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Erica’s Farm is faced with two mutually exclusive projects. The following is data on the two projects.

Project C K
Initial Investment $40,000 $50,000
Project Life 3 years 3 years
Annual Cash flow 15,000 25,000
Risk adjusted discount rate 10% 14%
Risk free rate of return 6% 6%

Evaluate the projects using risk-adjusted discount rates. What is the NPV for each project?

7. You are considering two mutually exclusive projects with the following cash flows. Which project(s) should you accept if the discount rate is 8.5 percent? What if the discount rate is 13 percent?

Year Project A Project B

0 -$80,000 $80,000

1 32,000 0

2 32,000 0

3 32,000 105,000

A) accept project A as it always has the higher NPV

B) accept project B as it always has the higher NPV

C) accept A at 8.5 percent and B at 13 percent

D) accept B at 8.5 percent and neither at 13 percent

1. The stock of Up-and-Away Inc. is selling for $80 per share, and it is currently paying a quarterly dividend of $0.25 per share. What is the dividend yield on Up-and-Away stock?

2. Sam Sharp purchased 100 shares of Electric Lighting Inc. (ELI) one year ago for $60 per share. He also received cash dividends totaling $5 per share over the past twelve months. Now that ELI’s stock price has increased to $64.50 per share, Sam has decided to sell his holdings. What is Sam’s gross (pre-tax) and net (after-tax) return on this investment, assuming that he faces a 15 percent tax rate on dividends and capital gains?

3. Casual Construction Corporation (CCC) earned $60,000,000 during 2009. The firm expects to earn $63,000,000 during 2010, in line with its long-term earnings growth rate. There are 20 million CCC shares outstanding, and the firm has a policy of paying out 40 percent of its earnings as cash dividends. Investors require a 10 percent return on CCC shares.

a. What is CCC’s current dividend per share? What is it expected to be next year?
b. Use the Gordon growth model (see Equation 5.6) to calculate CCC’s stock price today.

4. It is January 1, 2009. Boomer Equipment Company (BEC) currently has assets of $250 million and expects to earn a 10 percent return on assets during the year. There are 20 million shares of BEC stock outstanding. The firm has an opportunity to invest in a (minimally) positive-NPV project that will cost $25 million over the course of 2009. BEC needs to determine whether it should finance this investment by retaining profits over the course of the year or pay the profits earned as dividends and issue new shares to finance the investments. Show that the decision is irrelevant in a world of frictionless markets.

5. General Manufacturing Company (GMC) follows a policy of paying out 50 percent of its net income as cash dividends to its shareholders each year. The company plans to do so again this year, during which GMC earned $100 million in net profits after tax. The company has 40 million shares outstanding and pays dividends annually.

a. What is the company’s nominal dividend payment per share each year?
b. Assuming that GMC’s stock price is $54 per share immediately before its ex-dividend date, what is the expected price of GMC stock on the ex-dividend date if there are no personal taxes on dividend income received?

6. Recently a financial newspaper reported the following spot and forward rates for the Japanese
yen (¥)

Spot: $0.007556/¥ (¥132.34/$)
1-month: $0.007568/¥ (¥132.14/$)
3-month: $0.007593/¥ (¥131.71/$)

Supply the forward yen premium or discount (specify which it is) for both the one- and three-month quotes as an annual percentage rate.

7. If the expected rate of inflation in the United States is 1%, the one-year risk-free interest rate is 2%, and the one-year risk-free rate in Britain is 4%, what is the expected inflation rate in Britain?

Excel Corp. has recently witnessed a period of depressed earnings performance. As a result, cash dividend payments have been suspended. Investors do not anticipate a resumption of dividends until two years from today, when a yearly dividend of $0.25 will be paid. That yearly dividend is expected to be increased to $0.75 in the following year and $1.50 in the year after that. Beyond the time when the $1.50 dividend is paid, investors expect Excel’s dividends to grow at an annual rate of 5 percent into perpetuity. All dividends are assumed to be paid at the end of each year. If you require an 18 percent rate of return on Excel’s stock, what is the value of one share of this stock to you today?