Dahlia Enterprises needs someone to supply it with 110,000 cartons of machine screws per year to support its manufacturing needs over the next five years, and you’ve decided to bid on the contract. It will cost you $770,000 to install the equipment necessary to start production; you’ll depreciate this cost straight-line to zero over the project’s life.

July 9, 2014, 2:32 pm

≫ Next: Night Shades Inc. (NSI) manufactures biotech sunglasses. The variable materials cost is $18.50 per unit, and the variable labor cost is $7.00 per unit.

≪ Previous: You are evaluating two different silicon wafer milling machines. The Techron I costs $222,000, has a three-year life, and has pretax operating costs of $57,000 per year. The Techron II costs $390,000, has a five-year life, and has pretax operating costs of $30,000 per year. For both milling machines, use straight-line depreciation to zero over the project’s life and assume a salvage value of $34,000. If your tax rate is 35 percent and your discount rate is 9 percent, compute the EAC for both machines.

$

0

0

Dahlia Enterprises needs someone to supply it with 110,000 cartons of machine screws per year to support its manufacturing needs over the next five years, and you’ve decided to bid on the contract. It will cost you $770,000 to install the equipment necessary to start production; you’ll depreciate this cost straight-line to zero over the project’s life. You estimate that in five years, this equipment can be salvaged for $60,000. Your fixed production costs will be $315,000 per year, and your variable production costs should be $9.30 per carton. You also need an initial investment in net working capital of $65,000. If your tax rate is 34 percent and your required return is 10 percent on your investment, what bid price should you submit? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

Bid price

$

Explanation:

To find the bid price, we need to calculate all other cash flows for the project, and then solve for the bid price. The aftertax salvage value of the equipment is:

Aftertax salvage value = $60,000(1 − 0.34) = $39,600

Now we can solve for the necessary OCF that will give the project a zero NPV. The equation for the NPV of the project is:

NPV = 0 = −$770,000 − 65,000 + OCF(PVIFA10%,5) + [($65,000 + 39,600) / 1.105]

Solving for the OCF, we find the OCF that makes the project NPV equal to zero is:

OCF = $770,051.63 / PVIFA12%,5 = $203,137.68

The easiest way to calculate the bid price is the tax shield approach, so:

OCF = $203,137.68 = [(P − v)Q − FC](1 − T) + TD

$203,137.68 = [(P − $9.30)(110,000) − $315,000](1 − 0.34) + 0.34($770,000/5)

P = $14.24

---

Night Shades Inc. (NSI) manufactures biotech sunglasses. The variable materials cost is $18.50 per unit, and the variable labor cost is $7.00 per unit.

July 9, 2014, 2:35 pm

≫ Next: K-Too Everwear Corporation can manufacture mountain climbing shoes for $43.03 per pair in variable raw material costs and $25.45 per pair in variable labor expense. The shoes sell for $140 per pair. Last year, production was 110,000 pairs. Fixed costs were $1,150,000.

≪ Previous: Dahlia Enterprises needs someone to supply it with 110,000 cartons of machine screws per year to support its manufacturing needs over the next five years, and you’ve decided to bid on the contract. It will cost you $770,000 to install the equipment necessary to start production; you’ll depreciate this cost straight-line to zero over the project’s life.

$

0

0

Night Shades Inc. (NSI) manufactures biotech sunglasses. The variable materials cost is $18.50 per unit, and the variable labor cost is $7.00 per unit.

 

a.	What is the variable cost per unit? (Round your answer to 2 decimal places. (e.g., 32.16))

 

Variable cost

$

  

b.	Suppose NSI incurs fixed costs of $800,000 during a year in which total production is 350,000 units. What are the total costs for the year?

  

Total cost

$

  

c.	If the selling price is $48.00 per unit, what is the cash break-even point? If depreciation is $600,000 per year, what is the accounting break-even point? (Round your answers to 2 decimal places. (e.g., 32.16))

Cash break-even point	units
Break-even point	units

Explanation:

a.

The total variable cost per unit is the sum of the two variable costs, so:

Total variable costs per unit = $18.50 + 7.00

Total variable costs per unit = $25.50

 
b.

The total costs include all variable costs and fixed costs. We need to make sure we are including all variable costs for the number of units produced, so:

Total costs = Variable costs + Fixed costs

Total costs = $25.50(350,000) + $800,000

Total costs = $9,725,000

 
c.

