Fin 300 test 2

The stock price of Baskett Co. is $73. Investors require a return of 10.5 percent on similar stocks. If the company plans to pay a dividend of $4.25 next year, what growth rate is expected for the company's stock price?

g = .105 - ($4.25 / $73) g = .0468, or 4.68%

A Microgates Industries bond has a 10 percent coupon rate and a $1,000 face value. Interest is paid semiannually, and the bond has 20 years to maturity. If investors require a 12 percent yield, what is the bond's value? hat is the effective annual yield on the bond?

$849.54 Annual yield= 12.36%

Under what two assumptions can we use the dividend growth model presented in the chapter to determine the value of a share of stock?

(i) if dividends are expected to occur forever; that is, the stock provides dividends in perpetuity, and (ii) if a constant growth rate of dividends occurs forever

Year Cash Flow 0 −$27,500 1 10,430 2 13,850 3 11,270 4 9,830 5 − 4,050 1.What is the MIRR with 10% interest rate?

1. 14.14%

Year Cash Flow (A) Cash Flow (B) 0 −$78,500 −$78,500 1 43,000 21,000 2 29,000 28,000 3 23,000 34,000 4 21,000 41,000 1.Using IRR, which company should you choose? 2.If you require an 11% return, what is the NPV of each project? 3.What discount rate would you be indifferent between each both projects?

1. A=20.7 B=18.73 Choose A 2. NPV A=14,426.54 NPV B=15,012.82 Choose B 3. R=12.21%

How do you Salvage value/ Tax effects?

1. Figure out gain or loss 2. multiply by tax 3. Combine with sale

The Yurdone Corporation wants to set up a private cemetery business. According to the CFO, Barry M. Deep, business is "looking up." As a result, the cemetery project will provide a net cash inflow of $135,000 for the firm during the first year, and the cash flows are projected to grow at a rate of 4.7 percent per year forever. The project requires an initial investment of $1,575,000. 1. If Yurdone requires a return of 12 percent on such undertakings, should the cemetery business be started? 2. The company is somewhat unsure about the assumption of a 4.7 percent growth rate in its cash flows. At what constant growth rate would the company just break even if it still required a return of 12 percent on its investment?

1. NPV= $274,315.07 = take the project 2. 3.43%

A Macrohard Corp. bond carries an 8 percent coupon, paid semiannually. The par value is $1,000, and the bond matures in six years. If the bond currently sells for $911.37, what is its yield to maturity?

10%

Year Project I Project J 0 −$172,000 −$172,000 1 83,200 60,000 2 74,400 68,800 3 63,200 76,800 4 57,800 84,000 What is the crossover point?

14.06%

what is price of a $2.00 dividend in five years that is expected to grow at a rate of 8 percent?

2.00x(1.08^5)= 2.93 (2.93x1.08)/.08=39.55

Year Cash Flow 0 −$6,700 1 2,800 2 3,200 3 2,200 4 1,400 what is the payback period

2.32 years

Winnebagel Corp. currently sells 28,000 motor homes per year at $77,000 each and 7,000 luxury motor coaches per year at $120,000 each. The company wants to introduce a new portable camper to fill out its product line; it hopes to sell 29,000 of these campers per year at $23,500 each. An independent consultant has determined that if the company introduces the new campers, it should boost the sales of its existing motor homes by 2,500 units per year and reduce the sales of its motor coaches by 750 units per year. What is the amount to use as the annual sales figure when evaluating this project?

29,000($23,500) = $681,500,000 2,500($77,000) = $192,500,000 750($120,000) = $90,000,000 loss in sales Net sales = $681,500,000 + 192,500,000 -90,000,000 Net sales = $784,000,000

The last dividend, D0, was $2. The dividend is expected to grow steadily at 8 percent. The required return is 16 percent. Based on the dividend growth model, we can say that the current price is?

2x1.08/(.16-.08)= 27

Year CF 0 −$100 1 50 2 40 3 40 4 15 Calculate npv with a required return of 15%

8.6

Which has greater interest rate risk, a 30-year Treasury bond or a 30-year BB corporate bond?

All else the same, the Treasury security will have lower coupons because of its lower default risk, so it will have greater interest rate risk.

