PHILIPP SCHNABL

N YU STERN DEPARTMENT OF FINANCE

44 WEST FOURTH STREET SUITE 9-190
NEW YORK, NY 10012
SCHNABL@STERN.NYU.EDU

Corporate Finance

Professor Philipp Schnabl

EMBA Take Home Exam

Last Name: ____________________________ First Name: _________________

Stern Honor Code : “I pledge my honor that I have not violated the Stern Honor Code in the
completion of this examination.”

Signature: __________________________________________________

• Please work alone on this exam.

• Please submit the exam on Brightspace.
• You have 24 hours to finish the exam after you download it.
• There is partial credit awarded for incorrect or partially incomplete answers if some
of the work is correct. To receive partial credit, you must show your work. Mentioning
extra things that are wrong can hurt your partial credit.
• The exam is open book. You can use your lectures notes, problem sets, and any other
notes.
• Please round to two decimals after the comma. There won’t be any deductions for
rounding errors as long as I can clearly identify them as those.
• You can use a financial calculator or Excel, but it won’t be necessary. If you are using
a financial calculator or Excel, I want to see exactly how you derive the solution, i.e.,
I want to see all steps that lead to the solution. Hence your answer should look
exactly like one coming from someone who does not have a financial calculator or
Excel. If you cannot make transparent how you derive your solution, you won’t get full
points.

Good luck!
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Question 1: Net Present Value (15 points)

Stern Endowment (SE) is considering purchasing Columbia Uptown (CU) at a price of

$1,500,000. If Stern buys Columbia, its cash flow will increase by $110,000 per year and
remain at this new level forever (starting at t=1). Stern has a tax rate of 0% (i.e., Stern does
not pay any taxes). If the appropriate cost of capital is 9 percent, what is the NPV of
purchasing CU?

Answer:

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Question 2: Annuities (15 points)

Suppose you purchased a new house in December 2021 for $2 million. You were lucky and
the bank agreed to lend you the entire amount. That means, there is no down payment and
the bank provided you with a mortgage of $2 million. You took out a 30-year fixed-rate
mortgage at an interest rate of 3%. You will repay the mortgage in equal annual payments
over 30 years (i.e., you pay the same amount to the bank every year and there is no balance
after 30 years).

Now suppose it is March 2023. You have a friend who also wants to purchase a house. He
takes out a 30-year fixed-rate mortgage, just like you. The only difference is that the interest
rate is now 7%. Your friend agrees to the same annual mortgage payments as you. Your
friend has no other money and cannot borrow anywhere else.

(a) How large is the annual payment on your 30-year fixed-rate mortgage from December
2021?
(b) How much is the most your friend can pay for a house in March 2023?

Answer:

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Question 3: Internal Rate of Return (15 points)

You just graduated from Stern and a firm is offering you a consulting contract. You will get
paid $100,000 today (t=0). In return, you have to deliver 130 hours of consulting services in
the future. Your hourly rate is $900. You expect that the consulting hours will be delivered
roughly one year from now (t=1). Your cost of capital is 10%.

What is the Internal Rate of Return (IRR) of this consulting project? Should you accept or
reject the project?

Answer:

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Question 4: Cash Flows (30 points)

You are the CFO of an aluminum smelting firm. At the beginning of the year (t=0), you are
asked to assess the replacement of one of your firm’s plants. You have the following
information:

• All revenues and costs occur at the end of the year.

• The current plant produces 2.3 million tons of aluminum per year. If you do not
replace this plant, it will continue production for six years (until t=6). If you decide to
replace it, the current plant will continue to produce for just one more year (until
t=1). The current plant uses 15 megawatt hours (MWH) of electricity to produce
each ton of aluminum. In addition, it has operating expenses of $760 per ton.
• The new plant will produce 2 million tons of aluminum per year. It will take one year
to install the plant; hence, it will start producing a year from now (with no output in
the first year, i.e. at t=1). The new plant uses 10 megawatt hours (MWH) of
electricity to produce each ton of aluminum. In addition, it has operating expenses of
$685 per ton.
• A supply contract guarantees an electricity price of $17 per megawatt hour (MWH).
• You expect to sell the aluminum at a price of $1,400 per ton.
• The current plant has been fully depreciated for tax purposes. If it is replaced, then
its equipment will be sold for $200 million at the end of this year (t=1).
• The property on which your plants are located requires maintenance work (classified
as operating expense). This will cost $25 million at the end of the first year (t=1)
whether or not you decide to replace the plant.
• It will cost $540 million today (t=0) to install the new plant. Your tax accountant
informs you that the new plant can be fully depreciated over 6 years, starting in its
first year of operation, using straight-line depreciation (following IRS guidelines).
• Your current working capital is $60 million. If you do not replace the old plant,
working capital increases to $70 million in t=1, where it remains until t=6 when
working capital is fully recovered. If you replace the old plant, working capital
immediately increases to $70 million and then to $120 million in t=1, where it
remains until t=6 when working capital is fully recovered. Here is a timetable of the
working capital requirements:

t=0 t=1 to t=5 t=6

Working capital level (old plant) $60 million $70 million 0
Working capital level (new plant) $70 million $120 million 0

• If not replaced, the existing plant will produce until t=6 and will have no salvage
value after that. If the existing plant is replaced, the new plant will also produce until

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t=6. Moreover, the new plant will be sold for $100 million at the end of the sixth
year (t= 6).
• The opportunity cost of capital is 10%. The tax rate is 35%.

Put together a timetable and compute the net present value of replacing the old plant with
the new plant.

Answer:

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Question 5 – Capital Structure (25 points)

You are employed in the food industry. You are trying to calculate the cost of capital to
apply to a new project in the frozen food sector. Assume there are no taxes and no costs of
financial distress. You have the following information:

(i) Sweet Bread operates exclusively in the baked goods sector. It has a debt-to-value
ratio of 60%, and a debt beta of 0.2. Sweet Bread’s expected return on equity is
30%.
(ii) Home Chef has two divisions of equal size: one division is in the frozen goods sector
and the other division is in the baked goods sector. It has risk-free debt (i.e., the
debt beta is zero), and a debt-to-value ratio of 25%. Its expected return on equity is
18%.

The risk-free rate is 5% and the market risk premium is 8%.

(a) What is the asset beta of Sweet Bread?

(b) What is the asset beta of Home Chef?
(c) What is the cost of capital for the new project?

Answer:

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This question is optional. It will not count to your exam score. Enjoy, if you are so
inclined.

Optional Question: Real Options (no points):

You are planning to set up a new cafe in the Village and operate it for at most two years.
Your revenue in the first year is expected to be $400K. Your second-year revenue depends
on how many Starbucks shops have opened in your neighborhood during the first year:

Number of Starbucks shops Probability Your second-year

opening in your neighborhood revenue
0 1/3 660K
2 1/3 320K
1,000 1/3 220K

You are planning to rent the space for the cafe. The landlord requires that you sign a two-
year lease, i.e., you must pay rent for two years no matter what. The rent is $110K per year
payable at the end of a year. As usual, revenues also occur at the end of a year. The discount
rate is 10%.

a) What is the NPV of the project?

b) Suppose a real estate company comes up with the following idea. It offers you the same
contract as in part a) but gives you the option to terminate the lease after one year. That is,
after learning how many Starbucks shops have opened in your neighborhood during the first
year you have the option to close your cafe after one year and pay no rent for the second
year. The real estate company is asking you for a fee (payable today) in return for providing
you with the option to terminate the lease. What is the maximum fee you are willing to
pay?

c) How would your answer to part (b) change if the rent was $330K per year?

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