The cash break even, that is the point where cash flow is zero, is:

QC = $800,000 / ($48.00 – 25.50)

QC = 35,555.56 units

And the accounting breakeven is:

QA = ($800,000 + 600,000) / ($48.00 – 25.50)

QA = 62,222.22 units

K-Too Everwear Corporation can manufacture mountain climbing shoes for $43.03 per pair in variable raw material costs and $25.45 per pair in variable labor expense. The shoes sell for $140 per pair. Last year, production was 110,000 pairs. Fixed costs were $1,150,000.

July 9, 2014, 2:36 pm

≫ Next: Olin Transmissions, Inc., has the following estimates for its new gear assembly project: price = $2,500 per unit; variable costs = $500 per unit; fixed costs = $5.1 million; quantity = 80,000 units. Suppose the company believes all of its estimates are accurate only to within ±15 percent. What values should the company use for the four variables given here when it performs its best-case scenario analysis? What about the worst-case scenario?

≪ Previous: Night Shades Inc. (NSI) manufactures biotech sunglasses. The variable materials cost is $18.50 per unit, and the variable labor cost is $7.00 per unit.

$

0

0

K-Too Everwear Corporation can manufacture mountain climbing shoes for $43.03 per pair in variable raw material costs and $25.45 per pair in variable labor expense. The shoes sell for $140 per pair. Last year, production was 110,000 pairs. Fixed costs were $1,150,000.

 

What were total production costs?

 

Total production cost

$

 

What is the marginal cost per pair? (Round your answer to 2 decimal places. (e.g., 32.16))

Marginal cost per pair

$

What is the average cost per pair? (Round your answer to 2 decimal places. (e.g., 32.16))

 

Average cost per pair

$

   

If the company is considering a one-time order for an extra 9,000 pairs, what is the minimum acceptable total revenue from the order?

  

Total revenue

$

Explanation:

The total costs include all variable costs and fixed costs. We need to make sure we are including all variable costs for the number of units produced, so:

Total costs = ($43.03 + 25.45)(110,000) + $1,150,000

Total costs = $8,682,800

  

The marginal cost, or cost of producing one more unit, is the total variable cost per unit, so:

Marginal cost = $43.03 + 25.45

Marginal cost = $68.48

 

The average cost per unit is the total cost of production, divided by the quantity produced, so:

Average cost = Total cost / Total quantity

Average cost = $8,682,800/110,000

Average cost = $78.93

Minimum acceptable total revenue = 9,000($68.48)

Minimum acceptable total revenue = $616,320

Additional units should be produced only if the cost of producing those units can be recovered.

Olin Transmissions, Inc., has the following estimates for its new gear assembly project: price = $2,500 per unit; variable costs = $500 per unit; fixed costs = $5.1 million; quantity = 80,000 units. Suppose the company believes all of its estimates are accurate only to within ±15 percent. What values should the company use for the four variables given here when it performs its best-case scenario analysis? What about the worst-case scenario?

July 9, 2014, 2:37 pm

≫ Next: We are evaluating a project that costs $690,000, has a five-year life, and has no salvage value. Assume that depreciation is straight-line to zero over the life of the project. Sales are projected at 71,000 units per year. Price per unit is $75, variable cost per unit is $50, and fixed costs are $790,000 per year. The tax rate is 35 percent, and we require a 15 percent return on this project.

≪ Previous: K-Too Everwear Corporation can manufacture mountain climbing shoes for $43.03 per pair in variable raw material costs and $25.45 per pair in variable labor expense. The shoes sell for $140 per pair. Last year, production was 110,000 pairs. Fixed costs were $1,150,000.

$

0

0

Olin Transmissions, Inc., has the following estimates for its new gear assembly project: price = $2,500 per unit; variable costs = $500 per unit; fixed costs = $5.1 million; quantity = 80,000 units. Suppose the company believes all of its estimates are accurate only to within ±15 percent. What values should the company use for the four variables given here when it performs its best-case scenario analysis? What about the worst-case scenario?

 

Scenario	Units Sales	Unit Price	Unit Variable cost	Fixed Costs
Base		$	$	$
Best
Worst

Explanation:

Remember that in the best-case, sales and price increase, while costs decrease. In the worst-case, sales and price decrease, and costs increase.

We are evaluating a project that costs $690,000, has a five-year life, and has no salvage value. Assume that depreciation is straight-line to zero over the life of the project. Sales are projected at 71,000 units per year. Price per unit is $75, variable cost per unit is $50, and fixed costs are $790,000 per year. The tax rate is 35 percent, and we require a 15 percent return on this project.

