But I dont know how to calculate those answers, so I need the steps and explanations please.

Exercise 1

Laptop plc. is planning on setting up a laptop repair centre. They estimate that:

The required investment will be £0.3m and the investment’s life is expected to be 5 years.

The investment is to be depreciated using the straight line depreciation method and none of the costs are expected to be recovered at the end of the 5 years.

Total revenues from repairs are expected to be £200,000 in year one (one year from now), growing at 2.5% per annum. Staffing costs are £90,000 per year.

Administrative, advertising and general expenses associated with the centre are expected to be £20,000 per year.

All costs are expected to increase at 2.5% per annum.

The discount rate for ventures of similar risk is 12%.

Laptop plc. faces a corporate tax rate of 35%.

a. Calculate the NPV of this project and determine whether it should be accepted or rejected.

	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5
Investment	-300000
Revenues		200000	205000	210125	215378.1	220762.6
Total Costs		110000	112750	115568.8	118458	121419.4
Depreciation		60000	60000	60000	60000	60000
Total Income		30000	32250	34556.25	36920.16	39343.16
Taxes		10500	11287.5	12094.69	12922.05	13770.11
AT Income		19500	20962.5	22461.56	23998.1	25573.05
CF (add depr)		79500	80962.5	82461.56	83998.1	85573.05
PV	-300000	70982.14	64542.81	58694.51	53382.31	48556.45
R=0.12
NPV	-3841.78

b. Suppose you are told that Laptop plc. is totally equity financed. The company has a beta equal to 1.2. Appropriate estimates for the risk free rate and the market risk premium are 2% and 4%, respectively. Calculate the NPV of this project and determine whether it should be accepted or rejected.

RCAPM	0.068
	-300000	74438.2	70980.88	67692.07	64563.11	61585.83
NPV	39260.1

c. Suppose you are told that Laptop plc’s core business is not laptop repairs but production of laptop components. The beta of companies in the laptop repair business is generally around 2.5. Would you recommend accepting or rejecting the project? [Explain your answer in no more than 100 words]

d. In no more than 200 words, illustrate the concept of homemade leverage and explain the role it plays in Modigliani’s and Miller’s capital structure irrelevance result.

Exercise 2

Firms A and B are identical except for their capital structure. A carries no debt, whereas B carries £200 of debt on which it pays 6% interest rate. Assume no transaction costs, no taxes, risk-free debt and perfect capital markets. The relevant numbers are provided in the following table:

	A	B
Value of Firm	300(given)	400(given)
Debt	0(given)	200(given)
Equity	300	200
Earnings before interest	30(given)	30(given)
Interest payment	0	12
Interest rate	Not Applicable(given)	6%(given)
Earnings after interest	30	18
Return on Equity	10%	9%
Debt/Equity Ratio	0	1
Cost of Capital	10%	7.5%

a. Complete the blank spaces in the table above.

b. State whether each of the following statements is true or false

i. To reduce the company’s cost of capital, the management of Company A should start a programme of stock repurchases financed through the issue of new debt.

ii. To reduce the company’s cost of capital, the management of Company B should issue equity to reduce its debt burden.

iii. Relative to Company B, Company A is undervalued.

iv. The situation described in the table is the result of capital markets equilibrium.

v. The situation described in the table violates Modigliani-Miller Proposition 1.

Exercise 3

An investor is uncertain about how much to invest in two risky assets. The first asset (equity) yields an expected return of 12% and has a standard deviation equal to 8%. The second asset (debt) yields an expected return of 6% and has a standard deviation of 5%. The correlation coefficient between the returns is -0.1.

a. Compute the expected return and standard deviation of the following portfolios:

Portfolio	Percentage in equity	Percentage in debt
1	75	25
2	50	50
3	25	75

Portfolio	% in debt	% in eq	ExRet	Var	SD
3	0.75	0.25	0.075	0.001731	0.041608
2	0.5	0.5	0.09	0.002125	0.046098
1	0.25	0.75	0.105	0.003681	0.060673

b. Sketch the set of portfolios composed of debt and equity in the mean-standard deviation space and identify portfolios 1, 2 and 3.

c. Would a rational risk-averse investor ever choose a portfolio entirely composed of debt? Would a rational risk-averse investor ever choose a portfolio entirely composed of equity? [Explain your answer in no more than 100 words]

Exercise 4

1. (Please answer all parts of the question)

21st Century Cat is a film producing company which is contemplating the production of a new film. They estimate that:

The production of the film will require an investment of £300,000 in year 0.

The distribution will generate a stream of cash flows equal to £200,000 in year 1, and £100,000 in each of years 2 and 3.

In year 3, the producer will sell the rights to a tv broadcaster for £90,000.

Distribution costs will be £75,000 in year 1, and £50,000 in each of years 2 and 3.

Due to regulation aimed at promoting cinema, all income generated by the project is tax-free.

a. The company’s financial experts say that the appropriate discount factor for the project is 10%. Calculate the NPV using this discount factor and determine whether the project should be funded.

	0	1	2	3
Initial Inv	300
Revenues		200	100	190
Costs		75	50	50
Cash Flows	-300	125	50	140
Discount factor at 10% rate
1.1	1	0.909091	0.826446	0.751315
Discounted Cash flows	-300	113.6364	41.32231	105.1841
NPV at 10%	-39.8573

b. Assume now that the company has a debt/equity ratio equal to one. The company’s bonds yield a 6% return, the company’s beta is equal to 0.5, the market risk premium is 5%, while the risk-free rate is 3%. Calculate the NPV of the project with the new data.

Rcapm
0.055
Rwacc
0.0575
Discount factor at 5.75% rate
1.0575	1	0.945626	0.894209	0.845588
Discounted Cash flows	-300	118.2033	44.71047	118.3823
NPV at 5.75%	-18.7039

Exercise 5

2. (Please answer all parts of the question)

An investor is uncertain about how much to invest in two risky assets. The first asset (equity) yields an expected return of 10% and has a standard deviation equal to 8%. The second asset (debt) yields an expected return of 5% and has a standard deviation of 7%. The correlation coefficient between the returns is 0.1.

a. Compute the expected return and standard deviation of the following portfolios:

Portfolio	Percentage in equity	Percentage in debt
1	90	10
2	50	50
3	10	90
	Equity	Debt
R	0.1	0.05
SD	0.08	0.07
Var	0.0064	0.0049
Portfolio	% in equity	% in debt	Expected R	Var	SD
1	0.9	0.1	0.095	0.005	0.073
2	0.5	0.5	0.075	0.003	0.056
3	0.1	0.9	0.055	0.004	0.064

b. In the mean-standard deviation space, sketch the set of portfolios composed of debt and equity and identify portfolios 1, 2, and 3 on your graph.

c. Would a rational risk-averse investor ever choose portfolio 3? Would a rational risk-averse investor ever choose portfolio 1? [Explain your answer in no more than 100 words]