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1. Explain the relationship between risk and return. (2.1)
2. Evaluate the cost of capital for decisions related to financing the operations of a corporation. (2.3)
3. Measure financial corporate performance. (2.4)
Assignment Question(s): (6 x 2.5 = 15 Marks)
1. You are currently thinking about investing in a stock valued at $25.00 per share. The stock recently paid a dividend of $2.25 and its dividend is expected to grow at a rate of 5 percent for the foreseeable future. You normally require a return of 14 percent on stocks of similar risk. Is the stock overpriced, underpriced, or correctly priced?
2. Critical Thinking Question: What does it mean when a company has a very high P/E ratio? Give examples of industries in which you believe high P/E ratios are justified.
3. Nonconstant growth: Diaz Corp. is expected to grow rapidly at a rate of 35 percent for the next seven years. The company’s first dividend, to be paid three years from now, will be $5. After seven years, the company (and the dividends it pays) will grow at a rate of 8.5 percent. What is the value of Diaz stock with a required rate of return of 14 percent?
4. Calculate and interpret net present value (NPV), internal rate of return (IRR), payback period, discounted payback period, and profitability index (PI) of a single capital project.
5. Critical Thinking Question: Your manager just finished calculating your company’s weighted average cost of capital. He is relieved because he says that he can now use that cost of capital to evaluate all projects that the company is considering for the next 4 years. Evaluate that statement.
6. WACC for a company: Contemporary Products Ltd currently has $200 million of market value debt outstanding. The 9 percent coupon bonds (semiannual pay) have a maturity of 15 years, a face value of $1000 and are currently priced at $1,024.87 per bond. The company also has an issue of 2 million preference shares outstanding with a market price of $20. The preference shares offer an annual dividend of $1.20. Contemporary Products also has 14 million ordinary shares outstanding with a price of $20.00 per share. The company is expected to pay a $2.20 ordinary dividend 1 year from today, and that dividend is expected to increase by 7 percent per year forever. If the corporate tax rate is 40 percent, then what is the company’s weighted average cost of capital?
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