Question

Assignment Questions

Q1: Carrefour is expecting its new center to generate the following cash flows:

Years	0	1	2	3	4	5
Initial Investment	($35,000,000)
Net operating cash-flow		$6,000,000	$8,000,000	$16,000,000	$20,000,000	$30,000,000

a. Determine the payback for this new center. (1 mark)

b. Determine the net present value using a cost of capital of 15 percent. Should the project be accepted? (1 mark)

Q2. What is the EAC of two projects: project A, which costs $150 and is expected to last two years, and project B, which costs $190 and is expected to last three years? The cost of capital is 12%. (1 mark)

Answer:

Q3. A company pays annual dividends of $10.40 with no possibility of it changing in the next several years. If the firm’s stock is currently selling at $80, what is the required rate of return? (1 mark)

Answer:

Q4. Stag corp has a capital structure which is based on 50% common stock, 20% preferred stock and 30% debt. The cost of common stock is 14%, the cost of preferred stock is 8% and the pre-tax cost of debt is 10%. The firm's tax rate is 40%. (1 mark)

1. Calculate the WACC of the firm.
2. The firm is considering a project that is equally as risky as the firm's current operations. This project has initial costs of $280,000 and annual cash inflows of $66,000, $320,000, and $133,000 over the next three years, respectively. What is the net present value of this project ?

Answer 1

1)

a) Statement showing cummulative cash flow

Year	Cash flow	Cummulative cash flow
1	6000000	6000000
2	8000000	14000000
3	16000000	30000000
4	20000000	50000000
5	30000000	80000000

using interpolation we can find payback period

Year	Cummulative cash flow
3	30000000
4	50000000
1	20000000
?	5000000

=5000000/20000000

=0.25

Thus payback period = 3+0.25 = 3.25 years

b) Statement showing NPV

Year	Cash flow	PVIF @ 15%	PV
1	6000000	0.8696	5217391
2	8000000	0.7561	6049149
3	16000000	0.6575	10520260
4	20000000	0.5718	11435065
5	30000000	0.4972	14915302
PV of cash inflow	48137167
Initial Investment	35000000
NPV	13137167

NPV = $13137167

Thus project should be accepted

2)

EAC of project A = Cost/PVIFA(12%,2)

Cost = 150$

r=required rate of return =12%

n = no of years = 2

PVIFA(r%,n) = [1-(1/(1+r)^n /r]

PVIFA(12%,2) = [ 1-(1/(1+12%)^2 /12%]

=[1-(1/(1+0.12)^2 / 0.12]

=[1-(1/1.12)^2 /0.12]

=[1-0.7972 /0.12]

=[0.2028/0.12]

=1.6901

Thus EAC of project A = 150/1.6901

=88.75$

EAC of project B = Cost/PVIFA(12%,3)

Cost = 190$

r=required rate of return =12%

n = no of years = 3

PVIFA(r%,n) = [1-(1/(1+r)^n /r]

PVIFA(12%,3) = [ 1-(1/(1+12%)^3 /12%]

=[1-(1/(1+0.12)^3 / 0.12]

=[1-(1/1.12)^3 /0.12]

=[1-07118 /0.12]

=[0.2882/0.12]

=2.4018

Thus EAC of project A = 190/2.4018

=79.10$

3)

Required rate of return = Dividend/Current selling price

=10.40/80

=0.13

i.e 13%

4)

a) After tax cost of debt = pre-tax cost of debt(1-tax rtate)

=10%(1-0.4)

=10%(0.6)

=6%

Statement showing WACC

Particulars	Weight	Cost of capital	WACC
a	b	c =axb
Equity	50%	14%	7.00%
Pref shares	20%	8%	1.60%
Debt	30%	6%	1.80%
WACC			10.40%

Thus WACC = 10.40%

b)Statement showing NPV

Year	Cash flow	PVIF @ 10.40%	PV
1	66000	0.9058	59783
2	320000	0.8205	262550
3	133000	0.7432	98843
PV of cash inflow	421175
Initial Investment	280000
NPV	141175

Thus NPV = $141175