Reference no: EM132553582

Problem 1: A company invests $500 million in a project today. This project will start generating annual cash flows of $50 million forever starting at the end of year 5. Should the company accept or reject the project? Assume that the appropriate discount rate for this project is 10% per year with annual compounding.

a. The company is indifferent to this project as its NPV is zero.

b. Accept the project as its NPV is positive.

c. Reject the project as its NPV is negative.

d. Insufficient information to answer the question.

Problem 2: Two projects are expected to last for the same number of years, require the exact same initial investment at time 0 and generate identical annual cash flows. However, one project (call it Project A) is riskier than the other (Project B). Which will have the lower NPV?

a. Project A

b. Project B

c. Both will have the exact same NPV as risk does not affect NPV and they have identical cash flows.

d. We cannot say without knowing their exact risk levels.

Problem 3: Your company currently generates revenues of $20 million per year. Next year, based on the state of economy, your revenues will either increase by 20% or decrease by 25%. Both the increase as well as the decrease are equally likely. These changed revenues will be realized in perpetuity as long as you own the factory. Other operating costs are $16 million per year, which are also incurred in perpetuity as long as you own the factory. You can sell the plant any time to another company for $50 million. The appropriate discount rate is 10% per year. What is the value of the option to sell the factory?

a. $3.5 million

b. $65 million

c. $30 million

d. $35 million