FIN 305-An heiress has a rich grandfather who set up a trust

FIN 305-An heiress has a rich grandfather who set up a trust

Subject: Business    / Finance

10-2.An heiress has a rich grandfather who set up a trust that will pay her $5 million per year for 20 years beginning on her 25th birthday. Assume her 25th birthday is 4 years from now. Further assume that you are a wealthy investor and this heiress is anxious to get her hands on some serious cash. You are offered the opportunity to purchase the rights to receive the promised cash flows from the trust.

a.If you were to pay $80 million today for the right to receive these cash flows promised to the heiress, what is the net present value (NPV) of this investment, assuming a 10% discount rate is appropriate?

b.What is the internal rate of return (IRR) of this $80 million investment?

10-3.Three separate projects each have an initial cash outlay of $10,000. The cash flow for Peter’s Project is $4,000 per year for three years. The cash flow for Paul’s Project is $2,000 in years 1 and 3, and $8,000 in year 2. Mary’s Project has a cash flow of $10,000 in year 1, followed by $1,000 each year for years 2 and 3.

a.Use the payback method to calculate how many years it will take for each project to recoup the initial investment.

b. Which project would you consider most liquid?

10-11.The Trask Family Lettuce Farm is located in the fertile Salinas Valley of California. Adam Trask, the head of the family, makes all the financial decisions that affect the farm. Because of an extended drought, the family needs more water per acre than what the existing irrigation system can supply. The quantity and quality of lettuce produced are expected to increase when more water is supplied. Cal and Aron, Adam’s sons, have devised two different solutions to their problem. Cal suggests improvements to the existing system. Aron is in favor of a completely new system. The negative cash flow associated with the initial investment and expected positive net cash flows for years 1 through 7 for each project follow. Adam has no other alternatives and will choose one of the two projects. The Trask Family Lettuce Farm has a required rate of return of 8 percent for these projects.

a.Calculate the net present value for each project.

b.Calculate the internal rate of return for each project.

c.Which project should Adam choose? Why?

d.Is there a conflict between the decisions indicated by the NPVs and the IRRs?

10-12.Buzz Lightyear has been offered an investment in which he expects to receive payments of $4,000 at the end of each of the next 10 years in return for an initial investment of $10,000 now.

a.What is the IRR of the proposed investment?

b.What is the MIRR of the proposed investment? Assume a cost capital of 10%.

c. Why is the MIRR thought of as a more realistic indication of a project’s potential than the IRR?

10-21.Four capital investment alternatives have the following expected IRRs and standard deviations.

If the firm’s existing portfolio of assets has an expected IRR of 13 percent with a standard deviation of 3 percent, identify the lowest- and the highest-risk projects in the preceding list. You may assume the correlation coefficient of returns from each project relative to the existing portfolio is .50 and the investment in each project would constitute 20 percent of the firm’s total portfolio. For more, see6e Spreadsheet TemplatesforMicrosoft Excel
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