Q2. What is the EAC of two projects: project A, which costs $150 and is expected to last two years, and project B, which costs $190 and is expected to last three years? The cost of capital is 12%. (1 mark)
Answer:
Q3. A company pays annual dividends of $10.40 with no possibility of it changing in the next several years. If the firm’s stock is currently selling at $80, what is the required rate of return? (1 mark)
Answer:
Q4. Stag corp has a capital structure which is based on 50% common stock, 20% preferred stock and 30% debt. The cost of common stock is 14%, the cost of preferred stock is 8% and the pre-tax cost of debt is 10%. The firm's tax rate is 40%. (1 mark)
Q 1:
EAC of Project A= $88.75
EAC of Project B= $79.11
Calculation as below:
Q 3:
As per Dividend Discount Model, Current Price P0= D1/r-g
Where D1= next year dividend, r= rate of return and g= growth rate.
Given that P0= $80, g=Nil
Current Dividend= $10.40. With no growth, D1= $10.40
Substituting the values,
$80= $10.40/r.
Therefore, Rate of return r = $10.40/$80 = 0.13 =13%
Q 4:
WACC= We*Re + Wp*Rp + Wd*Rd*(1-T)
Where We= Weight of Equity (given as 50%),
Re= Cost of equity (14%),
Wp= Weight of Preferred stock (20%),
Rp= Cost of Preferred stock (8%),
Wd= Weight of debt (30%)
Rd= Pre tax cost of debt (10%) and
T =Tax rate (40%)
Substituting the values,
WACC= 0.50*0.14 + 0.2*0.08 + 0.3*0.1*(1-0.4) = 0.07+0.016+0.018 = 0.104= 10.40%
Net Present Value of the project= $ 141,175.15 as follows:
Q2. What is the EAC of two projects: project A, which costs $150 and is expected...
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What is the EAC of two projects: project A, which costs $150 and is expected to last two years, and project B, which costs $190 and is expected to last three years? The cost of capital is 12%.
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