1. Tank Industries Washers expects to pay the following dividends over the next 4 years: $2.50, $3.20, $4.75 and $5.20 respectively (starting at time 1).
a. After year 4, the firm expects a constant growth rate of 3%. If investors require 11%, what is the current share price?
b. The CEO, Major Payne, has identified several new investment opportunities. He is trying to convince investors to back his strategy. He would need to keep the dividends at $2.50 each year for the next four years. After year 4, the growth rate would be 10% forever. Based on the increased risk, the other investors increase the required return to 15%. Should they back his strategy? Hint: Re-estimate the current price based on the new cash flows.
2. BAC is considering an issue of preferred stock. The dividends are 8.12% of the $25 par value.
a. If the current price is $26.25 per share, what is the return on the preferred stock?
b. Suppose the preferred stock will mature in 20 years. If the price is $26.25 per share, what is the return on the preferred stock? HINT: This is just like a bond, but the face value is 25. For the problem, you can assume the dividends are annual.
3. One use of cash flow analysis is setting the bid price on a project. To calculate the bid price, we set the project NPV equal to zero and find the required price. Thus the bid price represents a financial break-even level for the project. Guthrie Enterprises needs someone to supply it with 230,000 cartons of machine screws per year to support its manufacturing needs over the next five years, and you've decided to bid on the contract. It will cost you $1,000,000 to install the equipment necessary to start production; you'll depreciate this cost straight-line to zero over the project's life. Your fixed production costs will be $410,000 per year, and your variable production costs should be $8.50 per carton. You also need an initial investment in net working capital of $60,000. No additional working capital is needed and no working capital will be returned. If your tax rate is 35% and you require a 14% return on your investment, what bid price should you submit?