Question 1: The summary of the forecast of your company next year is as follow:
a) The firm expects to have earning per share (ESP) of $5.
b) The firm will retain all of its earnings for the next two years.
c) For the subsequent two years the firm will retain 50% of its earning.
d) The firm will retain 20% of its earnings from that point AFTERWARD.
e) Each year, retained earnings will be invested in new projects with an expected return of 25% per year.
f) Any earning that are not retained will be paid our as dividends.
g) The firms share count remains constant and all earning growth comes from the investment of retained earnings.
h) The firms equity cost of capital is 10%.
A) Draw the time time that can show the amount and timing of cash flow.
B) What price does the dividend discount model predict that your firm’s stock should sell?
C) what is the difference or strength of the free cash flow model over the dividend discount model?
Question 2: You are the CFO of your company, have an investment project. The project summarized below.
a) The project requires an initial investment in plant and equipment of $2 million.
b) The investment will be depreciated straight- line over 5 years to a salvage value of zero and the old machine is fully depreciated.
c) The firm belives that working capital must be maintained at 10% of next years forcasted revenues.
d) Revenues generated by this project are forecast as follows:
years revenues
1 $1000,000
2 $800,000
3 $800,000
4 $600,000
5 $500,000
thereafter $ 0
e) Operating expenses are expected to be 30% of the current years revenues.
f) The firms tax rate is 40%.
g) The required return on the project is 10%.
A) What are project free cash flows in year 0 to 5 that should be used to evaluated the proposed project?
B) What is project NPV?
C) What would your investment decision-make be? And why?