Questions and Answers on Finance

The “Emu Is A Bird That Does Not Fly” company is experiencing significant growth. Dividends are growing at 15% and the company expects to stay at that rate of growth for the next 3 years. In the fourth year dividends will grow at 10% and thereafter dividends will grow indefinitely at a constant rate of 5%. The company just paid a dividend of $1.00 (i.e., an investor buying the stock today does not receive this dividend). If the required rate of return is 11%, what is the value per share of the company? How does your answer change if an investor buying the stock today is entitled to the recent $1.00 dividend?

4. You run a hedge fund specializing in identifying securities which are mispriced relative to the CAPM. Your research team has provided information about two potential investments, the “Redback Spider Company” and the “Koalas are Marsupials not Bears Company”, over the coming year. The expected market risk premium is 5% and the risk-free rate is 3%. Annual Forecast Return Standard Deviation Beta Redback Spider Company 12% 30% 2.0 Koalas are Marsupials not Bears Company 8% 30% 0.8 Which securities, if any, are underpriced or overpriced relative to the CAPM and by how much?

5.a. If you buy a stock for $100, receive a dividend of $3 and then sell the stock for $110, what is the total return from your investment (in percentage terms)?

5.b. If a project has a 35% chance of doubling your money and a 65% chance of losing half your money, what is the expected return for this project?

5.c. You own a portfolio of stocks with 40% of your money invested in company A, 40% of your money invested in company B and 20% of your money invested in company C. If the betas are 1.0 for stock A, 2.0 for stock B and 0.5 for stock C, what is the beta of your portfolio?

6. For the following project compute the Payback Period, Discounted Payback Period, Net Present Value, Profitability Index, Internal Rate of Return and the Modified Internal Rate of Return. The appropriate discount rate is 11%. Year Cash Flow

year cash flow

0 -$11,000

1 $5,000

2 $3,000

3 $8,000

7. For the following project compute the Internal Rate of Returns (there are more than one) and the Modified Internal Rate of Return. The appropriate discount rate is 10%. Year Cash Flow

year cash flow

0 -$11,000

1 $5,000

2 $3,000

3 $8,000

4 -$3,000

12. Refer to Exhibit 1 below. a). What is the best estimate of the after-tax cost of debt? b). Based on the CAPM, what is the firm’s cost of equity? c). What is the best estimate for the weight of debt to use in calculating the firm’s WACC?