PRINCIPLES OF CORPORATE FINANCE
Assignment type : Other types
Format APA
Volume of 3 pages (825 words)
Description
READ%CAREFULLY%INSTRUCTIONS%IN%ANSWER%SHEET
1. You!are!the!marketing!manager!of!a!company!that!produces!healthy!packaged!foods.!You!believe
you!can!increase!the!sales!numbers!through!a!targeted!marketing!campaign!where!you!will!
organize!events!for social!media!”influencers”!where!you!will!present!your!products. You!estimate!
the!cost!of!the!campaign!at!500’000!USD.!Based!on!the!number!of!followers!of!those!influencers,!
you!expect!that!the!campaign!will!generate!USD!120’000!of!additional!sales!in!each!of!the!next!6!
years.!You!have!a!meeting!with!the!CEO!and!the!financial!manager!to!convince!them!that!it!is!a!
good!investment!for!the!company.!A!friend!at!the!financial!department!tells!you!that!investments!
of!the!same!risk!require!a!return!of!8%,!calculate!the!NPV!so!that!you!can!use!it!for!your!meeting.
2. Your!friend!at!the!finance!department!tells!you!that!the!Financial!manager!really!likes!the!Payback!
rule!and!that!projects!that!have!payback!periods!higher!than!4!years!are!usually!dismissed.!What’s!
the!payback!for!this!project?!If!in!the!meeting,!the!financial!manager!argues!that!your!project’s!
payback!is!higher!than!4!and!therefore!has!a!payback!larger!than!the!average!of!projects!the!
company!approves,!what!would!you!tell!him?!(point!out!the!most!important!shortcoming!of!the!
payback!rule!applicable!to!this!particular!case).
3. What!is!the!IRR!of!the!project?!According!to!the!IRR!rule,!should!you!accept!or!reject!the!project?
Why?!Make!sure!you!respond!to!all!3!questions,!use!all!information!provided!in!the!prior!questions.!
In!case!you!don’t!have!a!financial!calculator!you!can!use!
https://www.calculatestuff.com/financial/irr_calculator
4. Your!marketing!intern!tells!you!that!in!his!finance!book!it!says!that!the!NPV!is!the!only!flawless!
method!to!take!capital!budgeting!decisions.!He!adds!that!the!IRR!and!Payback!have!several!
shortcomings!and!therefore!he!thinks!they!are!a!waste!of!time.!What!would!you!tell!him!to!justify!
also!preparing!the!IRR!and!payback!calculations!for!your!meeting?!
5. You!are!a!financial!manager!of!a!real!estate!company!in!Geneva.!The!company!owns!an!old!office!
building!in!the!banking!district.!You!are!currently!renting!it!out!to!a!swiss!bank!for!2million!CHF!per!
year.!You!are!considering!project!A!that!consists!on!renovating!the!building,!making!it!more!
modern!and!energy!efficient.!It!would!cost!1!million!CHF.!If!you!do!it,!you!could!increase!the!rent!by!
10%!over!the!next!7!years.!Should!you!go!ahead!with!the!investment!if!similar!risky!investments!
require!a!return!of!10%?!If!you!don’t!renovate,!you!expect!to!maintain!the!current!level!of!rent.
Explain!why!with!and!give!the!NPV!and!IRR.
6. Recalculate!the!NPV!for!the!previous!exercise!if!the!required!return!is!8%.!Describe!the!relationship!
between!the!NPV!and!IRR!for!this!particular!case.!What!is!the!NPV!if!the!required!rate!of!return!is!
equal!to!the!IRR?
7. You!have!an!alternative!project!to!reconvert!the!building!into!a!hotel.!The!cost!of!the!reconversion!
would!amount!to!2million!CHF.!If!you!go!ahead,!you!expect!to!be!able!to!rent!to!a!hotel!operator!
(like!Hilton!Hotels)!for!2.4mio!CHF!per!year!for!10!years.!You!also!expect!that!costs!such!as!
additional!city!taxes!and!minor!reparations!will!amount!to!100’000!chf!per!year.!You!estimate!this!
project!has!the!same!riskiness!than!the!renovation!(in!ex.!6),!and!thus!use!a!8%!required!rate!of!
return.!What!is!the!NPV?!Clue:!focus!on!NET!(of!costs)!ADDITIONAL!(vs.!current)!CASH!FLOWS.
For!the!next!2!questions,!consider!the!following!projects!A!and!B.
Project Cost 1 2 3 4 5
A _200 120 90 30 10 _20
B _200 10 10 30 90 120
8. What’s!the!payback!for!each!project?!If!you!had!to!choose!one!project!based!on!the!payback!
method,!which!one!would!you!choose?
9. What’s!the!NPV!of!each!project!at!2%!required!rate!of!return?!And!at!the!7%!required!rate!of!
return?!You!can!use!https://www.calculatestuff.com/financial/npv_calculator.!Most!importantly,!if!
you!had!to!choose!only!one!project,!why!is!it!that!your!choice!would!be!different!depending!on!the!
discount!rate?
10. Why!is!it!that!IRR!is!not!an!interesting!method!to!choose!capital!projects!when!the!project’s!cash!
flows!are!unconventional?!For!a!project!thas!has!a!cost!of!$60!and!cash!flows!of!$155!in!year!1!and!
$_100!in!year!2,!give!out!a!specific!example!of!why!the!IRR!rule!breaks.!
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