2. a) Vang Inc. is considering Projects S and L, whose cash flows are shown below. These projects are mutually exclusive, equally risky, and not repeatable. If the decision is made by choosing the project with the shorter payback, some value may be forgone. How much value will be lost in this instance? Note that under some conditions choosing projects on the basis of the shorter payback will not cause value to be lost. Also comment on PBP and NPV decision criteria in this regard. (5+5+2 marks) WACC: 10.25% Year 0 1 2 3 4 CFs -$950 $500 $800 SO SO CFL-$2,100 $400 $800 $800 $1.000 b) Let's assume, the CEO believes the IRR is the best selection criterion where IRRL =9.71181%, IRRS= 12.24157%, while the CFO advocates the NPV. If the decision is made by choosing IRR rather than NPV. how much, if any, value will be forgone? i.e., what's the chosen NPV versus the maximum possible NPV? Note that (1) "true value" is measured by NPV, and (2) under some conditions the choice of IRR vs. NPV might have no effect on the value gained or lost. Comment on which project to be chosen based on IRR and Why? (2marks) c) Assume that the project being considered has normal cash flows, with one outflow followed by a series of inflows like the scenario above. The payback is useful here as an indicator of a project's liquidity. However, will there be any difference in payback period and discounted payback period? Why or why not? (No calculation needed) (3 marks) Section-B Answer the following independent questions with examples or calculations (if needed) supporting your answers. i, Consider the following three government bonds: Bond Bond Price Coupon Rate Maturity X $1,034.98 5% 3 years Y $943 0% 1 years N ? 0% 2 years Assume that each bond has a par value of $1,000 and that coupon payments are made annually. The first coupon payments will be made one year from today. Suppose, bond z does not pay any coupons, but it will pay its par value of $1,000 back exactly two years from today. If the interest rate of these bonds remains constant over time is it true that the price of bond Z will be higher than the price of bond Y? - Do you agree? Justify your opinion for or against it. (5 marks) . The distributions of rates of return for Companies AA and BB are given below: State of the Probability of Economy This State Occurring AA BB Boom 0.2 30%-10% Normal 0.6 10% 5% Recession 0.2-5% 50% We can conclude from the above information that any rational, risk-averse investor would be better off adding Security AA to a well-diversified portfolio over Security BB. Do you agree? Explain your rationale. (5 marks) 2. a) Vang Inc. is considering Projects S and L, whose cash flows are shown below. These projects are mutually exclusive, equally risky, and not repeatable. If the decision is made by choosing the project with the shorter payback, some value may be forgone. How much value will be lost in this instance? Note that under some conditions choosing projects on the basis of the shorter payback will not cause value to be lost. Also comment on PBP and NPV decision criteria in this regard. (5+5+2 marks) WACC: 10.25% Year 0 1 2 3 4 CFs -$950 $500 $800 SO SO CFL-$2,100 $400 $800 $800 $1.000 b) Let's assume, the CEO believes the IRR is the best selection criterion where IRRL =9.71181%, IRRS= 12.24157%, while the CFO advocates the NPV. If the decision is made by choosing IRR rather than NPV. how much, if any, value will be forgone? i.e., what's the chosen NPV versus the maximum possible NPV? Note that (1) "true value" is measured by NPV, and (2) under some conditions the choice of IRR vs. NPV might have no effect on the value gained or lost. Comment on which project to be chosen based on IRR and Why? (2marks) c) Assume that the project being considered has normal cash flows, with one outflow followed by a series of inflows like the scenario above. The payback is useful here as an indicator of a project's liquidity. However, will there be any difference in payback period and discounted payback period? Why or why not? (No calculation needed) (3 marks) Section-B Answer the following independent questions with examples or calculations (if needed) supporting your answers. i, Consider the following three government bonds: Bond Bond Price Coupon Rate Maturity X $1,034.98 5% 3 years Y $943 0% 1 years N ? 0% 2 years Assume that each bond has a par value of $1,000 and that coupon payments are made annually. The first coupon payments will be made one year from today. Suppose, bond z does not pay any coupons, but it will pay its par value of $1,000 back exactly two years from today. If the interest rate of these bonds remains constant over time is it true that the price of bond Z will be higher than the price of bond Y? - Do you agree? Justify your opinion for or against it. (5 marks) . The distributions of rates of return for Companies AA and BB are given below: State of the Probability of Economy This State Occurring AA BB Boom 0.2 30%-10% Normal 0.6 10% 5% Recession 0.2-5% 50% We can conclude from the above information that any rational, risk-averse investor would be better off adding Security AA to a well-diversified portfolio over Security BB. Do you agree? Explain your rationale