July 9, 2014, 2:39 pm

≫ Next: In each of the following cases, calculate the accounting break-even and the cash break-even points. Ignore any tax effects in calculating the cash break-even. (Round your answers to 2 decimal places. (e.g., 32.16))

≪ Previous: Olin Transmissions, Inc., has the following estimates for its new gear assembly project: price = $2,500 per unit; variable costs = $500 per unit; fixed costs = $5.1 million; quantity = 80,000 units. Suppose the company believes all of its estimates are accurate only to within ±15 percent. What values should the company use for the four variables given here when it performs its best-case scenario analysis? What about the worst-case scenario?

$

0

0

We are evaluating a project that costs $690,000, has a five-year life, and has no salvage value. Assume that depreciation is straight-line to zero over the life of the project. Sales are projected at 71,000 units per year. Price per unit is $75, variable cost per unit is $50, and fixed costs are $790,000 per year. The tax rate is 35 percent, and we require a 15 percent return on this project.

   

a-1	Calculate the accounting break-even point.

 

Break-even point

units

   

a-2	What is the degree of operating leverage at the accountin g break-even point? (Round your answer to 3 decimal places. (e.g., 32.161))

   

DOL

   

b-1	Calculate the base-case cash flow and NPV.(Round your NPV answer to 2 decimal places. (e.g., 32.16))

 

Cash flow	$
NPV	$

 

b-2	What is the sensitivity of NPV to changes in the sales figure? (Do not round intermediate calculations and round your answer to 3 decimal places. (e.g., 32.161))

 

ΔNPV/ΔQ

$

  

c.	What is the sensitivity of OCF to changes in the variable cost figure? (Negative amount should be indicated by a minus sign.)

  

ΔOCF/ΔVC

$

Explanation:a.

To calculate the accounting breakeven OCF, we first need to find the depreciation for each year. The depreciation is:

Depreciation = $690,000/5

Depreciation = $138,000 per year

   

And the accounting breakeven is:

QA = ($790,000 + 138,000)/($75 – 50)

QA = 37,120 units

   

To calculate the accounting breakeven, we must realize at this point (and only this point), the OCF is equal to depreciation. So, the DOL at the accounting breakeven is:

DOL = 1 + FC/OCF = 1 + FC/D

DOL = 1 + [$790,000)/$138,000)]

DOL = 6.725

 
b. 

We will use the tax shield approach to calculate the OCF. The OCF is:

  

OCFbase = [(P – v)Q – FC](1 – T) + TD

OCFbase = [($75 – 50)(71,000) – $790,000](0.65) + 0.35($138,000)

OCFbase = $688,550

 

Now we can calculate the NPV using our base-case projections. There is no salvage value or NWC, so the NPV is:

NPVbase = –$690,000 + $688,550(PVIFA15%,5)

NPVbase = $1,618,126.39

  

To calculate the sensitivity of the NPV to changes in the quantity sold, we will calculate the NPV at a different quantity. We will use sales of 76,000 units. The NPV at this sales level is:

OCFnew = [($75 – 50)(76,000) – $790,000](0.65) + 0.35($138,000)

OCFnew = $769,800

  

And the NPV is:

NPVnew = –$690,000 + $769,800(PVIFA15%,5)

NPVnew = $1,890,488.99

  

So, the change in NPV for every unit change in sales is:

ΔNPV/ΔS = ($1,618,126.39 – 1,890,488.99)/(71,000 – 76,000)

ΔNPV/ΔS = +$54.473

  

If sales were to drop by 500 units, then NPV would drop by:

NPV drop = $54.473(500) = $27,236.26

You may wonder why we chose 76,000 units. Because it doesn’t matter! Whatever sales number we use, when we calculate the change in NPV per unit sold, the ratio will be the same.

 
c.

To find out how sensitive OCF is to a change in variable costs, we will compute the OCF at a variable cost of $51. Again, the number we choose to use here is irrelevant: We will get the same ratio of OCF to a one dollar change in variable cost no matter what variable cost we use. So, using the tax shield approach, the OCF at a variable cost of $51 is:

OCFnew = [($75 – 51)(71,000) – 790,000](0.65) + 0.35($138,000)

OCFnew = $642,400

So, the change in OCF for a $1 change in variable costs is:

ΔOCF/ΔVC = ($688,550 – 642,400)/($50 – 51)

ΔOCF/ΔVC = –$46,150

If variable costs decrease by $1 then, OCF would increase by $46,150

In each of the following cases, calculate the accounting break-even and the cash break-even points. Ignore any tax effects in calculating the cash break-even. (Round your answers to 2 decimal places. (e.g., 32.16))

July 9, 2014, 2:39 pm

≫ Next: You are considering a new product launch. The project will cost $2,200,000, have a four-year life, and have no salvage value; depreciation is straight-line to zero. Sales are projected at 150 units per year; price per unit will be $29,000, variable cost per unit will be $17,500, and fixed costs will be $590,000 per year. The required return on the project is 12 percent, and the relevant tax rate is 34 percent.

