Finance Questions
Question 1.
Assume Evco, Inc., has a current price of $50 and will pay a $2
dividend in one year, and its equity cost of capital is 15%. What price
must you expect it to sell for right after paying the dividend in one
year in order to justify its current price?
Question 4.
Krell Industries has a share price of $22 today. If Krell is expected
to pay a dividend of $0.88 this year, and its stock price is expected to
grow to $23.54 at the end of the year, what is Krell’s dividend yield
and equity cost of capital?
Question 5.
NoGrowth Corporation currently pays a dividend of $2 per year, and it
will continue to pay this dividend forever. What is the price per share
if its equity cost of capital is 15% per year?
Question 6.
Summit Systems will pay a dividend of $1.50 this year. If you expect
Summit’s dividend to grow by 6% per year, what is its price per share if
its equity cost of capital is 11%?
303
304
Question 7. Dorpac
Corporation has a dividend yield of 1.5%. Dorpac’s equity cost of
capital is 8%, and its dividends are expected to grow at a constant
rate.
a. What is the expected growth rate of Dorpac’s dividends?
b. What is the expected growth rate of Dorpac’s share price?
Question 12.
Procter & Gamble will pay an annual dividend of $0.65 one year from
now. Analysts expect this dividend to grow at 12% per year thereafter
until the fifth year. After then, growth will level off at 2% per year.
According to the dividend-discount model, what is the value of a share
of Procter & Gamble stock if the firm’s equity cost of capital is
8%?
Question 19. Heavy Metal Corporation is expected to generate the following free cash flows over the next five years:
Year
|
1
|
2
|
3
|
4
|
5
|
FCF ($ millions)
|
53
|
68
|
78
|
75
|
82
|
After
then, the free cash flows are expected to grow at the industry average
of 4% per year. Using the discounted free cash flow model and a weighted
average cost of capital of 14%:
- a. Estimate the enterprise value of Heavy Metal.
- b. If Heavy Metal has no excess cash, debt of $300 million, and 40 million shares outstanding, estimate its share price.
Problems pp. 427 – 429
Question 1.
Suppose Pepsico’s stock has a beta of 0.57. If the risk-free rate is 3%
and the expected return of the market portfolio is 8%, what is
Pepsico’s equity cost of capital?
Question 3.Aluminum
maker Alcoa has a beta of about 2.0, whereas Hormel Foods has a beta of
0.45. If the expected excess return of the marker portfolio is 5%,
which of these firms has a higher equity cost of capital, and how much
higher is it?
Question 26.
Unida Systems has 40 million shares outstanding trading for $10 per
share. In addition, Unida has $100 million in outstanding debt. Suppose
Unida’s equity cost of capital is 15%, its debt cost of capital is 8%,
and the corporate tax rate is 40%.
a. What is Unida’s unlevered cost of capital?
b. What is Unida’s after-tax debt cost of capital?
c. What is Unida’s weighted average cost of capital?
Question 20
You
are considering making a movie. The movie is expected to cost $10
million upfront and take a year to make. After that, it is expected to
make $5 million when it is released in one year and $2 million per year
for the following four years. What is the payback period of this
investment? If you require a payback period of two years, will you make
the movie? Does the movie have positive NPV if the cost of capital is
10%?
Question 1 Forecasting earnings
Pisa
Pizza, a seller of frozen pizza, is considering introducing a healthier
version of its pizza that will be low in cholesterol and contain no
trans fats. The firm expects that sales of the new pizza will be $20
million per year. While many of these sales will be to new customers,
Pisa Pizza estimates that 40% will come from customers who switch to the
new, healthier pizza instead of buying the original version.
a.
Assume customers will spend the same amount on either version. What
level of incremental sales is associated with introducing the new pizza?
b.
Suppose that 50% of the customers who will switch from Pisa Pizza’s
original pizza to its healthier pizza will switch to another brand if
Pisa Pizza does not introduce a healthier pizza. What level of
incremental sales is associated with introducing the new pizza in this
case?
Question 23
Bauer
Industries is an automobile manufacturer. Management is currently
evaluating a proposal to build a plant that will manufacture lightweight
trucks. Bauer plans to use a cost of capital of 12% to evaluate this
project. Based on extensive research, it has prepared the following
incremental free cash flow projections (in millions of dollars):
Year 0 Years 1–9 Year 10
|
Revenues
100.0 100.0
− Manufacturing expenses (other than depreciation) -35.0 -35.0
− Marketing expenses -10.0 -10.0
− Depreciation -15.0 -15.0
|
=
EBIT
40.0 40.0
− Taxes (35%) -14.0 -14.0
|
= Unlevered net income 26.0 26.0
+ Depreciation +15.0 +15.0
− Increases in net working capital -5.0 -5.0
− Capital expenditures -150.0
+
Continuation
value
+12.0
|
= Free cash flow -150.0 36.0 48.0
|
a. For this base-case scenario, what is the NPV of the plant to manufacture lightweight trucks?
b.
Based on input from the marketing department, Bauer is uncertain about
its revenue forecast. In particular, management would like to examine
the sensitivity of the NPV to the revenue assumptions. What is the NPV
of this project if revenues are 10% higher than forecast? What is the
NPV if revenues are 10% lower than forecast?
c.
Rather than assuming that cash flows for this project are constant,
management would like to explore the sensitivity of its analysis to
possible growth in revenues and operating expenses. Specifically,
management would like to assume that revenues, manufacturing expenses,
and marketing expenses are as given in the table for year 1 and grow by
2% per year every year starting in year 2. Management also plans to
assume that the initial capital expenditures (and therefore
depreciation), additions to working capital, and continuation value
remain as initially specified in the table. What is the NPV of this
project under these alternative assumptions? How does the NPV change if
the revenues and operating expenses grow by 5% per year rather than by
2%?
d.
To examine the sensitivity of this project to the discount rate,
management would like to compute the NPV for different discount rates.
Create a graph, with the discount rate on the x-axis and the NPV on the
y-axis, for discount rates ranging from 5% to 30%. For what ranges of
discount rates does the project have a positive NPV?
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