Reference no: EM132428793

Question 1: Ergon Inc. expects to have £225 million in earnings at the end of the year and earnings are expected to grow at 8% annually.The firm does not pay any dividends, but it intends to use 29% of its earnings for stock repurchases. Ergon's cost of equity is 35% and it has 45 million shares outstanding. Calculate Ergon's stock price.

Question 2: ABC Corporation expects to have earnings per share of £12 next year. Rather than reinvest these earnings and grow, the firm plans to pay out all of its earnings as a dividend. With these expectations, of no growth, ABC's current share price is £20. Suppose ABC could cut its dividend payout rate to 35% next year and use the retained earnings to open new stores. The return on its investment in these stores is expected to be 23.3%. Assuming its equity cost of capital and the new growth rate remain unchanged, what effect would this new policy have on ABC's stock price?

Question 3: You work for a manufacturing company and you are trying to decide between two projects. Table shows the cash flows and the Internal Rate of Return (IRR) for each project.

You can undertake only one project. If your cost of capital is 11%, use the incremental IRR rule to make the correct decision.

Question 4: You are the owner of a firm that currently generates revenues of £21 million per year. Next year, revenues will either decrease by 2% with 30% probability or increase by 20% with 48% probability and then stay at that level for as long as you run the business. You own the firm outright. Also, you have annual costs of £100,000. If you decide to shut down the firm the cost is zero. In that case, you can always sell the firm for £320,000. What is the business worth today if the cost of capital is 32%?

Question 5: Zweite Pharma is a fast-growing company. The company forecasts that in the next three years its growth rates will be 30%, 28% and 24% respectively. After three years, the company expects a more stable growth of 8% that will last forever. Last week it declared a dividend of £1.27. The required rate of return is 11%.

i) Compute the dividends for the next three years and find their present value.

ii) Calculate the price of the shares at the end of year 3 when the firm settles to a constant growth.

iii) What is the current price of the shares?