≪ Previous: We are evaluating a project that costs $690,000, has a five-year life, and has no salvage value. Assume that depreciation is straight-line to zero over the life of the project. Sales are projected at 71,000 units per year. Price per unit is $75, variable cost per unit is $50, and fixed costs are $790,000 per year. The tax rate is 35 percent, and we require a 15 percent return on this project.

$

0

0

In each of the following cases, calculate the accounting  break-even and the cash break-even points. Ignore any tax effects in calculating the cash break-even. (Round your answers to 2 decimal places. (e.g., 32.16))

   

Case	Unit Price			Unit Variable Cost			Fixed Costs			Depreciation
1	$	3,370		$	2,675		$	8,120,000		$	3,060,000
2		146			81			78,000			350,000
3		31			7			3,700			860

Case	Accounting break-even	Cash break-even
1
2
3

Explanation:

The cash break-even equation is:

QC = FC/(P – v)

And the accounting break-even equation is:

QA = (FC + D)/(P – v)

  

Using these equations, we find the following cash and accounting break-even points:

  

a.	QC = $8,120,000/($3,370 – 2,675)	QA = ($8,120,000 + 3,060,000)/($3,370 – 2,675)
	QC = 11,683.45	QA = 16,086.33

  

b.	QC = $78,000/($146 – 81)	QA = ($78,000 + 350,000)/($146 – 81)
	QC = 1,200.00	QA = 6,584.62

 

c.	QC = $3,700/($31 – 7)	QA = ($3,700 + 860)/($31 – 7)
	QC = 154.17	QA = 190.00

You are considering a new product launch. The project will cost $2,200,000, have a four-year life, and have no salvage value; depreciation is straight-line to zero. Sales are projected at 150 units per year; price per unit will be $29,000, variable cost per unit will be $17,500, and fixed costs will be $590,000 per year. The required return on the project is 12 percent, and the relevant tax rate is 34 percent.

July 9, 2014, 2:40 pm

≫ Next: Nofal Corporation will pay a $4.65 per share dividend next year. The company pledges to increase its dividend by 7 percent per year, indefinitely.

≪ Previous: In each of the following cases, calculate the accounting break-even and the cash break-even points. Ignore any tax effects in calculating the cash break-even. (Round your answers to 2 decimal places. (e.g., 32.16))

$

0

0

You are considering a new product launch. The project will cost $2,200,000, have a four-year life, and have no salvage value; depreciation is straight-line to zero. Sales are projected at 150 units per year; price per unit will be $29,000, variable cost per unit will be $17,500, and fixed costs will be $590,000 per year. The required return on the project is 12 percent, and the relevant tax rate is 34 percent.

  

a.

Based on your experience, you think the unit sales, variable cost, and fixed cost projections given here are probably accurate to within ±10 percent. What are the upper and lower bounds for these projections? What is the base-case NPV? What are the best-case and worst-case scenarios? (Negative amount should be indicated by a minus sign. Round your NPV answers to 2 decimal places. (e.g., 32.16))

 

Scenario	Unit Sales	Variable Cost	Fixed Costs	NPV
Base		$	$	$
Best
Worst

 

b.	Evaluate the sensitivity of your base-case NPV to changes in fixed costs. (Negative amount should be indicated by a minus sign. Round your answer to 3 decimal places. (e.g., 32.161))

 

ΔNPV/ΔFC

$

  

c.	What is the cash break-even level of output for this project (ignoring taxes)? (Round your answer to 2 decimal places. (e.g., 32.16))

  

Cash break-even

  

d-1	What is the accounting break-even level of output for this project? (Round your answer to 2 decimal places. (e.g., 32.16))

  

Accounting break-even

 

d-2	What is the degree of operating leverage at the accounting break-even point? (Round your answer to 3 decimal places. (e.g., 32.161))

  

Degree of operating leverage

Explanation:

a.

The base-case, best-case, and worst-case values are shown below. Remember that in the best-case, sales and price increase, while costs decrease. In the worst-case, sales and price decrease, and costs increase.

