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EMBA AUBG FALL 2022

BUS540-Corporate Finance
Homework 1 DUE 10 October 2022 at 11:59pm.

From chapter 3 (pp.117-120)

3-1. Motor Company is considering offering a $1,600 rebate on its minivan, lowering the vehicle’s price
from $29,000 to $27,400. The marketing group estimates that this rebate will increase sales over the
next year from 42,000 to 60,000 vehicles. Suppose Honda’s profit margin with the rebate is $5400 per
vehicle. If the change in sales is the only consequence of this decision, what are its costs and benefits?
Is it a good idea?

3-14. An American Depositary Receipt (ADR) is security issued by a U.S. bank and traded on a U.S. stock
exchange that represents a specific number of shares of a foreign stock. For example, Nokia
Corporation trades as an ADR with symbol NOK on the NYSE. Each ADR represents one sh are of
Nokia Corporation stock, which trades with symbol NOK1V on the Helsinki stock exchange. If the U.S.
ADR for Nokia is trading for $7.12 per share, and Nokia stock is trading on the Helsinki exchange for
€5.01 per share, use the Law of One Price to determine the current $/€ exchange rate.

3-17. Consider two securities that pay risk-free cash flows over the next two years and that have the current
market prices shown here:
Security Price Today ($) Cash Flow in One Year Cash Flow in Two
($) Years ($)
B1 279 300 0
B2 255 0 300
a. What is the no-arbitrage price of a security that pays cash flows of $300 in one year and $300 in
two years?
b. What is the no-arbitrage price of a security that pays cash flows of $300 in one year and $2700 in
two years?
c. Suppose a security with cash flows of $150 in one year and $300 in two years is trading for a price of
$390. What arbitrage opportunity is available?

3-19. Xia Corporation is a company whose sole assets are $100,000 in cash and three projects that it will undertake.
The projects are risk-free and have the following cash flows:

Project Cash Flow Today ($) Cash Flow in One Year ($)

A -22,000 26,000

B -7,000 26,000

C -57,000 76,000

Xia plans to invest any unused cash today at the risk-free interest rate of 9.8%. In one year, all cash will be
paid to investors and the company will be shut down.
a. What is the NPV of each project? Which projects should Xia undertake and how much cash should it
retain?
b. What is the total value of Xia’s assets (projects and cash) today?
c. What cash flows will the investors in Xia receive? Based on these cash flows, what is the value of Xia
today?

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EMBA AUBG FALL 2022

d. Suppose Xia pays any unused cash to investors today, rather than investing it. What are the cash flows
to the investors in this case? What is the value of Xia now?

From chapter 4 (p.172)

4-37. You are thinking of purchasing a house. The house costs $350,000. You have $50,000 in cash that you
can use as a down payment on the house, but you need to borrow the rest of the purchase price. The
bank is offering a 30-year mortgage that requires annual payments and has an interest rate of 7% per
year. What will your annual payment be if you sign up for this mortgage?

4-39. You have just made an offer on a new home and are seeking a mortgage. You need to borrow
$600,000.
a. The bank offers a 30-year mortgage with fixed monthly payments and an interest rate of 0.5%
per month. What is the amount of your monthly payment if you take this loan?
b. Alternatively, you can get a 15-year mortgage with fixed monthly payments and an interest rate
of 0.4% per month. How much would your monthly payments be if you take this loan instead?

4-42. You are saving for retirement. To live comfortably, you decide you will need to save $2 million by the
time you are 65. Today is your 30th birthday, and you decide, starting today and continuing on every
birthday up to and including your 65th birthday, that you will put the same amount into a savings
account. If the interest rate is 5%, how much must you set aside each year to make sure that you will
have $2 million in the account on your 65th birthday?

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3.1
Profit margin with rebate 7000
Less: Rebate -1600
Profit margin without rebate 5400

Profit margin without rebate 7000

No. of units sold 42000
Profit without rebate 294000000

Profit margin with rebate 5400

No. of units sold 60000
Profit with rebate 324000000

3.14
Price of Nokia ADR in US 7.12
Price of Nokia stock on Helsinki Exchange 5.01
The $/€ exchange rate 1.4212

3.17
a)
Non-arbitrage price of a security that pays 300 in one year and 300 in two years 534

b)
Non-arbitrage price of a security that pays 300 in one year and 2700 in two years 2574

c) Theoretical price of the security 394.5

Price in the market 390
Gain through arbitrage 4.5

3.19
a)
Cash Inflow Cash Outflow NPV
NPV of Project A 26000 22000 4000
NPV of Project B 26000 7000 19000
NPV of Project C 76000 57000 19000

b)
Total value of projects and cash today
Cash 14000
Project A 22000
Project B 7000
Project C 57000
Total value of projects and cash today 100000
c)
Value based on future cash flows
Cash after 1 year 15372
Project A 26000
Project B 26000
Project C 76000
Total value of projects and cash today 143372

d)
Value if cash is paid to investors now
Project A 26000
Project B 26000
Project C 76000
Total value of projects and cash today 128000

4.37
Cost 350000
Cash available 50000
Borrowing amount 300000

Interest rate 7%
Tenure 30
Annual installment ₹ 24,175.92

4.39
a)
Mortgage amount 600000
Interest 0.50%
Tenure 360
Monthly installment ₹ 3,597.30

b)
Mortgage amount 600000
Interest 0.40%
Tenure 180
Monthly installment ₹ 4,682.49

4.42
Future Value 2000000
Tenure 35
Interest Rate 5%
Annual installment -
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