Your firm is contemplating the purchase of a new $410,000 computer-based order entry system. The system will be depreciated straight-line to zero over its five-year life. It will be worth $30,000 at the end of that time. You will save $125,000 before taxes per year in order processing costs, and you will be able to reduce working capital by $35,000 at the beginning of the project. Working capital will revert back to normal at the end of the project. If the tax rate is 35 percent, what is the IRR for this project?

Annual depreciation charge = $410,000 / 5 Annual depreciation charge = $82,000 Aftertax salvage value = $30,000(1 - .35) Aftertax salvage value = $19,500 OCF = $125,000(1 - .35) + .35($82,000) OCF = $109,950 NPV = 0 = -$410,000 + 35,000 + $109,950(PVIFAIRR%,5) + [($19,500 - 35,000) / (1+IRR)5] IRR = 13.37%

Kenny, Inc., is looking at setting up a new manufacturing plant in South Park. The company bought some land six years ago for $5.3 million in anticipation of using it as a warehouse and distribution site, but the company has since decided to rent facilities elsewhere. The land would net $7.4 million if it were sold today. The company now wants to build its new manufacturing plant on this land; the plant will cost $26.5 million to build, and the site requires $1.32 million worth of grading before it is suitable for construction. What is the proper cash flow amount to use as the initial investment in fixed assets when evaluating this project?

Cash flow = $7,400,000 + 26,500,000 + 1,320,000 Cash flow = $35,220,000

Incremental cash flows=...

Corporate cash flow with the project - corporate cash flow without the project

relevant cash flows

Corporate cash flows with project minus corporate cash flow without the project

Gontier Corporation stock currently sells for $53.95 per share. The market requires a return of 10.3 percent on the firm's stock. If the company maintains a constant 4.9 percent growth rate in dividends, what was the most recent dividend per share paid on the stock?

D0 = $53.95(.103 - .049) / (1 + .049) D0 = $2.78

Rolston Music Company is considering the sale of a new sound board used in recording studios. The new board would sell for $27,300, and the company expects to sell 1,500 per year. The company currently sells 1,850 units of its existing model per year. If the new model is introduced, sales of the existing model will fall to 1,520 units per year. The old board retails for $24,900. Variable costs are 55 percent of sales, depreciation on the equipment to produce the new board will be $2,150,000 per year, and fixed costs are $3,200,000 per year. If the tax rate is 38 percent, what is the annual OCF for the project?

Depreciation 2,150,000 EBT $9,379,850 Tax 3,564,343 Net income $5,815,507 OCF = $9,379,850 + 2,150,000 - 3,564,343 OCF = $7,965,507

Suppose you know that a company's stock currently sells for $67 per share and the required return on the stock is 11.5 percent. You also know that the total return on the stock is evenly divided between capital gains yield and dividend yield. If it's the company's policy to always maintain a constant growth rate in its dividends, what is the current dividend per share?

Dividend yield = 1/2(.115) Dividend yield = .0575 = Capital gains yield D1 = .0575($67) D1 = $3.85 This is next years dividend, so current dividend is D0 = $3.85 / 1.0575 D0 = $3.64

Sales $558,400 Costs 346,800 Depreciation 94,500 EBIT ? Taxes (35%) ? Net income ? What is the OCF? what is the depreciation tax shield?

EBIT $ 117,100 Taxes@35% 40,985 Net income $ 76,115 OCF = $117,100 + 94,500 - 40,985 OCF = $170,615 Depreciation tax shield = .35($94,500) Depreciation tax shield = $33,075

OCF=

EBIT + depreciation - taxes

Mater Pasta, Inc., has projected a sales volume of $1,432 for the second year of a proposed expansion project. Costs normally run 70 percent of sales, or about $1,002 in this case. The depreciation expense will be $80, and the tax rate is 34 percent. What is the operating cash flow?

Ebit=1,432-1002-80 = 350 Taxes= 350 x .34 = 119 Net Income= 350-119 = 231 OCF= 350+80-119 = 311

Given the choice, would a firm prefer to use MACRS depreciation or straight-line depreciation?

