Exam 3 Review Survey of Finance

8.1

Bohan Inc. has just paid a dividend of $3.75 on its stock. The growth rate in dividends is expected to be a
constant 8% per year, indefinitely. Investors require a 16% return on the stock for the first three years, an
11% for the next three years, and then a 10% return, thereafter. What is the current share price for Bohan
stock?

8.2

Weaver Co. is growing quickly. Dividends are expected to grow at a 28% rate for the next three years, with
the growth rate falling off to a constant 8% thereafter. If the required return is 14% and the company just
paid a $1.75 dividend, what is the current share price?

8.3

Koop Inc. stock currently sells for $45 per share. The market requires a 10% return on the firms stock. If
the company maintains a constant 9% growth rate in dividends, what was the most recent dividend per
share paid on the stock?

8.4

Cromwell Bank just issued some new preferred stock. The issue will pay a $10 annual dividend in
perpetuity, beginning eight years from now. If the market requires a 7% return on this investment, how
much does a share of preferred stock cost today?

8.5

Bettiga Building Company has fallen on hard times. Its management expects to pay no dividends for the
next 3 years. However, the dividend for Year 4, D4, will be $2.00 per share, and the dividend is expected to
grow at a rate of 4% in Year 5, 7% in Year 6, and 11% in Year 7 and thereafter. If the required return for
Bettiga is 18%, what is the current price of the stock?

9.1

Consider the following two mutually exclusive projects:

Year
0
1
2
3
4

Project A
-180,000
10,000
25,000
25,000
380,000

Project B
-18,000
10,000
5,000
3,000
2,000

Calculate the payback, discounted payback, internal rate of return, and net present value. Assume a
discount rate of 15%. Which project should be selected?
10.1

Bendogs Franks is looking at a new cooking system with an installed cost of $305,000. This cost will be
depreciated straight-line to zero over the projects five-year life, at the end of which the system can be
scrapped for $60,000. The system will save the firm $90,000 per year in pretax operating costs, and the
system requires an initial investment in net working capital of $27,000. If the tax rate is 34% and the
discount rate is 10%, what is the NPV of the project?

10.2

Your firm is contemplating the purchase of a new $850,000 computer-based order entry system. The system
will be depreciated straight-line to zero over its five-year life. It will be worth $150,000 at the end of that
time. You will save $350,000 before taxes per year in order processing costs and you will be able to reduce
working capital by $125,000 (this is a one-time reduction). If the tax rate is 35%, what is the IRR for this
project?

10.3

In the previous problem, suppose your required return on the project s 20% and your pretax cost savings are
only $300,000 per year. Will you accept the project? At what level of pretax cost savings would you be
indifferent between accepting the project and not accepting it (NPV = 0).

10.4

Your firm is considering a project that will save the firm $75,000 per year for its 3-year life. The
equipment for the project will cost $250,000, falls into the 3-year MACRS, and will be sold for $90,000 at
the end of the project. The project will require a working capital investment of $12,000. The tax rate is
35% and the required return is 15%. What is the NPV for this project?

8.1

0 .16
1
2
3 .11
4
5
6 .10
7
8
|---------------|---------------|--------------|---------------|---------------|---------------|---------------|---------------|
3.75 .08 4.05
4.37
4.72
5.10
5.51
5.95
6.43
6.94
D1 = 3.75(1.08) = 4.05
D5 = 5.10(1.08) = 5.51

P0

8.2

D2 = 4.05(1.08) = 4.37
D6 = 5.51(1.08) = 5.95

P6

6.43
321.34
.10 .08

P3

5.10
5.51
5.95
321.34

248.38
3
1.11 1.11 2
1.11
1.11 3

D4 = 4.72(1.08) = 5.10
D8 = 6.43(1.08) = 6.94

4.05
4.37
4.72
248.38

168.89
2
3
1.16 1.16
1.16
1.16 3

D1 = 1.75(1.28) = 2.24

D2 = 2.24(1.28) = 2.87

3.96
66.06
.14 .08

8.3

45

D0 1.09
.10 .09

45(.01) = D0(1.09)

8.4

P7

10
142.86
.07

P0

8.5

D4 = 2.00

P6

P0

142.86

1.07 7

D5 = 2.00(1.04) = 2.08

2.47
35.29
.18 .11

P0

D3 = 2.87(1.28) = 3.67

D4 = 3.67(1.08) = 3.96

2.24
2.87
3.67
66.06

51.24
1.14 1.14 2 1.14 3 1.14 3

P3

9.1

D3 = 4.37(1.08) = 4.72
D7 = 5.95(1.08) = 6.43

.45/1.09 = D0 = $.41

88.96

D6 = 2.08(1.07) = 2.23
2.00

1.18

2.08

1.18

D7 = 2.23(1.11) = 2.47

2.23

1.18

35.29

1.18 6

26.02

Payback
A:

-180,000

B:

