Chapter 1



FINC 340 Financial Management

Homework Assignment III

Please provide your answer in the allowed space and show your work. Unexplained answers may loose points.

Each question/problem is 2 points.

1. Green Company’s common stock is currently selling at $24.00 per share. The company recently paid dividends of $1.92 per share and projects growth at a rate of 4%. At this rate, what is the stock’s expected rate of return?

2. Tri State Pickle Company preferred stock pays a perpetual annual dividend of 2 1/2% of its par value. Par value of TSP preferred stock is $100 per share. If investors’ required rate of return on this stock is 15%, what is the value of per share?

3. You are evaluating the purchase of Cool Toys, Inc. common stock that just paid a dividend of $1.80. You expect the dividend to grow at a rate of 12%, indefinitely. You estimate that a required rate of return of 17.5% will be adequate compensation for this investment. Assuming that your analysis is correct, what is the most that you would be willing to pay for the common stock if you were to purchase it today?

4. Fris B. Corporation stock is currently selling for $42.86. It is expected to pay a dividend of $3.00 at the end of the year. If the required return on the stock is 10% what is the implied dividend growth rate? Please note that required should be considered same as expected return in this case.

5. You are considering the purchase of Wahoo, Inc. The firm just paid a dividend of $4.20 per share. The stock is selling for $115 per share. Security analysts agree with top management in projecting steady growth of 12% in dividends and earnings over the foreseeable future. Your required rate of return for stocks of this type is 17.5%. If you were to purchase and hold the stock for three years, what would the expected dividends be worth today? (Hint: You should estimate and discount the dividend payments over the next three years.)

6. You are considering the purchase of AMDEX Company stock. You anticipate that the company will pay dividends of $2.00 per share next year and $2.25 per share the following year. You believe that you can sell the stock for $17.50 per share two years from now. If your required rate of return is 12%, what is the maximum price that you would pay for a share of AMDEX Company stock?

7. Discuss two reasons why preferred stock would be viewed as less risky than common stock to investors.

The next five problems are based on the following cash flows. Please assume a 10% required return for all discounting purposes.

|Year |Cash Flow |Cumulative CIF |PVCIF |Cumulative PVCIF |

|0 |($32,000) | | | |

|1 |$10,000 | | | |

|2 |$20,000 | | | |

|3 |$10,000 | | | |

|4 |$5,000 | | | |

8. Manheim Candles is considering a project with the above incremental cash flows. What is the payback period of the project?

9. What is the discounted payback period of the Manheim Candles’ project?

10. What is the NPV of Manheim Candles’ project

11. What is the IRR of Manheim Candles’ project

12. What is the MIRR of Manheim Candles’ project

The next three questions are based on the following:

The Deacon Company is considering two mutually exclusive projects with lives of 3 and 6 years. The required rate of return on these projects is 15%. The after-tax cash flows for projects P and T are listed below.

|Year |Cash Flow P |Cash Flow T |

|0 |-$80,000 |-$80,000 |

|1 |$30,625 |$40,000 |

|2 |$30,625 |$40,000 |

|3 |$30,625 |$40,000 |

|4 |$21,563 | |

|5 |$21,563 | |

|6 |$21,563 | |

13. What is each project's net present value?

14. What is each projects equivalent annual annuity (EAA)?

15. Which project would you choose? Why?

The next five questions are based on the following:

A firm is trying to determine whether to purchase a new asset. The proposed asset has a purchase price of $50,000 and has installation costs of $3,000. The asset will be depreciated over its five year life using the straight-line method. The new asset is expected to increase sales by $17,000 and non-depreciation expenses by $2,000 annually over the life of the asset. Due to the increase in sales, the firm expects an increase in working capital during the asset’s life of $1,500, and the firm expects to be able to sell the asset for $6,000 at the end of its life. The firm’s marginal tax rate is 34 percent and its required rate of return is 12 percent.

16. What is the initial investment of the project?

17. What is the annual depreciation expense?

18. What are the annual after-tax cash flows (annual free cash flows (FCF)) during years 1 through 5? Note: Annual free cash flows are the same.

19. What is the amount of terminal cash flow?

20. What are the net present value, internal rate of return and your decision on investing?

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