For tax purposes, a firm would choose MACRS because it provides for larger depreciation deductions earlier. These larger deductions reduce taxes, but have no other cash consequences. Notice that the choice between MACRS and straight-line is purely a time value issue; the total depreciation is the same, only the timing differs.

Pro forma projects...

Future cash flows

What is the relationship between IRR and NPV?

IRR is the interest rate that causes NPV for a series of cash flows to be zero

A substantial percentage of the companies listed on the NYSE and the NASDAQ don't pay dividends, but investors are nonetheless willing to buy shares in them. How is this possible?

Investors believe the company will eventually start paying dividends (or be sold to another company)

What are the problems associated with using the payback period as a means of evaluating cash flows?

It ignores the time value of money, fully ignoring any cash flows after the cutoff point

Year Cash Flow 0 −$168,500 1 86,000 2 91,000 3 53,000 NPV: At a required rate of 9% should the firm accept this project? IRR: Required rate is 11% should the firm accept?

NPV=27,917.69 (Accept) IRR=18.79 (Accept)

Is it true that a U.S. Treasury security is risk free?

No. As interest rates fluctuate, the value of a Treasury security will fluctuate.

The Sleeping Flower Co. has earnings of $2.65 per share. The benchmark PE for the company is 18. What stock price would you consider appropriate? What if the benchmark PE were 21?

P = 18($2.65) P = $47.70 P = 21($2.65) P = $55.65

Antiques 'R' Us is a mature manufacturing firm. The company just paid a dividend of $16.30 but management expects to reduce the payout by 4.5 percent per year, indefinitely. If you require a return of 12 percent on this stock, what will you pay for a share today?

P0 = $16.30(1 - .045) / [(.12 - (-.045)] P0 = $94.34

Take Time Corporation will pay a dividend of $3.65 per share next year. The company pledges to increase its dividend by 5.1 percent per year, indefinitely. If you require a return of 11 percent on your investment, how much will you pay for the company's stock today?

P0 = $3.65 / (.11 - .051) P0 = $61.86

Hot Wings, Inc., has an odd dividend policy. The company has just paid a dividend of $3 per share and has announced that it will increase the dividend by $5 per share for each of the next four years, and then never pay another dividend. If you require a return of 10.4 percent on the company's stock, how much will you pay for a share today?

P0 = $8 / 1.104 + $13 / 1.104^2 + $18 / 1.104^3 + $23 / 1.104^4 P0 = $46.77

Burkhardt Corp. pays a constant $13.50 dividend on its stock. The company will maintain this dividend for the next 9 years and will then cease paying dividends forever. If the required return on this stock is 9.2 percent, what is the current share price?

P0 = $80.28

whatever Inc has a new issue of preferred stock it calls 20/20 preferred. The stock will pay a $20 dividend per year, but the first dividend will not be paid until 20 years from today. If you require a return of 7.1 percent on this stock, how much should you pay today?

P19 = D20 / R P19 = $20 / .071 P19 = $281.69 P0 = $281.69 / 1.071^19 P0 = $76.52

Burton Corp. is growing quickly. Dividends are expected to grow at a rate of 25 percent for the next three years, with the growth rate falling off to a constant 6 percent thereafter. If the required return is 11.5 percent and the company just paid a dividend of $2.50, what is the current share price?

P3 = $2.50(1.25)^3 (1.06) / (.115 - .06) P3 = $94.11 P0 = $2.50(1.25) / 1.115 + $2.50(1.25)^2 / 1.115^2 + $2.50(1.25)^3 / 1.115^3 + $94.11 / 1.115^3 P0 = $77.35

Apocalyptica Corporation is expected to pay the following dividends over the next four years: $6, $12, $17, and $3.25. Afterward, the company pledges to maintain a constant 5 percent growth rate in dividends, forever. If the required return on the stock is 11 percent, what is the current share price?

P4 = $3.25(1.05) / (.11 - .05) P4 = $56.88 P0 = $6 / 1.11 + $12 / 1.11^2 + $17 / 1.11^3 + $3.25 / 1.11^4 $56.88 / 1.11^4 P0 = $67.18

Apocalyptica Corporation is expected to pay the following dividends over the next four years: $6, $12, $17, and $3.25. Afterward, the company pledges to maintain a constant 5 percent growth rate in dividends, forever. If the required return on the stock is 11 percent, what is the current share price?

