GSBA 548: Corporate Finance, Spring 2020
Home Assignment 1
Question 1
You have an opportunity to construct an office building on a plot of land appraised at $50,000.
This investment has a positive NPV of $5,000 at a discount rate of 12 percent. Suppose E. Coli
Associates, a firm of genetic engineers, offers to purchase the land for $58,000, consisting of
$20,000 paid immediately and $38,000 after one year. U.S. government securities maturing in
one year yield 5 percent.
a. Assume E. Coli is sure to pay the second $38,000 instalment. Should you take this offer or
start on the office building? Explain.
b. Suppose you are not sure E. Coli will pay. You observe that other investors demand a 10
percent return on their loans to E. Coli. Assume that the other investors have correctly
assessed the risks that E. Coli will not be able to pay. Should you accept E. Coli’s offer?
Question 2
It is November 2015. You are the owner of the Palo Alto Micro-Brewing Co, a very fancy and
high-quality micro-brewery in the Bay area. You are considering acquiring at the end of 2015 a
$3m Brauhaus 1000A, a large microbrewery system. Such investment can be depreciated over its
three-year life. Afterwards, you will be able to sell it to another beer enthusiast for $1m and close
down shop.
The financials below contain estimates of the costs and revenues, in millions of dollars, from
operating this system. Assume all numbers are year-end figures. Also assume that 2015 payments
are made at year-end (and for the purposes of discounting assume you value the project on
December 31, 2015)
2015 2016 2017 2018
Capital investment 3.000 - - (1.000)
Accumulated depreciation - 1.000 2.000 3.000
Year-end fixed assets 3.000 2.000 1.000 -
Net Working Capital 0.150 0.250 0.250 -
Total book value 3.150 2.250 1.250 -
Sales 0.500 2.500 2.500 2.500
Cost of goods sold 0.100 0.500 0.500 0.500
Other costs 0.020 0.375 0.375 0.375
Depreciation - 1.000 1.000 1.000
Pretax profit 0.380 0.625 0.625 0.625
