1. Financial Market is expecting a period of intense growth and has decided to retain more of its earnings to help finance that growth. As a result, it is going to reduce its annual dividend by thirty percent a year for the next seven years. After that, it will maintain a constant dividend. The pay out ratio is 32.5% and the company's PE is 12. Last year, the company paid $3.60 as the annual dividend per share. You bought the stock at $34.
a. What is the market value of this stock if the required rate of return is 14.5 percent?
b. What are the dividends yields and capital gains yield today? Briefly discuss your findings.
2. A firm is considering Projects S and L, and X whose cash flows are shown below. These projects are mutually exclusive, equally risky, and not repeatable. The CEO wants to use the NPV and/or IRR criterion, while the CFO favors the IRR method. You were hired to advise the firm on the best procedure. If the wrong decision criterion were used, how much potential value would the firm lose? Your required return is 6.00%
Year 0 1 2 3 4
CFS -$1,025 $380 $380 $380 $380
CFL -$2,150 $765 $765 $765 $765
CFx -3,670 $568 $675 $1630 $1850
a. Calculate Payback, discounted payback, NPV, IRR and Profitability Index for each and briefly discuss your findings.
b. Which project would you recommend is they are all mutually exclusive?
c. If you had enough funding for all three independent projects which would you recommend and why?
3. Top Motors has a beta of 1.30, the T-bill rate is 3.00%, and the T-bond rate is 6.5%. The annual return on the stock market during the past three years was 15.00%, but investors expect the annual future stock market return to be 13.00%.
a. What is the firm's required return? Discuss your findings.
b. You have a portfolio of three securities with a beta of 1.05, what are the weights of the portfolio?
c. What is the beta of a three-asset portfolio with an expected return of 11?
4. Consider the following information on three stocks: A Portfolio is invested 35 percent in Stock A, B and 30 percent in stock C. What is the expected risk premium on the portfolio if the T-bill rate is 3.3 percent?
5.ESSAYS: Answer the following three essays. Do not use the textbook wording or you will be penalized. Each question should be one side of one page in length including all parts.
A. 1) Briefly discuss the importance of Capital Budgeting to a corporation. 2) How does the net present value (NPV) decision rule relate to the primary goal of financial management, which is creating wealth for shareholders? 3) Briefly discuss the IRR along with one pro and on con to this rule.
B. 1) Describe the relationships that exist between the coupon rate, The yield to maturity, and the current yield for both a discount bond and a premium bond. 2) What does the Yield to Maturity represent to the bond investors?
C. According to Capital Asset Pricing Model (CAPM), the expected return on a risky asset depends on three components. 1) Describe each component and explain its role in determining expected return. 2) Differentiate between systematic and unsystematic risk and what one has a risk premium? Give one example of each type of risk.