Reference no: EM133076622
Question 1 - a) Stock A just distributed a dividend of $2. It is expected that the company will increase its dividend by 12% in the coming year, 15% in the second year and 8% in the third year. After the third year, the company will maintain the dividend growth rate at 5% forever. How much would Stock A be worth today if its yearly required rate of return is 8%?
b) Suppose you are willing to pay $50 today for a share of stock which you expect to sell in one year for $52. If you require an annual rate of return of 10%, what must be the amount of the annual dividend which you expect to receive at the end of Year 1?
Question 2 - Silicon Co. is a start-up company. It is now considering going ahead with one of the following projects next month. The details about the two projects are as follows: Project A - The initial cost is $1,500,000. In return, the company forecast year-end cash inflow of $600,000 from year 1 to year 3. The cash flow will drop to $400,000 in year 4. Project B - The initial cost is $1,800,000. The company forecasts to receive $500,000, $550,000, $400,000 and $1,200,000 from year 1 to 4 respectively. Assume that the required yearly return of both projects are 5%.
a) Calculate the payback period of the two projects. Given the target payback period is 3 years, which project should the company choose? Explain your answer.
b) Calculate the discount payback period of the two projects. Given the target payback period is 4 years, which project should the company choose? Explain your answer.
c) Calculate the NPV of the two projects. Which project should the company choose? Explain your answer.
d) Based on your answers in parts (a) - (c), which project should the company choose? Explain.
e) Instead of choosing one out of the two projects, Silicon Co. has just realized that they can implement projects A and B simultaneously if they install a new machine. The installation cost is $200,000. Explain whether Silicon Co. should install this new machine. (Hint: Justify your answer base on the NPV of the two projects.).
Question 3 - Sam has $10,000 and is considering investing in two stocks - HSCC and Sixcent. The table below shows the return of the stocks under different possible scenarios:
|
State of Affair
|
Probability
|
HSCC
|
Sixcent
|
|
Pandemic (long period of lockdown)
|
0.25
|
2%
|
20%
|
|
Pandemic (short period of lockdown)
|
0.3
|
5%
|
10%
|
|
No Pandemic
|
0.45
|
18%
|
2%
|
a) Calculate the expected rate of return, variance and standard deviation of HSCC & Sixcent.
b) Suppose Sam forms a portfolio with the stocks of HSCC and Sixcent. If he wants the portfolio to have 9.26% expected return, how much should he invest in HSCC? Calculate the variance and standard deviation of this portfolio given the covariance between HSCC and Sixcent is - 0.003 (or -30%2).
c) Explain why the risk of Sam's portfolio is lower than the weighted average risk of HSCC and Sixcent.
d) Suppose the risk-free rate is 2.5%, the market risk premium is 8% and the betas for HSCC and Sixcent are 0.45 and 1.55 respectively. Using the CAPM model, estimate the required rates of return of HSCC & Sixcent.
e) Determine if the two stocks are overpriced or underpriced and which (if any) should be purchased.
f) Sixcent is having higher beta while HSCC is having larger standard deviation. Explain why the results of beta and standard deviation can be different even though both of them are measuring "risk".