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Chapter 4: 18BP (page 283)
Rita Gonzales won the \(41 million lottery. She is to receive \)1.5 million a year for the next 19 years plus an additional lump sum payment of $12.5 million after 19 years. The discount rate is 14 percent. What is the current value of her winnings?
The current value is $10,862,407.79.
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Murray Motor Company wants you to calculate its cost of common stock. During the next 12 months, the company expects to pay dividends (D1) of \(2.50 per share, and the current price of its common stock is \)50 per share. The expected growth rate is 8 percent.
a. Compute the cost of retained earnings (Ke). Use Formula 11-5.
b. If a $3 flotation cost is involved, compute the cost of new common stock (Kn). Use Formula 11-6.
The Suboptimal Glass Company uses a process of capital rationing in its decision making. The firm鈥檚 cost of capital is 10 percent. It will only invest \(77,000 this year. It has determined the internal rate of return for each of the following projects:
Project | Project size | Internal rate of return |
A | \)10,500 | 21% |
B | 30,500 | 22 |
C | 25,500 | 18 |
D | 10,500 | 13 |
E | 10,500 | 20 |
F | 20,500 | 11 |
G | 10,500 | 16 |
a. Select the projects that the firm should accept.
b. If Projects A and B are mutually exclusive, how would that affect your overall answer? That is, which projects would you accept in spending the $77,000?
What are the basic benefits and purposes of developing pro forma statements and a cash budget?
Sheila Goodman recently received her MBA from the Harvard Business School. She has joined the family business, Goodman Software Products Inc., as vice president of finance.
She believes in adjusting projects for risk . Her father is somewhat skeptical but agrees to go along with her. Her approach is somewhat different than the risk-adjusted discount rate approach, but achieves the same objective.
She suggests that the inflows for each year of a project be adjusted downward for lack of certainty and then be discounted back at a risk-free rate. The theory is that the adjustment penalty makes the inflows the equivalent of riskless inflows, and therefore a risk-free rate is justified.
A table showing the possible coefficient of variation for an inflow and the associated adjustment factor is shown next:
Coefficient of Variation Adjustment Factor
0鈥�0.25 0.90
0.26鈥�0.50 0.80
0.51鈥�0.75 0.70
0.76鈥�1.00 0.60
1.01鈥�1.25 0.50
Assume a \(184,000 project provides the following inflows with the associated coefficients of variation for each year:
Year Inflow Coefficient of Variation
1 \)32,200 0.12
2 59,500 0.28
3 79,900 0.45
4 59,200 0.79
A Fill in the following table:
Year Inflow Coefficient of Variation Adjustment Factor Adjusted Inflow
1 \(32,200 0.12
2 59,500 0.28
3 79,900 0.45
4 59,200 0.79
5 65,600 1.15
b. If the risk-free rate is 5 percent, should this \)184,000 project be accepted? Compute the net present value of the adjusted inflows
Assume a \(40,000 investment and the following cash flows for two alternatives:
Year | Investment X | Investment Y |
1 | \)6,000 | $15,000 |
2 | 8,000 | 20,000 |
3 | 9,000 | 10,000 |
4 | 17,000 | -- |
5 | 20,000 | -- |
Which of the alternatives would you select under the payback method?
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