ACC501 Business Finance Assignment no 2 Semester fall 22 December 2011

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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.
Required:
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?

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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