Problem 11-03

An investor with a required return of 14 percent for very risky investments in common stock has analyzed three firms and must decide which, if any, to purchase. The information is as follows:

Stock A: $  

Stock B: $  

Stock C: $  

%

Stock A: $  

Stock B: $  

Stock C: $  

1. • What is the maximum price that the investor should pay for each stock based on the dividend-growth model? Round your answers to the nearest cent.
   • If the investor does buy stock A, what is the implied percentage return? Round your answer to two decimal places.
   • If the appropriate P/E ratio is 11, what is the maximum price the investor should pay for each stock? Round your answers to the nearest cent.
2. If the appropriate P/E ratio is 5, what is the maximum price the investor should pay for each stock? Round your answers to the nearest cent.

   Stock A: $  

   Stock B: $  

   Stock C: $  

The risk-free rate of return is 4 percent, and the expected return on the market is 7.5 percent. Stock A has a beta coefficient of 1.6, an earnings and dividend growth rate of 8 percent, and a current dividend of $2.10 a share. Do not round intermediate calculations. Round your answers to the nearest cent.

a) What should be the market price of the stock?

b) If the current market price of the stock is $118.00, what should you do?

c) If the expected return on the market rises to 8.8 percent and the other variables remain constant, what will be the value of the stock?

d)If the risk-free return rises to 6 percent and the return on the market rises to 9.1 percent, what will be the value of the stock?

e) If the beta coefficient falls to 1.5 and the other variables remain constant, what will be the value of the stock?

Suppose there are two independent economic factors, M₁ and M₂. The risk-free rate is 4%, and all stocks have independent firm-specific components with a standard deviation of 49%. Portfolios A and B are both well diversified.

What is the expected return–beta relationship in this economy? (Do not round intermediate calculations. Round your answers to 2 decimal places.)

Expected return–beta relationship E(r_P) = % + β_P1 + β_P2

Bilbo Bags & Things makes fashionable handbags. They are considering extending trade credit to some customers previously considered poor risks. The following estimations are made for this new customer base:

• Sales would increase by $100,000 if credit is extended to these new customers.
• Production and selling costs will be 80% of sales.
• All sales will be on credit, and 10% of them will prove to be uncollectible.
• Additional collection costs will be 5% of sales, and
• Customer Service costs will be 3% of Sales.
• The firm is in the 20 percent tax bracket.

What is the incremental income after taxes?

a). 2,000

b). 80,000

c). 1,600

d). 100,000

Your firm is contemplating the purchase of a new $475,000 computer based order entry system will be depreciated straight line to zero over its 6 year life . It will be worth $60 ,000 at the end of that time . You will save $165,000 before taxes per year in order processing costs, and you will be able to reduce working capital by $45,000 at the beginning of the project. Working capital will revert back to normal at the end of the project. If the tax rate is 25 percent, what is the IRR for this project?

Global company is considering replacing one of its equipment with a more efficient one. The old machine has a book value of $60,000 and a remaining useful life of 5 years. It can sell the old machine now for $ 265,000. The old machine is being depreciated by 120,000 per year straight line. The new machine has a purchase price of $ 1,175,000 an estimated useful life and 5 years MACRS class life and salvage value of $145,000. Annual economic savings is $255,000 if new machine is installed. Taxes 40% and WACC is 12%. Show your work the best you can with this problem.

1. Calculate the initial cash flow at time 0, which is today.
2. Calculate the cash flows for years 1 thru 5.
3. Calculate the terminal value at year 5
4. Calculate the NPV and IRR of the project and make a decision on wheather the company should accept or reject the investment and why?

A share of preferred stock pays a quarterly dividend of $1.00. If the price of the stock is $50, what is the effective annual (not nominal) rate of return on the preferred stock?

Teta Traders purchases 500 pen sets during the year at R100 per set. The pen sets are sold at R400 each at a steady rate during the year. The cost of placing a single order amounts to R40. Inventory holding cost is R10 per set. Calculate the economic order quantity.

