Financial Management: Theory & Practice
15th Edition
ISBN: 9781337248006
Author: Eugene F. Brigham; Michael C. Ehrhardt
Publisher: Cengage Learning US
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Chapter 21, Problem 5MC
Summary Introduction
Case summary:
Company L is an unlevered company and it uses only equity funds as the source of finance except for using short term debt to meet working capital requirements. Owner of the company L seeks advice on financial effect of using long term debt.
To calculate:
Horizon value of unlevered operations, current value of unlevered operations, horizon value of tax shield, current value of tax shield, and current total value.
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A certain investment will require an immediate cash outflow of $4m. At the end of each ofthe next 4 years, the investment will generate cash inflows of $1.25m.
a) Assuming that these cash flows are in nominal terms and that the nominal discount rate is 10.25%, calculate the projects NPV.
b) Now assume that the expectedd rate of inflation is 5% per year. Recalculate the projects cash flow in real terms, discount htem at the real interest rate, and verify that you obtain the same NPV.
Hint: find the reall cash flows by adjusting the values of cash flows by the 5% inflation rate. Then using the equation of real rate and nominal rate, determine the real rate of return.
An investment requires $16,000 today, and produces the first cash flow of $800 in two years (year 2). Cash flow is expected to grow at 2% per year after year 2.
a) What is the NPV of this investment if the discount rate is 6% ?
b) What is the rate of return of this investment?
Suppose an investment costing $15,600 generates semi-annual cash flows growing at 2% indefinitely. If the interest rate is 8%, Find the initial cash flow. Assume the first cash flow is received immediately.
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Financial Management: Theory & Practice
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