Question

1. Alaa works for a pharmaceutical company that has developed a new drug. The patent on the drug will last 17 years. She expects that the drug’s profits will be $2 million in its first year and that this amount will grow at a rate of 5% per year for the next 17 years. Once the patent expires, other pharmaceutical companies will be able to produce the same drug and competition will likely drive profits to zero. What is the present value of the new drug if the interest rate is 10% per year? (Ref: BMA, 13/e, Ch 2) Answer: The following data apply to the next two problems (Q2&Q3): Maryam Industries must choose from six capital budgeting proposals outlined below. The firm is subject to capital rationing and has a capital budget of $1,000,000; the firm's cost of capital is 15 percent. 2. Using the internal rate of return (IRR) approach to ranking projects, which projects should the firm accept? (Ref: BMA, 13/e, Ch 2,5&6) A) 1, 2, 3, 4, and 5 B) 1, 2, 3, and 5 C) 2, 3, 4, and 6 D) 1, 3, 4, and 6 Answer: 3. Using the net present value (NPV) approach to ranking projects, which projects should the firm accept? (Ref: BMA, 13/e, Ch 2&5) A) 1, 2, 3, 4, and 5 B) 1, 2, 3, 5, and 6 C) 2, 3, 4, and 5 D) 1, 3, 5, and 6 Answer: 4. Reem Design wishes to estimate the value of its outstanding 25-year bond with the following features. The annual coupon rate for the first 10 years will be 5% of the face value of $1,000. After 10 years, the annual coupon rate will increase to 8% for the remaining 15 years. What is the value of this bond, if Reem Design is rated BBB. (BBB-rated bonds are trading at a default spread of 0.75% over the Treasury bond rate of 7.00%.) (Ref: BMA, 13/e, Ch 3) Answer: 5. A firm with unlimited funds must evaluate five projects. Projects 1 and 2 are independent and Projects 3, 4, and 5 are mutually exclusive. The projects are listed with their returns. Project Status Return (%) 1 Independent 14 2 Independent 12 3 Mutually Exclusive 10 4 Mutually Exclusive 15 5 Mutually Exclusive 12 A ranking of the projects on the basis of their returns from the best to the worst according to their acceptability to the firm would be: (Ref: BMA, 13/e, Ch 2&5) a. 4, 1, 2 or 5, and 3. b. 4, 1, and 2. c. 3, 2 or 5, 1, and 4. d. 4, 1, 5, and 3. Answer: 6. Noora owns her own business and is considering an investment. If she undertakes the investment, it will pay $4000 at the end of each of the next three years. The opportunity requires an initial investment of $1000 plus an additional investment at the end of the second year of $5000. What is the NPV of this opportunity if the interest rate is 2% per year? Should Noor take it? (Ref: BMA, 13/e, Ch 2&5) Answer: 7. Sayed International is a mature manufacturing firm. The company just paid a $5.30 dividend, but management expects to reduce the payout by 10%, indefinitely. If you require a 12% return on this stock, what will you pay for a share today? (Ref: BMA, 13/e, Ch 4) a. $17.98 b. $18.65 c. $19.71 d. $21.68 Answer: 8. Ali is running a hot Internet company. Analysts predict that its earnings will grow at 30% per year for the next five years. After that, as competition increases, earnings growth is expected to slow to 2% per year and continue at that level forever. His company has just announced earnings of $1,000,000. What is the present value of all future earnings if the interest rate is 8%? (Assume all cash flows occur at the end of the year.) (Ref: BMA, 13/e, Ch 2) Answer: 9. Muneera has been asked to calculate the share price of Gamma Industries. She did some research and find out that Gamma Industries has a target debt-equity ratio of 0.5. Gamma has a 60% payout ratio, 6.75% return on equity (ROE), and recently paid a dividend of $2.00 per share. Analysts estimate Gamma’s stock to be 20% more risky than the market portfolio. Assume that T-bills yield 5% and the market risk premium (MRP) is 7%. (Ref: BMA, 13/e, Ch 4,7&8) Answer: 10. Hameeda Corporation 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 Hameeda stock if the firm’s equity cost of capital is 8%? (Ref: BMA, 13/e, Ch 4) Answer: 11. Huda Industries issued 25-year, 11% coupon bonds 5 years ago, at par. Two years ago, you purchased one of their bonds when it was yielding 6%. Today the yield-to-maturity (YTM) on these bonds is 14%. What is your Capital gains / (losses) yield if the annual inflation rate was 2.5% over the past two years, and you sell your bond today? (Ref: BMA, 13/e, Ch 3) Answer: 12. Bond P is a premium bond with a 13% coupon. Bond D is a 8% coupon bond currently selling at a