EBK CORPORATE FINANCE
4th Edition
ISBN: 9780134202778
Author: DeMarzo
Publisher: PEARSON CUSTOM PUB.(CONSIGNMENT)
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Textbook Question
Chapter 5, Problem 38P
Suppose you have outstanding debt with an 8% interest rate that can be repaid any time, and the interest rate on U.S. Treasuries is only 5%. You plan to repay your debt using any cash that you don’t invest elsewhere. Until your debt is repaid, what cost of capital should you use when evaluating a new risk-free investment opportunity? Why?
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A firm is considering two investment projects, Y and Z. These projects are NOT mutually
exclusive. Assume the firm is not capital constrained. The initial costs and cashflows for these
projects are:
0
1
2
3
Y
-40,000
17,000
17,000
15,000
Z
-28,000
12,000
12,000
20,000
Using a discount rate of 9% calculate the net present value for each project. What decision
would you make based on your calculations?
How would your decision change if the discount rate used for calculating the net present
value is 15%?
Calculate an approximate IRR for each project. Assume the hurdle rate is 9%. What decision
would you make based on your calculations?
Calculate the payback period for each project. The company looks to select investment projects
paying back in 2 years. What decision would you make based on your calculations?
Critically discuss Net Present Value (NPV), Internal Rate of Return (IRR) and payback
period as criteria for investment appraisal.
You are going to allocate capital into safe and risky assets. The risky asset will earn 200% return
if the economy is good (with a 55% chance). If, otherwise, it will lose 60% of the investment principal.
States of
Rate of
Prob.
nature
Return
According to the Kelly's criterion, how much do you have to allocate for the risky asset to maximize
final wealth? (The safe asset earns zero return.) → (1) 35%; (2) 47%; (3) 59%; (4) 65%;
1
Good
55%
200%
your
|(5) 69%; (6) 75%; (7) 85%; (8) 97%; (9) 102%; (10) 114%; (11) 115%;
Bad
45%
-60%
Consider an investment that pays off $800 or $1,500 per $1,000 invested with equal probability. Suppose you have $1,000 but are willing to borrow to increase your expected return. What would happen to the expected value and standard deviation of the investment if you borrowed an additional $1,000 and invested a total of $2,000? What if you borrowed $2,000 to invest a total of $3,000?
Chapter 5 Solutions
EBK CORPORATE FINANCE
Ch. 5.1 - Prob. 1CCCh. 5.1 - Prob. 2CCCh. 5.2 - How can you compute the outstanding balance on a...Ch. 5.2 - What is an amortizing loan?Ch. 5.3 - What is the difference between a nominal and real...Ch. 5.3 - How do investors expectations of future short-term...Ch. 5.4 - Prob. 1CCCh. 5.4 - How do taxes affect the interest earned on an...Ch. 5.5 - What is the opportunity cost of capital?Ch. 5.5 - Why do different interest rates exist, even in a...
Ch. 5 - Your bank is offering you an account that will pay...Ch. 5 - Which do you prefer: a bank account that pays 5%...Ch. 5 - Prob. 3PCh. 5 - Prob. 4PCh. 5 - You are considering moving your money to a new...Ch. 5 - Prob. 6PCh. 5 - Prob. 7PCh. 5 - You can earn 50 in interest on a 1000 deposit for...Ch. 5 - Prob. 9PCh. 5 - Prob. 10PCh. 5 - Prob. 11PCh. 5 - Prob. 12PCh. 5 - Prob. 13PCh. 5 - Prob. 14PCh. 5 - You have just sold your house for 1,000,000 in...Ch. 5 - Prob. 16PCh. 5 - Your mortgage has 25 years left, and has an APR of...Ch. 5 - Prob. 18PCh. 5 - Prob. 19PCh. 5 - Prob. 20PCh. 5 - Prob. 21PCh. 5 - Prob. 22PCh. 5 - The mortgage on your house is five years old. It...Ch. 5 - You have credit card debt of 25,000 that has an...Ch. 5 - Prob. 25PCh. 5 - Prob. 26PCh. 5 - Prob. 27PCh. 5 - Prob. 28PCh. 5 - Suppose the term structure of risk-free interest...Ch. 5 - Prob. 30PCh. 5 - Prob. 31PCh. 5 - Suppose the current one-year interest rate is 6%....Ch. 5 - Figure 5.4 shows that Johnson and Johnsons...Ch. 5 - Prob. 34PCh. 5 - Prob. 35PCh. 5 - Prob. 36PCh. 5 - Your best friend consults you for investment...Ch. 5 - Suppose you have outstanding debt with an 8%...Ch. 5 - In the summer of 2008, at Heathrow Airport in...Ch. 5 - Your firm is considering the purchase of a new...Ch. 5 - Prob. 41P
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