 

Using the tax shield approach, the OCF and NPV for the base case estimate is:

  

OCFbase = [($29,000 – 17,500)(150) – $590,000](0.66) + 0.34($2,200,000/4)

OCFbase = $936,100

 

NPVbase = –$2,200,000 + $936,100(PVIFA12%,4)

NPVbase = $643,262.72

 

The OCF and NPV for the worst case estimate are:

OCFworst = [($29,000 – 19,250)(135) – $649,000](0.66) + 0.34($2,200,000/4)

OCFworst = $627,385

  

NPVworst = –$2,200,000 + $627,385(PVIFA12%,4)

NPVworst = –$294,412.58

  

And the OCF and NPV for the best case estimate are:

OCFbest = [($29,000 – 15,750)(165) – $531,000](0.66) + 0.34($2,200,000/4)

OCFbest = $1,279,465

  

NPVbest = –$2,200,000 + $1,279,465(PVIFA12%,4)

NPVbest = $1,686,182.18

 
b.

To calculate the sensitivity of the NPV to changes in fixed costs we choose another level of fixed costs. We will use fixed costs of $600,000. The OCF using this level of fixed costs and the other base case values with the tax shield approach, we get:

OCF = [($29,000 – 17,500)(150) – $600,000](0.66) + 0.34($2,200,000/4)

OCF = $929,500

And the NPV is:

NPV = –$2,200,000 + $929,500(PVIFA12%,4)

NPV = $623,216.22

  

The sensitivity of NPV to changes in fixed costs is:

ΔNPV/ΔFC = ($643,262.72 – 623,216.22)/($590,000 – 600,000)

ΔNPV/ΔFC = –$2.005

For every dollar FC increases, NPV falls by $2.005.

 
c.

The cash breakeven is:

QC = FC/(P – v)

QC = $590,000/($29,000 – 17,500)

QC = 51.30

 
d.

The accounting breakeven is:

QA= (FC + D)/(P – v)

QA = [$590,000 + ($2,200,000/4)]/($29,000 – 17,500)

QA = 99.13

 

At the accounting breakeven, the DOL is:

DOL = 1 + FC/OCF

DOL = 1 + ($590,000/$550,000) = 2.073

For each 1% increase in unit sales, OCF will increase by 2.073%.

Nofal Corporation will pay a $4.65 per share dividend next year. The company pledges to increase its dividend by 7 percent per year, indefinitely.

July 31, 2014, 4:09 am

≫ Next: Anton, Inc., just paid a dividend of $2.40 per share on its stock. The dividends are expected to grow at

≪ Previous: You are considering a new product launch. The project will cost $2,200,000, have a four-year life, and have no salvage value; depreciation is straight-line to zero. Sales are projected at 150 units per year; price per unit will be $29,000, variable cost per unit will be $17,500, and fixed costs will be $590,000 per year. The required return on the project is 12 percent, and the relevant tax rate is 34 percent.

$

0

0

Nofal Corporation will pay a $4.65 per share dividend next year. The company pledges to increase its dividend by 7 percent per year, indefinitely.

Required:

If you require a return of 11 percent on your investment, how much will you pay for the company’s stock today?(Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).)

Current stock price

$

Explanation:

Using the constant growth model, we find the price of the stock today is:

P0 = D1 / (R– g)

P0 = $4.65 / (.11 – .0700)

P0 = $116.25

---

Anton, Inc., just paid a dividend of $2.40 per share on its stock. The dividends are expected to grow at

July 31, 2014, 4:10 am

≫ Next: The next dividend payment by Wyatt, Inc., will be $3.10 per share. The dividends are anticipated to

≪ Previous: Nofal Corporation will pay a $4.65 per share dividend next year. The company pledges to increase its dividend by 7 percent per year, indefinitely.

$

0

0

Anton, Inc., just paid a dividend of $2.40 per share on its stock. The dividends are expected to grow at a constant rate of 6.25 percent per year, indefinitely. Assume investors require a return of 12 percent on this stock.

Requirement 1:

What is the current price? (Do not round intermediate calculations.Round your answer to 2 decimal places (e.g., 32.16).)

Current price

$

Requirement 2:

What will the price be in four years and in sixteen years? (Do not round intermediate calculations.Round your answers to 2 decimal places (e.g., 32.16).)

Four years	$
Sixteen years	$

Explanation:1:

The constant dividend growth model is:

Pt = Dt× (1 + g) / (R– g)

So, the price of the stock today is:

P0 = D0 (1 + g) / (R– g)

P0 = $2.40 (1.0625) / (0.12 – 0.0625)

P0 = $44.35

2:

The dividend at year 5 is the dividend today times the FVIF for the growth rate in dividends and five years, so:

P4 = D4 (1 + g) / (R– g)

P4 = D0 (1 + g)5 / (R– g)

P4 = $2.40 (1.0625)5 / (0.12 – 0.0625)

P4 = $56.52

We can do the same thing to find the dividend in Year 17, which gives us the price in Year 16, so:

P16 = D16 (1 + g) / (R– g)

