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ACC501 Business Finance-assignment 2 idea solution
Semester “Fall 2011”
“ Business Finance (ACC501) ”
Assignment No. 02 Marks: 30
Question # 01 (15 Marks)
Mr. Ashar is a financial manager in S&T Leather Company. He has been given the task of assessing the firm’s stock values. In order to perform the required assessment, he has analyzed that the firm’s common stock currently pays an annual dividend of Rs. 2.10 per share and the required return on the common stock is 11 percent.
By using the given information, estimate the value of common stock under each of the following dividend-growth-rate assumption:
a) Dividends are expected to grow at an annual rate of 0% to infinity.
b) Dividends are expected to grow at a constant annual rate of 5% to infinity.
c) Dividends are expected to grow at an annual rate of 5% for each of the next three years followed by a constant annual growth rate of 4% in fourth year to infinity.
Question # 02 (15 Marks)
Standard Manufacturing Company has estimated cash revenues of Rs. 30,000 per year from a proposed project. Cash costs will be Rs. 20,000 (including taxes) per year. The company will wind up its business in 8 years. The plant, property and equipment will worth Rs. 2,000 as salvage value at the time of winding up the business. The project costs Rs. 40,000 to launch and opportunity cost associated with this project is 15%.
Required:
Keeping above information into consideration, you are required to find out:
a) Is this a good investment? Support your answer with complete calculations of NPV and Payback period of the project.
b) What will be the effect on price per share of 1,000 shares from taking the investment?
Important Tips
1. This Assignment can be best attempted from the knowledge acquired after watching video lecture no. 1 to 26 and reading handouts as well as recommended text book).
2. Video lectures can be downloaded for free from www.youtube.com/vu.
Schedule
Opening Date and Time December 22, 2011 At 12:00 A.M. (Mid-Night)
Due Date and Time December 28, 2011 At 11:59 P.M. (Mid-Night)
Tags: 2, ACC501, Business, Finance-assignment, idea, solution
Replies to This Discussion
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Permalink Reply by Yasmeen(S.admin) on -
ACC501 Business Finance-assignment 2 idea solution
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Permalink Reply by hunny on -
Question # 02:
a) Is this a good investment? Support your answer with complete calculations of NPV and Payback period of the project.
We will know this by applying the NPV rule,
Calculating the future cash flows:
PV = 10,000 x (1-1/1.15^8 ) / 0.15 + 2000 / 1.15^8
PV = 10,000 x 4.4873 + 2000 / 3.0590
PV = 45,527
Comparing this value with the estimated costs, NPV is;
NPV = -40,000 + 45,527
NPV = 5,527
Therefore, this is a good investment, as it would increase the total worth.
Requirement: What is the Payback period of the project?
Project costs = 40,000
After the first year cash revenue is 30,000
Remaining 10,000 will be paid during 2nd year so the Payback period of project is
10,000 / 30,000 = 0.3
1 + 0.3 = 1.3 Years
Question # 01
Requirement:
By using the given information, estimate the value of common stock under each of the following dividend-growth-rate assumption:
a) Dividends are expected to grow at an annual rate of 0% to infinity.
Po = D/R
= 210 / 0.11
Po = 1909.09
b) Dividends are expected to grow at a constant annual rate of 5% to infinity.
Po = Do x (1 + g) / R – g
Po = 210 x (1+0.05) / 0.11 – 0.05
Po = 220.5 / 0.06
Po = 3675
c) Dividends are expected to grow at an annual rate of 5% for each of the next three years followed by a constant annual growth rate of 4% in fourth year to infinity.
First we calculate the present value of stock price three years then we will add in the present value of the dividends that will be paid between now and then.
So, the price in three years is:
P3 = D3 x (1 + g) /(R - g)
To find the value of D3 we will use:
Dt = D0 x (1 + g) ^t
D3 = 210 x (1.05) ^3
D3 = 243.096
Now Price till 3rd year:
P3 = 243.096 x (1.04) / (0.11 – 0.04)
P3 = 4254.16
Po = Do(1+g)^1 / (1+R)^1 + Do(1+g)^2 / (1+R)^2 + Do(1+g)^3 / (1+R)^3 + P3 + Do(1+g)^4 / (1+R)^4
After putting the values calculate value of stock …
For fourth year your growth rate g = 0.04 -
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Permalink Reply by Yasmeen(S.admin) on
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Permalink Reply by ZAID BIN YOUSAF SHEIKH on -
a) Dividends are expected to grow at an annual rate of 0% to infinity.
Po = D/R
Po = 2.10/0.11
Po = 19.0909
b) Dividends are expected to grow at a constant annual rate of 5% to infinity.
Po = Do x (1 + g) / R – g
Po = 2.10x (1+0.05) / 0.11 – 0.05
Po = 2.10x1.05 / 0.06
Po = 2.205 / 0.06
Po = 36.75
c) Dividends are expected to grow at an annual rate of 5% for each of the next three years
First we calculate the present value of stock price of three years then we will add in the present value of the dividends that will be paid between now and then, so the price of three years is:
P3 = D3 x (1+g) / (R-g)
To find the value of D3,
Dt = D0 x (1 + g) ^t
D1 = 2.10 x (1+0.05)^1
D1 = 2.205
D2 = 2.10 x (1+0.05)^2
D2 = 2.10 x 1.1025
D2 = 2.315
D3 = 2.10 x (1+0.05) ^ 3
D3 = 2.10 x 1.157
D3 = 2.4297
P3 = D3 x (1+g) / (R-g)
P3 = 2.4297 x (1+0.04) / (0.11-0.04)
P3 = 2.4297 x 1.04 / 0.07
P3 = 2.52688 / 0.07
P3 = 36.098
a) Is this a good investment? Support your answer with complete calculations of NPV and Payback period of the project.
PV = 10,000 x (1-1/1.15^8) / 0.15 + 2000 / 1.15^8
PV = 10,000 x 4.4873 + 2000 / 3.0590
PV = 45,527
Comparing this value with the estimated costs, NPV is;
NPV = -40,000 + 45,527
NPV = 5,527
Therefore, this is a good investment, as it would increase the total worth.
Requirement: What is the Payback period of the project?
Project costs = 40,000
After the first year cash revenue is 30,000
Remaining 10,000 will be paid during 2nd year so the Payback period of project is
10,000 / 30,000 = 0.3
1 + 0.3 = 1.3 Years
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Permalink Reply by Yasmeen(S.admin) on
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another solution
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ACC501 HAfiz Nauman Shah.pdf, 171 KB
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