UNIVERSITY OF TORONTO
MGTC09H3 (Intermediate Finance)
Total Marks: 100n Time: 7:00 – 9:30pm0
ASSIGNMENT 2 Due Date: Nov 30, 2010 by 3 pm
Prof. Syed W. Ahmed
Last First Middle
STUDENT’S I.D. NO.:_______________________________________________
QUESTION NO. MAX. MARKS MARKS OBTAINED
1 25 __________________
2 15 __________________
3 20 __________________
4 20 __________________
5 20 __________________
TOTAL MARKS 100 __________________ -2-
Markham Technologies is (MT) is considering a project, which will require an initial investment
of $11,000,000. The project will generate cash flows forever. One year from today after tax
operating cash flows will be $1,600,000, after that they will decline at a rate of 4% per year for
ever. The risk free interest rate is 4%, marginal tax rate is 40%, and the unlevered cost of equity
capital is 12%.
a. What is the project’s NPV?
b. If the project is financed entirely with equity, floatation costs are equal to 5% of the gross
proceeds. What is the project’s NPV now?
c. Independent of (b), assume that the project will be financed entirely with debt at an interest
rate of 8%. Ignore floatation costs. What is the project’s APV if the loan is
1. paid back in total at the end of 5 years?
2. paid back in equal principal amounts per year over 5 years?
3. amortized over 5 years so that the total before tax payment (interest + principal
repayment) is constant per year?
4. loan is provided by the federal government at a subsidized rate of 3% and the loan
will be paid back at the end of 5 years?
Denison Medical Techies is a fast growing biomedical technology firm. Its target debt/equity
ratio is 0.60. It has 2 million shares of common stock outstanding.
a. The cash flow available to be paid out in the form of cash dividends, to pay down debt, or
to fund new capital investments, is $10,000,000. It has the following set of investment
Project Initial Investment IRR
A $2,000,000 40%
B 5,000,000 35
C 3,000,000 27
D 5,000,000 17
E 2,000,000 21
F 4,000,000 14
1. If the firm’s opportunity cost of capital is 18% and it follows a residual dividend
policy, what should the firm do? What will be the cash dividend per share?
2. What happens if everything is as in (1) except that firm initiates a policy of paying a
cash dividend of $1.875 per share per year? Assume that the firm will take all wealth-
maximizing projects and that it will not increase its debt/equity ratio. Also the capital
projects are not divisible; that is partial projects may not be undertake