P16 = D0 (1 + g)17 / (R– g)

P16 = $2.40 (1.0625)17 / (0.12 – 0.0625)

P16 = $116.99

There is another feature of the constant dividend growth model: The stock price grows at the dividend growth rate. So, if we know the stock price today, we can find the future value for any time in the future we want to calculate the stock price. In this problem, we want to know the stock price in Year four, and we have already calculated the stock price today. The stock price in Year four will be:

P4 = P0(1 + g)4

P4 = $44.35(1 + 0.0625)4

P4 = $56.52

And the stock price in Year 16 will be:

P16 = P0(1 + g)16

P16 = $44.35(1 + 0.0625)16

P16 = $116.99

The next dividend payment by Wyatt, Inc., will be $3.10 per share. The dividends are anticipated to

July 31, 2014, 4:12 am

≫ Next: The next dividend payment by Wyatt, Inc., will be $2.50 per share. The dividends are anticipated to

≪ Previous: Anton, Inc., just paid a dividend of $2.40 per share on its stock. The dividends are expected to grow at

$

0

0

The next dividend payment by Wyatt, Inc., will be $3.10 per share. The dividends are anticipated to maintain a growth rate of 3.75 percent, forever.

Required:

If the stock currently sells for $49.80 per share, what is the required return?(Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).)

Required return

%

Explanation:

We need to find the required return of the stock. Using the constant growth model, we can solve the equation for R. Doing so, we find:

R = (D1 / P0) + g

R = ($3.10 / $49.80) + .0375

R = .0997, or 9.97%

The next dividend payment by Wyatt, Inc., will be $2.50 per share. The dividends are anticipated to

July 31, 2014, 4:13 am

≫ Next: Raffalovich, Inc., is expected to maintain a constant 5.4 percent growth rate in its dividends, indefinitely.

≪ Previous: The next dividend payment by Wyatt, Inc., will be $3.10 per share. The dividends are anticipated to

$

0

0

The next dividend payment by Wyatt, Inc., will be $2.50 per share. The dividends are anticipated to maintain a growth rate of 5.75 percent, forever. Assume the stock currently sells for $48.60 per share.

Requirement 1:

What is the dividend yield? (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).)

Dividend yield

%

Requirement 2:

What is the expected capital gains yield?(Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).)

Capital gains yield

%

Explanation:1:

The dividend yield is the dividend next year divided by the current price, so the dividend yield is:

Dividend yield = D1 / P0

Dividend yield = $2.50 / $48.60

Dividend yield = .0514, or 5.14%

2:

The capital gains yield, or percentage increase in the stock price, is the same as the dividend growth rate, so:

Capital gains yield = 5.75%

Raffalovich, Inc., is expected to maintain a constant 5.4 percent growth rate in its dividends, indefinitely.

July 31, 2014, 4:15 am

≫ Next: Suppose you know that a company’s stock currently sells for $66.90 per share and the required return on the stock is 9 percent. You also know that the total return on the stock is evenly divided between capital gains yield and dividend yield.

≪ Previous: The next dividend payment by Wyatt, Inc., will be $2.50 per share. The dividends are anticipated to

$

0

0

Raffalovich, Inc., is expected to maintain a constant 5.4 percent growth rate in its dividends, indefinitely.

Required:

If the company has a dividend yield of 3.9 percent, what is the required return on the company’s stock? (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).)

Required return

%

Explanation:

The required return of a stock is made up of two parts: The dividend yield and the capital gains yield. So, the required return of this stock is:

R = Dividend yield + Capital gains yield

R = .0390 + .0540

R = .0930, or 9.30%

Suppose you know that a company’s stock currently sells for $66.90 per share and the required return on the stock is 9 percent. You also know that the total return on the stock is evenly divided between capital gains yield and dividend yield.

July 31, 2014, 4:16 am

≫ Next: Bui Corp. pays a constant $14.20 dividend on its stock. The company will maintain this dividend for the next ten years and will then cease paying dividends forever.

≪ Previous: Raffalovich, Inc., is expected to maintain a constant 5.4 percent growth rate in its dividends, indefinitely.

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Suppose you know that a company’s stock currently sells for $66.90 per share and the required return on the stock is 9 percent. You also know that the total return on the stock is evenly divided between capital gains yield and dividend yield.

Required:

If it’s the company’s policy to always maintain a constant growth rate in its dividends, what is the current dividend per share? (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).)

