends. The key shows the steps and calculations for determining NPV, internal rate of return, expected returns, and stock valuations based on discounted future cash flows.

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Yassin Bouhassoun
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16 views

Class1 Solutions

This document contains the answer key for questions from a classwork on net present value calculations. It includes examples of calculating NPV for investment projects and determining if a project should be undertaken. It also covers examples of expected value, risk, and using capitalization rates and discount rates to determine the present value of stocks based on future dividends. The key shows the steps and calculations for determining NPV, internal rate of return, expected returns, and stock valuations based on discounted future cash flows.

Uploaded by

Yassin Bouhassoun
Copyright
© © All Rights Reserved
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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LSE Summer School

AF250 – Finance

Classwork 1: Net Present Value


Answer key

Question 1
NPV = $1,300,000 + ($1,500,000/1.10) = +$63,636
Since the NPV is positive, you would construct the motel.
Alternatively, we can compute r as follows:
r = ($1,500,000/$1,300,000) – 1 = 0.1539 = 15.39%
Since the rate of return is greater than the cost of capital, you would construct the motel.

Question 2
Investment NPV Return

(1) 18,000 18,000−10,000 5.5−5


−10,000+ =$5,000 =0 . 80=80 . 0% 5
1. 20 10,000

(2)
−5,000+
9,000
=$2,500
9,000−5,000
=0 . 80=80 .0%
1 .20 5,000

(3) 5,700 5,700−5,000


−5,000+ =−$250 =0 . 14=14 .0%
1. 20 5,000

(4) 4,000 4,000 −2,000


−2,000+ =$1,333 . 33 =1. 00=100. 0%
1 .20 2,000

(a) Investment 1, because it has the highest NPV.


(b) Investment 1, because it maximizes shareholders’ wealth.

Question 3
(a) Expected cash flow = (€8 million + €12 million + €16 million)/3 = €12 million

(b) Expected rate of return = (€12 million/€8 million) – 1 = 0.50 = 50%

Expected cash flow = (€8 + €12 + €16)/3 = €12


Expected rate of return = (€12/€10) – 1 = 0.20 = 20%
The net cash flow from selling the tanker load is the same as the payoff from one million shares of
Stock Z in each state of the world economy. Therefore, the risk of these two cash flows is the same.

(d) NPV = €8,000,000 + (€12,000,000/1.20) = +€2,000,000


The project is a good investment because the NPV is positive. Investors would be prepared to pay
as much as €10,000,000 for the project.

Question 4

a. PV = $100,000

b. PV = $180,000/1.125 = $102,137

c. PV = $11,400/0.12 = $95,000

Question 5

At a capitalization rate of 10 percent, Stock C is the most valuable.

Question 6
Using the concept that the price of a share of common stock is equal to the present value of the
future dividends, we have:

Using trial and error, we find that r is approximately 11.12 percent.

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