Question

Dundee Co. is considering Project “X” whose cash flows are shown below:

Year 0 1 2 3
CF -$1,200 $600 $550 $300

The company’s capital structure is distributed equally between debt, preferred stock and common stock. It has also the following information:

1- After tax cost of debt: 2%
2- Preferred stocks are selling at $120 per share and pay a dividend of $5 per share
3- Common stocks are selling at $40 per share, pay a year-end dividend of $2 per share and grow at a constant rate of 10%.

The company is also considering another two projects “Y” & “Z” with the following information:

Project Y Z
NPV $96.00 $281.9
MIRR 6.26% 9.24%
IRR 12.41% 10.98%
Payback Period 1.44 years 2.33 Year


Note: This problem is related to Questions 1 to 9

1. NPV of project “X” is: *

A. $86

B. $250

C. $600

D. $-1,200

E. None of the above

2. MIRR of project “X” is: *

A. 11.00%

B. 9.5%

C. 8.88%

D. 15.64%

E. None of the above

3. The Pay-Back Period of “X” is: *

A. 1.93 years

B. 2.17 years

C. 2.06 years

D. 3.00 years

E. None of the above

4. The Discounted Pay-Back Period of project “X” is: *

A. 2.06 years

B. 1.639 years

C. 2.65 years

D. 3.00 years

E. None of the above

5. Assuming that the three projects X, Y & Z are independent, which project (s) should the company choose: *

A. X, Y & Z

B. X & Z

C. Only X

D. Only Y

E. Reject all projects

6. Assuming that the three projects X, Y & Z are Mutual Exclusive, which project (s) should the company choose: *

A. X, Y & Z

B. X & Z

C. Only X

D. Only Z

E. Reject all projects

7. Assuming that the three projects X, Y & Z are independent, then based on MIRR which project (s) should the company choose: *

A. X, Y & Z

B. X & Z

C. Only X

D. Only Z

E. Reject all projects

8. Assuming that the three projects X, Y & Z are Mutual Exclusive, then based on MIRR which project (s) should the company choose: *

A. X, Y & Z

B. X & Y

C. Only X

D. Only Z

E. Reject all projects

9. If IRR for “X” is 11.00%, and the three project X, Y & Z are Independent, which project (s) should the company choose: *

A. X, Y & Z

B. X & Y

C. Only X

D. Only Y

E. Reject all projects

10. Wilson Co. is considering two mutually exclusive projects. Both require an initial investment of $10,000 at t = 0. Project X has an expected life of 2 years with after-tax cash inflows of $6,000 and $8,500 at the end of Years 1 and 2, respectively. Project Y has an expected life of 4 years with after-tax cash inflows of $4,600 at the end of each of the next 4 years. Each project has a WACC of 11%. What is the equivalent annual annuity of the most profitable project? *

A. $1,345.50

B. $1,346.30

C. $1,361.52

D. $1,376.74

E. $1,411.15

Answer 1

Cost of preference share = dividend / price

= 5/120

= 4.17

Cost of equity= dividend / price + growth rate

= 2/40 + 0.10

= 0.05 + 0.10

= 15%

Wacc= weight of debt × cost of debt +weight of preference share × cost of preference share + weight of equity × cost of equity

= 1/3 × 2% + 1/3 × 4.17% + 1/3 × 15%

= 0.67% + 1.39% + 5%

= 7.06%

Q1) E) none of the above

Explanation:

Using financial calculator to calculate Npv

Inputs: C0= -1,200

C1= 600. Frequency=1

C2= 550. Frequency= 1

C3= 300. Frequency= 1

I= 7.06%

We get, Npv of the project as $84.76

Q2) E) none of the above

Future value of cashinflows

= 600 (1+0.0706)^2 + 550 (1+0.706)^1 + 300

= 600 (1.1462) + 500 (1.0706) + 300

= 687.71 + 535.3 + 300

= 1,523

MIRR= (future value of cash inflow / present value of outflow)^1/3 - 1

= (1,523 / 1,200)^1/3 - 1

= (1.2692)^1/3 - 1

= 1.0827 - 1

= 0.0827 or 8.27%

Explanation:

Q3) B) 2.17 years

Explanation: payback period = year before full payment + left money to be recovered / amount of year after full payment

= 2 + 50 / 300

= 2 + 0.17

= 2.17 years

Q4) C) 2.65 years

Explanation:

Present value of cash flows

A) 600 /1.0706 = 560.43

B) 550 / (1.0706)^2 = 479.85

C) 300 / (1.0706)^3 = 243.2509

Discounted payback = year before full payment + left amount to be recovered / amount of year after full payment

= 2 + 159.72 / 243.2509

= 2 + 0.65

= 2.65 years

Q5) A) X,Y and Z

Explanation: all three have positive Npv.

Q6) D) Only Z

Explanation: Because it has the highest npv