Dividend per share

$

Explanation:

We know the stock has a required return of 9 percent, and the dividend and capital gains yield are equal, so:

Dividend yield = 1/2(.09)

Dividend yield = .045 = Capital gains yield

Now we know both the dividend yield and capital gains yield. The dividend is simply the stock price times the dividend yield, so:

D1 = .045($66.90)

D1 = $3.01

This is the dividend next year. The question asks for the dividend this year. Using the relationship between the dividend this year and the dividend next year:

D1 = D0(1 + g)

We can solve for the dividend that was just paid:

$3.01 = D0(1 + .045)

D0 = $3.01 / 1.045

D0 = $2.88

Bui Corp. pays a constant $14.20 dividend on its stock. The company will maintain this dividend for the next ten years and will then cease paying dividends forever.

July 31, 2014, 4:17 am

≫ Next: Rabie, Inc., has an issue of preferred stock outstanding that pays a $5.70 dividend every year, in perpetuity.

≪ Previous: Suppose you know that a company’s stock currently sells for $66.90 per share and the required return on the stock is 9 percent. You also know that the total return on the stock is evenly divided between capital gains yield and dividend yield.

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Bui Corp. pays a constant $14.20 dividend on its stock. The company will maintain this dividend for the next ten years and will then cease paying dividends forever.

Required:

If the required return on this stock is 9 percent, what is the current share price? (Do not round intermediate calculations.Round your answer to 2 decimal places (e.g., 32.16).)

Current share price

$

Explanation:

The price of any financial instrument is the present value of the future cash flows. The future dividends of this stock are an annuity for ten years, so the price of the stock is the present value of an annuity, which will be:

P0 = $14.20(PVIFA9%,10)

P0 = $91.13

Rabie, Inc., has an issue of preferred stock outstanding that pays a $5.70 dividend every year, in perpetuity.

July 31, 2014, 4:20 am

≫ Next: Hot Wings, Inc., has an odd dividend policy. The company has just paid a dividend of $9.25 per share

≪ Previous: Bui Corp. pays a constant $14.20 dividend on its stock. The company will maintain this dividend for the next ten years and will then cease paying dividends forever.

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Rabie, Inc., has an issue of preferred stock outstanding that pays a $5.70 dividend every year, in perpetuity.

Required:

If this issue currently sells for $80.45 per share, what is the required return?(Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).)

Required return

%

Explanation:

The price of a share of preferred stock is the dividend divided by the required return. This is the same equation as the constant growth model, with a dividend growth rate of zero percent. Remember, most preferred stock pays a fixed dividend, so the growth rate is zero. This is a special case of the dividend growth model where the growth rate is zero, or the level perpetuity equation. Using this equation, we find the price per share of the preferred stock is:

R = D / P0

R = $5.70 / $80.45

R = 0.0709, or 7.09%

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Hot Wings, Inc., has an odd dividend policy. The company has just paid a dividend of $9.25 per share

July 31, 2014, 4:28 am

≫ Next: Antiques ‘R’ Us is a mature manufacturing firm. The company just paid a dividend of $12.10, but management expects to reduce the payout by 4.5 percent per year, indefinitely.

≪ Previous: Rabie, Inc., has an issue of preferred stock outstanding that pays a $5.70 dividend every year, in perpetuity.

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Hot Wings, Inc., has an odd dividend policy. The company has just paid a dividend of $9.25 per share and has announced that it will increase the dividend by $7.25 per share for each of the next four years, and then never pay another dividend.

Required:

If you require a return of 14 percent on the company’s stock, how much will you pay for a share today? (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).)

Current share price	$

Explanation:

The price of a stock is the PV of the future dividends. This stock is paying four dividends, so the price of the stock is the PV of these dividends discounted at the required return. So, the price of the stock is:

P0 = $16.50 / 1.14 + $23.75 / 1.142 + $31.00 / 1.143 + $38.25 / 1.144

P0 = $76.32

Antiques ‘R’ Us is a mature manufacturing firm. The company just paid a dividend of $12.10, but management expects to reduce the payout by 4.5 percent per year, indefinitely.

July 31, 2014, 4:31 am

≫ Next: Gontier Corporation stock currently sells for $64.58 per share. The market requires a return of 10 percent on the firm’s stock.

≪ Previous: Hot Wings, Inc., has an odd dividend policy. The company has just paid a dividend of $9.25 per share

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Antiques ‘R’ Us is a mature manufacturing firm. The company just paid a dividend of $12.10, but management expects to reduce the payout by 4.5 percent per year, indefinitely.

Required:

If you require a return of 11 percent on this stock, what will you pay for a share today? (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).)

