ECO389 Corporate Finance Problem Set 4
Fall 2015
Professor: Jake Zhao
Due: 11/9/15
1. You are deciding between two mutually exclusive investment opportunities. Both require the same initial investment of $10 million. Investment A will generate $2 million
per year (starting at the end of the rst year) in perpetuity. Investment B will generate
$1.5 million at the end of the rst year and its revenues will grow at 2% per year for
every year after that.
(a) Plot the NPV prole for each project.
(b) What is the IRR for each project?
(c) Which investment has the higher NPV when the cost of capital is 7%?
(d) Which investment has the higher NPV when the cost of capital is 9%?
(e) For what values of the cost of capital does picking the higher IRR give the correct
answer as to which investment is the best opportunity?
2. Pisa Pizza, a seller of frozen pizza, is considering introducing a healthier version of its
pizza that will be low in cholesterol and contain no trans fats. The rm expects that
sales of the new pizza will be $20 million per year. While many of these sales will be to
new customers, Pisa Pizza estimates that 40% will come from customers who switch
to the new, healthier pizza instead of buying the original version.
(a) Assume customers will spend the same amount on either version. What level of
incremental sales is associated with introducing the new pizza?
(b) Suppose that 50% of the customers who will switch from Pisa Pizza’s original
pizza to its healthier pizza will switch to another brand if Pisa Pizza does not
introduce a healthier pizza. What level of incremental sales is associated with
introducing the new pizza in this case?
3. Hyperion, Inc. currently sells its latest high-speed color printer, the Hyper 500, for
$350. It plans to lower the price to $300 next year. Its cost of goods sold for the Hyper
500 is $200 per unit, and this year’s sales are expected to be 20,000 units.1

(a) Suppose that if Hyperion drops the price to $300 immediately, it can increase this
year’s sales by 25% to 25,000 units. What would be the incremental impact on
this year’s EBIT of such a price drop?
(b) Suppose that for each printer sold, Hyperion expects additional sales of $75 per
year on ink cartridges for the next three years, and Hyperion has a gross prot
margin of 70% on ink cartridges. What is the incremental impact on EBIT for
the next three years of a price drop this year?
4. Cellular Access, Inc. is a cellular telephone service provider that reported net income
of $250 million for the most recent scal year. The rm had depreciation expenses of
$100 million, capital expenditures of $200 million, and no interest expenses. Working
capital increased by $10 million. Calculate the free cash ow for Cellular Access for
the most recent scal year.
5. In September 2008, the IRS changed tax laws to allow banks to utilize the tax loss
carryforwards of banks they acquire to shield their future income from taxes (prior law
restricted the ability of acquirers to use these credits). Suppose Fargo Bank acquires
Covia Bank and with it acquires $74 billion in tax loss carryforwards. If Fargo Bank
is expected to generate taxable income of 10 billion per year in the future, and its tax
rate is 30%, what is the present value of these acquired tax loss carryforwards given a
cost of capital of 8%?

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