1) Spencer Supplies’ stock is currently selling for $60 a share. The firm is expected to earn $5.40 per share this year and to pay a year-end dividend of $3.60. a. If investors require a 9% return, what rate of growth must be expressed for Spencer? b. If Spencer reinvests earnings in projects with average returns equal to the stock’s expected rate of return, then what will be next year’s EPS ? (Hint: g = ROE x Retention ratio).
2) Suppose the Schoof Company has this book value balance sheet:
Current Assets 50,000,000; Fixed Assets $ 30,000,000; Total Assets $ 80,000,000
Current Liabilities $ 10,000,000 Long-term debt 30,000,000 Common equity Common stock (1 million shares) 1,000,000 Retained Earnings 39,000,000
Total Claims $ 80,000,000
The current liabilities consist entirely of notes payable to banks, and the interest rate on this debt is 10%, the same as the rate on new bank loans. These bank loans are not used for seasonal financing but instead are part of the company’s permanent capital structure. The long-term debt consists of 30,000 bonds, each with a par value of $1,000, an annual coupon interest rate of 6%, and a 20-year maturity. The going rate of interest on new long-term debt, r_d , is 10%, and this is the percent yield to maturity on bonds. The common stock sells at a price of $60 per share. Calculate the firm’s market value capital structure.
3) The Pinkerton Publishing Company is considering two mutually exclusive expansion plans. Plan A calls for the expenditure of $50 million on a large-scale, integrated plant that will provide an expected cash flow stream of $8 million per year for 20 years. Plan B calls for the expenditure of $15 million to build a somewhat less efficient, more labor-intensive plant that has an expected cash flow stream of $3.4 million per year for 20 years. The firm’s cost of capital is 10%.
a. Calculate each project’s NPV and IRR.
b. Set up a Project Δ by showing the cash flows that will exist if the firm goes with the large plant rather than the smaller plant. What are the NPV and IRR for this Project Δ?
c. Give a logical brief explanation, based on reinvestment rates and opportunity costs, as to why the NPV method is better that the IRR method when the firm’s cost of capital is constant at some value such as 10%.