National University of Ireland Department of Economics Finance 1 (FN205) 2007-2008 Workshop 2 Attendance at workshops is recommended.

Students are expected to complete all questions and bring written answers to workshops. Q1. A. It is forecasted that next year, Nunes Oil Company will pay a dividend of £2 on its common stock. Thereafter you expect dividends to grow at a constant rate of 4% per annum. If you require a return of 12% on your investment, how much should you be prepared to pay for the stock? If you observe the current price to be £27, what should you do? B. What would happen to the price of the stock if the growth rate is raised to 6%? Explain why this is so. C. If the growth rate remains at 4%, but the required return falls to 10%, what does this imply for the price of the stock? Why? Q2. At the beginning of 1998, AAG Paper’s stock sold for £73. Security analysts were forecasting a long-term earnings growth rate of 8.5%. The company was paying dividends of £1.68 per share. A. Assume dividends are expected to grow along with earnings at g = 8.5 % per year in perpetuity. What rate of return, r, were investors expecting? B. AAG Paper was expected to earn about 12% on book equity and to pay out about 50% of earnings as dividends. What do these forecasts imply for the growth rate, g?, for the expected return, r? Q3. Sally-Ann has been employed as a portfolio manager. The value of her portfolio is estimated to be £100 million at the end of the first year. It consists entirely of equities and pays a dividend yield of 5%. Dividends and portfolio value are expected to grow at a constant rate. Her remuneration is linked to the performance of the portfolio and she receives an annual salary of 0.5% of the portfolio value at the end of each year. Assuming that she manages the portfolio forever, what is the value of her contract?

975 C1 2500 0 200 1600 C2 2500 0 2900 800 C3 2500 10000 0 0 A B C D a. The opportunity cost of capital is 16%.266 -8. They are faced with the following projects: Project 1 2 3 4 5 6 7 Investment 300.000 250.000 NPV 66. Calculate the NPV of each project and rank the projects.100 -1.2 10.000 48.000 7.or 3-year lives.000 -2. (Ignore tax and inflation) C0 -5.000 IRR(%) 17.Q4.000 43.000 -4.1 11.5 Which projects should they accept to stay within their capital budget? How much does the budget limit cost the company in terms of its market value? The appropriate opportunity cost of capital is 11%. which have 2.000 100.000 350. Byrne Pharmaceuticals are considering 4 major projects.000 14. Calculate the IRR (or IRRs) for the following project: C0 -3000 C1 3500 C2 4000 C3 -4000 For what range of discount rates does the project have positive NPV’s? Q5.000 63. Claire and Mike have opened up a business and have allocated £1 million for capital expenditures.000 100. .6 12. The four projects are expected to generate the following cash flows.000 200.8 18.0 13. b.7 16. Calculate the IRR of each project and rank the projects based on this calculation.000 400. Why do these differ and which rule should we follow? Q6.

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