discount. Both bonds make annual payments, have a YTM of 10%, and have 20 years to maturity. What is the current yield for bond P? For Bond D? If interest rates remain unchanged, what is the expected capital gains yield over the next year for bond P? For Bond D? Explain your answers and the interrelationship among the various types of yields. (Ref: BMA, 13/e, Ch 3) Answer: 13. Azzam Corporation expects to pay a $3.00 per share dividend on its common stock at the end of the year (D1 = $3.00). The dividend is expected to grow 25 percent a year until t = 3, after which time the dividend is expected to grow at a constant rate of 5 percent a year. The stock’s beta is 1.2, the risk-free rate of interest is 6 percent, and the rate of return on the market is 11 percent. What is the company’s current stock price? (Ref: BMA, 13/e, Ch 4,7&8) a. $29.89 b. $30.64 c. $37.29 d. $53.69 e. $59.05 Answer: 14. You are thinking of purchasing a house. The house costs $350,000. You have $50,000 in cash that you can use as a down payment on the house, but you need to borrow the rest of the purchase price. The bank is offering a 30-year mortgage that requires annual payments and has an interest rate of 7% per year. What will your annual payment be if you sign up for this mortgage? (Ref: BMA, 13/e, Ch 2) Answer: 15. Rana Inc., is evaluating three capital projects. The net present values (NPV) for the projects are as follows: The firm should A) accept Projects 1 and 2 and reject Project 3. B) accept Projects 1 and 3 and reject Project 2. C) accept Project 1 and reject Projects 2 and 3. D) reject all projects. (Ref: BMA, 13/e, Ch 2&5) Answer: 16. Abdulaziz has just arranged a $15,000 loan from your bank at an annual rate of 10%. The loan calls for annual payments of $1,000 over the next 14 years, and a final payment at the end of year 15. How big will the final payment (balloon) be? (Ref: BMA, 13/e, Ch 2) Answer: 17. Yusuf is considering installing a new energy-efficient lighting in his firm’s warehouse. The installation will cost $300,000, and he estimates total savings of $75,000 per year. The lights will depreciate evenly over five years, at which point they must be replaced. The cost of capital is 7% per year. What do the NPV and EVA rules indicate about whether Yusuf should install the lights? (Ref: BMA, 13/e, Ch 2, 5, and 12) Answer: 18. Zainab has an investment opportunity that requires an initial investment of $5000 today and will pay $6000 in one year. What is the IRR of her opportunity? (Ref: BMA, 13/e, Ch 2&5) Answer: 19. Mansoor Inc. is considering the following two projects: Year Project 1 Cash Flow Project 2 Cash Flow 0 -$100 ? 1 30 40 2 50 80 3 40 60 4 50 60 The two projects have the same payback period. What is Project 2’s internal rate of return (IRR)? (Ref: BMA, 13/e, Ch 2&5) a. 44.27% b. 23.40% c. 20.85% d. 14.73% e. 17.64% Answer: 20. Your boss has just congratulated you on the wonderful job you did this year. In order to formally recognize your achievements, he would like to either give you a bonus or increase your salary. If you take the bonus, you will receive $5,000 immediately. The salary increase would be a 1.5% addition to the 40,000 per annum you currently receive, payable at each year-end. In either event, you must pay taxes at a rate of 44% and plan to work at this company for the next 10 years. If you can invest any earning at a rate of 7%, which should you choose? (Ref: BMA, 13/e, Ch 2) Answer:

Answer 1

You have asked multiple unrelated questions in the same post. I have addressed the first one. Please post the balance questions separately one by one.

1. Alaa works for a pharmaceutical company that has developed a new drug. The patent on the drug will last 17 years. She expects that the drug’s profits will be $2 million in its first year and that this amount will grow at a rate of 5% per year for the next 17 years. Once the patent expires, other pharmaceutical companies will be able to produce the same drug and competition will likely drive profits to zero. What is the present value of the new drug if the interest rate is 10% per year? (Ref: BMA, 13/e, Ch 2)

This is the case of a growing annuity. The present value of the growing annuity is given by the expression below:

- 1- T-9L (1+ 9 1+r P = First Payment r=rate per period 9 = growth rate n= number of periods

IN this case, P = $ 2 million; r = 10%; g = 5%; n = 17 years.

Hence, the present value of the new drug if the interest rate is 10% per year = 2 / (10% - 5%) x [1 - (1 + 5%)¹⁷ / (1 + 10%)¹⁷] = $ 21.86 million = $ 21,861,456