Consider an unleveraged company worth $150 million. The average investor in the company faces a 15% tax rate on equity investments and a 40% tax rate on debt investments? If debt of $50 million is borrowed and invested by the company and the company faces a 40% corporate tax rate, what is the new value of the company?

Please show work on Excel if you can.

Thank you!

: A stock price is currently $60. It is known that at the end of eight months it will be either $65 or $55. The risk-free interest rate is 8% per annum with continuous compounding. (1) What is the value of an eight-month European put option with a strike price of $60? (2) Verify that no-arbitrage arguments and risk-neutral valuation arguments give the same answers.

Google stock rose from $208 at year-end 2005 to $770 per share at year-end 2015. Google has made sizable profits but never paid a dividend. Why were people willing to pay such a high price knowing that they might not get dividends for many years?

You are considering the following two projects and can only take one. Your cost of capital is

11.2 %11.2%.

The cash flows for the two projects are as follows​ ($ million):

a. What is the IRR of each​ project?

b. What is the NPV of each project at your cost of​ capital?

c. At what cost of capital are you indifferent between the two​ projects?

d. What should you​ do?

a. The IRR for project A is nothing​%. ​ (Round to one decimal​ place.) The IRR for project B is nothing​%. ​(Round to one decimal​ place.) b. The NPV for project A is ​$ nothing million. ​(Round to two decimal​ places.) The NPV for project B is ​$ nothing million. ​(Round to two decimal​ places.) c. You will be indifferent if the cost of capital is nothing​%. ​(Round to one decimal​ place.) d. Given your cost of​ capital, which project would you​ choose? ​(Select the best choice​ below.) A. You should invest in project Upper A​, as it has the higher IRR. B. You should invest in project Upper B​, as it has the higher NPV. C. You should invest in project Upper A​, as it has the higher NPV. D. You should invest in project Upper B​, as it has the higher IRR.

2. Candy Cotton Ice-cream House currently rents an ice-cream machine for $50,000 per year, including all maintenance expenses. It is considering purchasing a machine instead, and is comparing two options:

1. Purchase the machine it is currently renting for $150,000. This machine will require $20,000 per year in ongoing maintenance expense.
2. Purchase a new more advanced machine for $250,000. This machine will require $15,000 per year in ongoing maintenance expense and lower annual packaging costs by $10,000. Additionally, the machine will require an upfront expense of $35,000 for training of operators.

Suppose the appropriate discount rate is 8% per year and the machine is purchased today. Maintenance and packaging costs are paid at the end of each year, but the rental of the machine is paid at the beginning of the year. Assume also that the machines will be depreciated via the straight-line to zero method over seven years and that they have a 10-year life with no salvage value. The marginal corporate tax rate is 35%. Should Candy Cotton Ice-cream House continue to rent, purchase its current machine, or purchase the advanced machine?

Problem 26-01
Investment Timing Option: Decision-Tree Analysis

Kim Hotels is interested in developing a new hotel in Seoul. The company estimates that the hotel would require an initial investment of $16 million. Kim expects the hotel will produce positive cash flows of $2.72 million a year at the end of each of the next 20 years. The project's cost of capital is 12%.

1. What is the project's net present value? A negative value should be entered with a negative sign. Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answer to two decimal places.
   $ million
   
2. Kim expects the cash flows to be $2.72 million a year, but it recognizes that the cash flows could actually be much higher or lower, depending on whether the Korean government imposes a large hotel tax. One year from now, Kim will know whether the tax will be imposed. There is a 50% chance that the tax will be imposed, in which case the yearly cash flows will be only $1.44 million. At the same time, there is a 50% chance that the tax will not be imposed, in which case the yearly cash flows will be $4 million. Kim is deciding whether to proceed with the hotel today or to wait a year to find out whether the tax will be imposed. If Kim waits a year, the initial investment will remain at $16 million. Assume that all cash flows are discounted at 12%. Use decision-tree analysis to determine whether Kim should proceed with the project today or wait a year before deciding.
   -Select-It makes sense to proceed with the project today.It makes sense to wait a year before deciding.