Current share price	$

Explanation:

The constant growth model can be applied even if the dividends are declining by a constant percentage, just make sure to recognize the negative growth. So, the price of the stock today will be:

P0 = D0 (1 + g) / (R– g)

P0 = $12.10(1 – 0.0450) / [(.11 – (–.0450)]

P0 = $74.55

Gontier Corporation stock currently sells for $64.58 per share. The market requires a return of 10 percent on the firm’s stock.

July 31, 2014, 4:35 am

≫ Next: Global Toys, Inc., imposes a payback cutoff of three years for its international investment projects. Assume the company has the following two projects available.

≪ Previous: Antiques ‘R’ Us is a mature manufacturing firm. The company just paid a dividend of $12.10, but management expects to reduce the payout by 4.5 percent per year, indefinitely.

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Gontier Corporation stock currently sells for $64.58 per share. The market requires a return of 10 percent on the firm’s stock.

Required:

If the company maintains a constant 5.75 percent growth rate in dividends, what was the most recent dividend per share paid on the stock? (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).)

Dividend per share

$

Explanation:

We are given the stock price, the dividend growth rate, and the required return, and are asked to find the dividend. Using the constant dividend growth model, we get:

P0 = D0 (1 + g) / (R– g)

Solving this equation for the dividend gives us:

D0 = P0(R– g) / (1 + g)

D0 = $64.58(0.10 – 0.0575) / (1 + 0.0575)

D0 = $2.60

Global Toys, Inc., imposes a payback cutoff of three years for its international investment projects. Assume the company has the following two projects available.

August 3, 2014, 2:02 am

≫ Next: A firm evaluates all of its projects by applying the IRR rule. Year Cash Flow 0 –$ 158,000 1 58,000 2 81,000 3 65,000

≪ Previous: Gontier Corporation stock currently sells for $64.58 per share. The market requires a return of 10 percent on the firm’s stock.

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Global Toys, Inc., imposes a payback cutoff of three years for its international investment projects. Assume the company has the following two projects available.

Year	Cash Flow A		Cash Flow B
0	–$	62,000	–$	107,000
1		25,500		27,500
2		33,200		32,500
3		27,500		26,500
4		13,500		233,000

Requirement 1:

What is the payback period for each project? (Do not round intermediate calculations.Round your answers to 2 decimal places (e.g., 32.16).)

	Payback period
Project A	years
Project B	years

Requirement 2:

Should it accept either of them?

Accept project A and reject project B

Explanation:1: 

Project A has cash flows of:

Cash flows = $25,500 + 33,200

Cash flows = $58,700

during the first two years. The cash flows are still short by $3,300 of recapturing the initial investment, so the payback for Project A is:

Payback = 2 + ($3,300 / $27,500)

Payback = 2.12 years

Project B has cash flows of:

Cash flows = $27,500 + 32,500 + 26,500

Cash flows = $86,500

during the first three years. The cash flows are still short by $20,500 of recapturing the initial investment, so the payback for Project B is:

Payback = 3 + ($20,500 / $233,000)

Payback = 3.09 years

2:

Using the payback criterion and a cutoff of 3 years, accept project A and reject project B.

A firm evaluates all of its projects by applying the IRR rule. Year Cash Flow 0 –$ 158,000 1 58,000 2 81,000 3 65,000

August 3, 2014, 2:05 am

≫ Next: Problem 8-7 Calculating NPV and IRR [LO 3, 4] A project that provides annual cash flows of $2,800 for nine years costs $9,200 today. Requirement 1: At a required return of 11 percent, what is the NPV of the project? (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).)

≪ Previous: Global Toys, Inc., imposes a payback cutoff of three years for its international investment projects. Assume the company has the following two projects available.

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A firm evaluates all of its projects by applying the IRR rule.

Year	Cash Flow
0	–$	158,000
1		58,000
2		81,000
3		65,000

Requirement 1:

What is the project's IRR? (Do not round intermediate calculations. Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).)

Internal rate of return

%

Requirement 2:

If the required return is 15 percent, should the firm accept the project?

No

Explanation:

1:

The IRR is the interest rate that makes the NPV of the project equal to zero. So, the equation that defines the IRR for this project is:

0 = – $158,000 + $58,000 / (1 + IRR) + $81,000 / (1 + IRR)2 + $65,000 / (1 + IRR)3

Using a spreadsheet, financial calculator, or trial and error to find the root of the equation, we find that:

IRR = 13.66%

2:

Since the cash flows are conventional and the IRR is lower than the required return, we would not accept the project.

   

Calculator Solution:

Note: Intermediate answers are shown below as rounded, but the full answer was used to complete the calculation.

  

CFo	–$158,000
C01	$58,000
F01	1
C02	$81,000
F02	1
C03	$65,000
F03	1
IRR CPT
13.66%