2024 – Question 1 Assume Evco Inc has a current price of 50 and will pay a 2

Question 1.  Assume Evco, Inc., has a current price of $50 and will pay a $2 dividend in one year, and its equity cost of capital is 15%. What price must you expect it to sell for right after paying the dividend in one year in order to justify its current price?

 

Question 4. Krell Industries has a share price of $22 today. If Krell is expected to pay a dividend of $0.88 this year, and its stock price is expected to grow to $23.54 at the end of the year, what is Krell’s dividend yield and equity cost of capital?

 

Question 5.  NoGrowth Corporation currently pays a dividend of $2 per year, and it will continue to pay this dividend forever. What is the price per share if its equity cost of capital is 15% per year?

 

Question 6. Summit Systems will pay a dividend of $1.50 this year. If you expect Summit’s dividend to grow by 6% per year, what is its price per share if its equity cost of capital is 11%?

 

303

 

304

 

Question 7. Dorpac Corporation has a dividend yield of 1.5%. Dorpac’s equity cost of capital is 8%, and its dividends are expected to grow at a constant rate.

 

a. What is the expected growth rate of Dorpac’s dividends?

b. What is the expected growth rate of Dorpac’s share price?

 

Question 12. Procter & Gamble will pay an annual dividend of $0.65 one year from now. Analysts expect this dividend to grow at 12% per year thereafter until the fifth year. After then, growth will level off at 2% per year. According to the dividend-discount model, what is the value of a share of Procter & Gamble stock if the firm’s equity cost of capital is 8%?

 

Question 19. Heavy Metal Corporation is expected to generate the following free cash flows over the next five years:

 

Year	1	2	3	4	5
FCF ($ millions)	53	68	78	75	82

After then, the free cash flows are expected to grow at the industry average of 4% per year. Using the discounted free cash flow model and a weighted average cost of capital of 14%:

• a. Estimate the enterprise value of Heavy Metal.
• b. If Heavy Metal has no excess cash, debt of $300 million, and 40 million shares outstanding, estimate its share price.

 

Problems pp. 427 – 429

 

Question 1.  Suppose Pepsico’s stock has a beta of 0.57. If the risk-free rate is 3% and the expected return of the market portfolio is 8%, what is Pepsico’s equity cost of capital?

 

Question 3.Aluminum maker Alcoa has a beta of about 2.0, whereas Hormel Foods has a beta of 0.45. If the expected excess return of the marker portfolio is 5%, which of these firms has a higher equity cost of capital, and how much higher is it?

 

Question 26.  Unida Systems has 40 million shares outstanding trading for $10 per share. In addition, Unida has $100 million in outstanding debt. Suppose Unida’s equity cost of capital is 15%, its debt cost of capital is 8%, and the corporate tax rate is 40%.

 

a. What is Unida’s unlevered cost of capital?

b. What is Unida’s after-tax debt cost of capital?

c. What is Unida’s weighted average cost of capital?

 

 

 

 

Question 20

You are considering making a movie. The movie is expected to cost $10 million upfront and take a year to make. After that, it is expected to make $5 million when it is released in one year and $2 million per year for the following four years. What is the payback period of this investment? If you require a payback period of two years, will you make the movie? Does the movie have positive NPV if the cost of capital is 10%?

 

 

Question 1 Forecasting earnings

Pisa Pizza, a seller of frozen pizza, is considering introducing a healthier version of its pizza that will be low in cholesterol and contain no trans fats. The firm expects that sales of the new pizza will be $20 million per year. While many of these sales will be to new customers, Pisa Pizza estimates that 40% will come from customers who switch to the new, healthier pizza instead of buying the original version.

 

a. Assume customers will spend the same amount on either version. What level of incremental sales is associated with introducing the new pizza?

b. Suppose that 50% of the customers who will switch from Pisa Pizza’s original pizza to its healthier pizza will switch to another brand if Pisa Pizza does not introduce a healthier pizza. What level of incremental sales is associated with introducing the new pizza in this case?

 

Question 23

Bauer Industries is an automobile manufacturer. Management is currently evaluating a proposal to build a plant that will manufacture lightweight trucks. Bauer plans to use a cost of capital of 12% to evaluate this project. Based on extensive research, it has prepared the following incremental free cash flow projections (in millions of dollars):

 

Year 0 Years 1–9 Year 10

Revenues                                                                                                                100.0          100.0   − Manufacturing expenses (other than depreciation)                             -35.0             -35.0   − Marketing expenses                                                          -10.0            -10.0   − Depreciation                                                                        -15.0           -15.0

= EBIT                                                                                                             40.0           40.0   − Taxes (35%)                                                                        -14.0         -14.0

= Unlevered net income                                                                26.0          26.0   + Depreciation                                                                        +15.0       +15.0   − Increases in net working capital                                         -5.0        -5.0   − Capital expenditures                                    -150.0 + Continuation value                                                                                                                +12.0

= Free cash flow          -150.0        36.0        48.0

a. For this base-case scenario, what is the NPV of the plant to manufacture lightweight trucks?

b. Based on input from the marketing department, Bauer is uncertain about its revenue forecast. In particular, management would like to examine the sensitivity of the NPV to the revenue assumptions. What is the NPV of this project if revenues are 10% higher than forecast? What is the NPV if revenues are 10% lower than forecast?

c. Rather than assuming that cash flows for this project are constant, management would like to explore the sensitivity of its analysis to possible growth in revenues and operating expenses. Specifically, management would like to assume that revenues, manufacturing expenses, and marketing expenses are as given in the table for year 1 and grow by 2% per year every year starting in year 2. Management also plans to assume that the initial capital expenditures (and therefore depreciation), additions to working capital, and continuation value remain as initially specified in the table. What is the NPV of this project under these alternative assumptions? How does the NPV change if the revenues and operating expenses grow by 5% per year rather than by 2%?

d. To examine the sensitivity of this project to the discount rate, management would like to compute the NPV for different discount rates. Create a graph, with the discount rate on the x-axis and the NPV on the y-axis, for discount rates ranging from 5% to 30%. For what ranges of discount rates does the project have a positive NPV?