Posted: September 18th, 2017
Week 5 Problems—Solution Ranges, AMBA 630
For this problem set, we are not going to give you the exact answer but a range within which the correct answer can be found. For example, if the problem was “How much is 20 plus 50?” we would say, “The correct answer is between 65 and 75” and you would need to specify the exact answer of “70.”
Range: the cost of debt is somewhere between 2% and 5%. Please specify the exact answer. The cost of retained earnings is somewhere between 6.0% and 8%. Please specify the exact answer.
Point value: 5%
2-A The risk-free rate on 30 year U.S. Treasury bonds is 3.25% and the expected rate of return on the overall stock market is 12%. The company has a beta of 1.6. What is the cost of equity? Range: Between 14% and 22%
Point Value 3%
2-B Les argues that the 10 year note is a better risk free rate at 2%. He also argues that the stock market is too high and the expected return is really only 5%. Assume that he is correct. The company has a beta of 1.6. What is the cost of equity?
Range: Between 4% and 9%
Point Value 7%
Range: Between 4% and 9%
Point Value 15%
4.. West Berwick is considering two projects for a new investment, but it can afford only one. It has determined that the appropriate discount rate is 7.39%. Please answer the following questions based on the data below:
Net Cash Flow
Year
Project A Project B
0 -$4,000,000 -$5,000,000
1 $800,000 $1,900,000
2 $1,000,000 $1,700,000
3 $1,200,000 $1,400,000
4 $1,400,000 $900,000
5 $1,600,000 $300,000
4-A Calculate the payback period for each project.
Range: For Project A, the answer is somewhere between 2 and 5 years. Please specify the exact answer. For Project B The answer is somewhere between 2 and 5 years. Please specify the exact answer.
Point Value 6%
4-B Calculate the net present value for each project.
Range: For Project A The answer is somewhere between $600,000 and $800,000. Please specify the exact answer. For Project B The answer is somewhere between $100,000 and $400,000. Please specify the exact answer.
Point Value 6%
4-C Which project do you think will be approved, if only one project can be approved? Why?
Range: Project A or Project B Specify your choice
Point Value 3%
4-D What if the required rate of return was 10%?
Range: For Project A, the answer is somewhere between $300,000 and $500,000. Please specify the exact answer. For Project B, the answer is somewhere between $14,000 and $16,000. Please specify the exact answer.
Point Value 6%
4-E What is the Internal rate of return?
Range: For Project A, the answer is somewhere between 11% and 15%. Please specify the exact answer. For Project B, the answer is somewhere between 7% and 13%. Please specify the exact answer.
Point Value 6%
4-F. Which is the best to use for deciding: Payback, NPV or IRR? Why?
Answer: Give your answer
Point Value 8
6-A Kennebunk Manufacturing is expected to pay a dividend of $8 per share next year. The dividend growth rate is expected to continue to be 3%. Required rate of return is 7%. What should be the current market price per share?
Range: The answer is somewhere between $65 and $400. Please specify the exact answer.
Point Value 6
6-B. If you buy the stock in Kennebunk (above) at $185 and the stock price grows at the expected rate, What would be your percent return after one year?
Range: The answer is somewhere between 4% and 9%. Please specify the exact answer.
Point Value 6
Range: The answer is somewhere between 10% and 13%. Please specify the exact answer.
Point Value 6
Range: The answer is somewhere between 2% and 6%. Please specify the exact answer.
Point Value 6
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