P4 = $56.88 P0 = $67.18

Metallica Bearings, Inc., is a young start-up company. No dividends will be paid on the stock over the next nine years, because the firm needs to plow back its earnings to fuel growth. The company will then pay a dividend of $19 per share 10 years from today and will increase the dividend by 5 percent per year thereafter. If the required return on this stock is 13 percent, what is the current share price?

P9 = $19.00 / (.13 - .05) P9 = $237.50 P0 = $237.50 / 1.13^9 P0 = $79.06

Treasury bid and ask quotes are sometimes given in terms of yields, so there would be a bid yield and an ask yield. Which do you think would be larger?

Prices and yields move in opposite directions. Since the bid price must be lower, the bid yield must be higher.

The next dividend payment by Dizzle, Inc., will be $2.48 per share. The dividends are anticipated to maintain a growth rate of 4.5 percent forever. If the stock currently sells for $39.85 per share, what is the required return? what is the dividend yield? capital gains?

R = ($2.48 / $39.85) + .045 = 10.72% dividend yield = $2.48 / $39.85= 6.22% capital gains= 4.5% (same as dividend growth rate)

Mitchell, Inc., is expected to maintain a constant 4.6 percent growth rate in its dividends, indefinitely. If the company has a dividend yield of 5.8 percent, what is the required return on the company's stock?

R = .058 + .046 R = .1040, or 10.40%

TwitterMe, Inc., is a new company and currently has negative earnings. The company's sales are $1.35 million and there are 130,000 shares outstanding. If the benchmark price-sales ratio is 4.8, what is your estimate of an appropriate stock price?

Sales per share = Sales / Shares outstanding Sales per share = $1,350,000 / 130,000 Sales per share = $10.38 P = 4.8($10.38) P = $49.85

Shark Attack problem: Estimated sales 50,000 cans Sales Price per can $4.00 Cost per can $2.50 Estimated life 3 years Fixed costs $12,000/year Initial equipment cost $90,000 100% depreciated over 3 year life Investment in NWC $20,000 Tax rate 34% Cost of capital 20%

Sales= $200,000 Variable cost= 125,000 Gross profit= 75,000 (sales-VC) Fixed= 12,000 Depreciation= 30,000 (90,000/3) EBIT= 33,000 (GP- FC-Depr) taxes= 11,220 NI= $21,780 refer to ch9 slide 10 and on

Cochran, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of $1,950,000. The fixed asset will be depreciated straight-line to zero over its three-year tax life, after which time it will be worthless. The project is estimated to generate $2,145,000 in annual sales, with costs of $1,205,000. If the tax rate is 35 percent, what is the OCF for this project?

Tax shield approach OCF = (Sales - Costs)(1 - TC) + Depreciation(TC) OCF = ($2,145,000 - 1,205,000)(1 - .35) + .35($1,950,000 / 3) OCF = $838,500

If the company has 450,000 shares outstanding and the stock currently sells for $34, how much will it cost you to buy a seat if the company uses straight voting? Assume that the company uses cumulative voting and there are 4 seats in the current election; how much will it cost you to buy a seat now?

Shares needed = (450,000 shares / 2) + 1 Shares needed = 225,001 Total cost = 225,001 × $34 Total cost = $7,650,034 Percent of stock needed = 1 / (4 + 1) Percent of stock needed = .20, or 20% Number of shares to purchase = (450,000 × .20) + 1 Number of shares to purchase = 90,001 Total cost = 90,001 × $34 Total cost = $3,060,034

relavant cash flows Sunk costs? Opportunity costs? Side effects/ erosion? NWC? Financing costs? Tax Effects?

Sunk= no Opportunity= Yes Side/Erosion= yes NWC= yes Financing= No Tax= yes

Suppose a company has a preferred stock issue and a common stock issue. Both have just paid a $2 dividend. Which do you think will have a higher price, a share of the preferred or a share of the common?

The common stock probably has a higher price because the dividend can grow, whereas it is fixed on the preferred. However, the preferred is less risky because of the dividend and liquidation preference, so it is possible the preferred could be worth more, depending on the circumstances

Based on the dividend growth model, what are the two components of the total return on a share of stock?