-18,000

-170,000

-145,000

-120,000

260,000

-8,000

-3,000

2,000

18,904
16,438
-152,401 -135,963

217,266
81,303

3 + 120,000/380,000 = 3.32 years

3 years

Discounted Payback
A:
B:

-180,000
-180,000
-18,000
-18,000

8,696
-171,304
8,696
-9,304

3,781
-5,524

1,973
-3,551

1,144
-2,407

3 + 135,963/217,266 = 3.63 years

doesnt pay back

Net Present Value

NPVA = -180,000 + 10,000/1.15 + 25,000/(1.15)2 + 25,000/(1.15)3 + 380,000/(1.15)4 = 81,303.38
NPVB = -18,000 + 10,000/1.15 + 5,000/(1.15)2 + 3,000/(1.15)3 + 2,000/(1.15)4 = -2,407.57

Internal Rate of Return

10.1

IRRA = .2732

27.32%

IRRB = .0596

5.96%

Sales
Costs
Gross profit
Depreciation
EBIT
Tax (.34)
NI

?
?
90,000
(61,000)
29,000
(9,860)
19,140

Cap Inv.
NWC
OCF

0
-305,000
-27,000
-332,000

Depr = 305,000/5 = 61,000

OCF = 29,000 + 61,000 9,860 = 80,140
After-tax salvage = 60,000 (60,000 0)(.34) = 39,600

80,140
80,140

80,140
80,140

80,140
80,140

80,140
80,140

5
39,600
27,000
80,140
146,740

NPV10% = 13,147
10.2

Sales
Costs
Gross profit
Depreciation
EBIT
Tax (.35)
NI
Cap Inv.
NWC
OCF

?
?
350,000
(170,000)
180,000
(63,000)
117,000
0
-850,000
125,000
-725,000

Depr = 850,000/5 = 170,000

OCF = 180,000 + 170,000 63,000 = 287,000
After-tax salvage = 150,000 (150,000 0)(.35) = 97,500

287,000
287,000

287,000
287,000

3
287,000
287,000

4
287,000
287,000

5
97,500
-125,000
287,000
259,500

IRR = 27.55%
10.3

300,000
Sales
Costs
Gross profit
Depreciation
EBIT
Tax (.35)
NI
Cap Inv.
NWC
OCF

?
?
300,000
(170,000)
130,000
(45,500)
84,500
0
-850,000
125,000
-725,000

NPV20% = 25,059
Breakeven

Depr = 850,000/5 = 170,000

OCF = 130,000 + 170,000 45,500 = 254,500
After-tax salvage = 150,000 (150,000 0)(.35) = 97,500

254,500
254,500

254,500
254,500

3
254,500
254,500

4
254,500
254,500

5
97,500
-125,000
254,500
227,000

This one is difficult. You first must find the operating cash flows that generate a zero NPV. Once you have
those, you can find the income statement information by plugging your numbers in. (hint: Tax = ebit(t),
therefore, OCF = EBIT + Depr ebit(t))
0
-850,000
125,000

Cap Inv.
NWC
OCF

OCF
OCF

-725,000

OCF
OCF

OCF
OCF

OCF
OCF

5
97,500
-125,000
OCF
OCF + -27,500

Set your numbers into the NPV equation at 20% and equal to zero.
OCF
OCF
OCF
OCF
OCF
27,500

2
3
4
5
1.2
1.2
1.2
1.2
1.2
1.2 5
0 = -725,000 + .83(OCF) + .694(OCF) + .579(OCF) + .482(OCF) + .402(OCF) + -11,052
0 725,000

736,052 = 2.99(OCF)

OCF = 246,121

Now, we will plug numbers into an income statement and recall that our depreciation is 170,000.
Gross profit
Depreciation
EBIT
Tax (.35)
NI

?
(170,000)
?
?
?

OCF = EBIT + Depr tax (or ebit(t))

246,121 = EBIT + 170,000 EBIT(.35)
117,109 = (.65)EBIT

EBIT = 117,109

Breakeven savings = 117,109 + 170,000 = 287,109

10.4

Depreciation:

1
250,000
.33
82,500

2
250,000
.45
112,500

3
250,000
.15
37,500

Sales
Costs
Gross profit
Depreciation
EBIT
Tax (.35)
NI

?
?
75,000
(82,500)
-7,500
(-2,625)
-4,875

?
?
75,000
(112,500)
-37,500
(-13,125)
-24,375

?
?
75,000
(37,500)
37,500
(13,125)
24,375

OCF1 = -7,500 + 82,500 + 2,625 = 77,625

OCF3 = 37,500 + 37,500 13,125 = 61,875

4
250,000
.07
17,500

OCF2 = -37,500 + 112,500 + 13,125 = 88,125

Salvage = 90,000 (90,000 17,500)(.35) = 64,625

Capital investment
Working capital
OCF

0
-250,000
-12,000
-262,000

NPV12% = -23,858

77,625
77,625

88,125
88,125

3
64,625
12,000
61,875
138,500