The two components are the dividend yield and the capital gains yield

Consider four different stocks, all of which have a required return of 17 percent and a most recent dividend of $2.40 per share. Stocks W, X, and Y are expected to maintain constant growth rates in dividends for the foreseeable future of 8 percent, 0 percent, and −5 percent per year, respectively. Stock Z is a growth stock that will increase its dividend by 20 percent for the next two years and then maintain a constant 12 percent growth rate, thereafter. What is the dividend yield for each of these four stocks? What is the expected capital gains yield?

W: P0 = D0(1 + g) / (R - g) P0 = $2.40(1.08) / (.17 - .08) P0 = $28.80 Dividend yield = D1/P0 Dividend yield = $2.40(1.08) / $28.80 Dividend yield = .09, or 9% Capital gains yield = Total return - Dividend yield Capital gains yield = .17 - .09 Capital gains yield = .08, or 8% X: Dividend yield = .17, or 17% Capital gains yield = .00, or 0% Y: P0 = D0(1 + g) / (R - g) P0 = $2.40(1 - .05) / [.17 - (-.05)] P0 = $10.36 Dividend yield = D1 / P0 Dividend yield = $2.40(1 - .05) / $10.36 Dividend yield = .22, or 22% Capital gains yield = Total return - Dividend yield Capital gains yield = .17 - .22 Capital gains yield = -.05, or -5% Z: P2 = $2.40(1.20)^2 (1.12) / (.17 - .12) P2 = $77.41 P0 = $2.40(1.20) / 1.17 + $2.40(1.20)^2 / 1.17^2 + $77.41 / 1.17^2 P0 = $61.54 Dividend yield = .0468, or 4.68% Capital gains yield = .1232, or 12.32%

The incremental cash flows for project evaluation consist of

any and all changes in the firm's future cash flows that are a direct consequence of taking the project.

Production of the implants will require $1,500,000 in net working capital to start and additional net working capital investments each year equal to 15 percent of the projected sales increase for the following year. Total fixed costs are $1,950,000 per year, variable production costs are $230 per unit, and the units are priced at $355 each. The equipment needed to begin production has an installed cost of $18,500,000. Because the implants are intended for professional singers, this equipment is considered industrial machinery and thus qualifies as seven-year MACRS property. In five years, this equipment can be sold for about 20 percent of its acquisition cost. AAI is in the 35 percent marginal tax bracket and has a required return on all its projects of 15 percent. Based on these preliminary project estimates, what is the NPV of the project? What is the IRR? Year Unit Sales 1 67,500 2 83,900 3 98,700 4 86,000 5 72,000

look at #25 on solutions manual

Stand Alone Principle

once we have determined the incremental cash flows from undertaking a project, we can view that project as a kind of "minifirm" with its own future revenues and costs, its own assets, and, of course, its own cash flows

In the context of capital budgeting, what is an opportunity cost?

opportunity cost refers to the value of an asset or other input that will be used in a project. The relevant cost is what the asset or input is actually worth today, not, for example, what it cost to acquire.

Gilmore, Inc., just paid a dividend of $2.35 per share on its stock. The dividends are expected to grow at a constant rate of 4.1 percent per year, indefinitely. If investors require a return of 10.4 percent on this stock, what is the current price? What will the price be in three years? In 15 years?

price today P0 = $2.35(1.041) / (.104 - .041) =38.83 3 years P3 = P3 = $38.83(1 + .041)^3 = 43.81 15 years P15 = P15 = $38.83(1 + .041)^15 = 70.95

current stock value reflects....

risk, timing, and magnitude of all future cash flows, both short-term and long-term

real gain=....

sales price- cost basis Cost basis = BV on day of sale

Suppose today a 10 percent coupon bond sells at par. Two years from now, the required return on the same bond is 8 percent. What is the coupon rate on the bond now?

the coupon rate on the bond is still 10 percent, and the YTM is 8 percent.

Erosion is only relevant when...

the sales would not otherwise be lost.

why would investors buy shares of stock with no voting rights?

they want to

Pro Forma Financial statements need....

unit sales, the selling price per unit, the variable cost per unit, and total fixed costs, and total investment required, including any investment in net working capital