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Course:- Accounting Basics
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ALL formulas, calculations, and timelines are clearly shown as these constitute a significant portion of the total marks available. If any assumptions to solve the problem, clearly state them at the beginning of the solution and explain the reason.

Question 1:  You are an analyst in charge of valuing common stocks. You are expected to give a buy-hold-sell recommendation for DEF, a pharmaceutical company specializing in anti-inflammatory drugs. Observing the current market trends, you expect future growth in this company. You expect the firm to pay its firstdividend of $5.00 per share 2 years from today. You expect the dividends to increase by 40.0% the following year. The next year dividends will increase by 30.0%, and the next year dividends will increase by 20.0% and thereafter dividends will increase by 5% each year in perpetuity. 

DEF’s required rate of return is 18.0% for the next 4 years, and thereafter the required rate of return will be 12%.

a) Draw a detailed timeline incorporating the dividends and clearly label all components.

b) From your analysis what is the value of DEF today? If the company’s stock was $25.00 what would you recommend to your firm’s clients? Explain.

c) Despite your positive outlook for DEF, other analysts indicate that DEF’s future growth is not as positive as your analysis. They believe the first dividend won’t be paid until year 3. They believe that the initial dividend will be $4.00. In addition, they believe that dividends will grow by 3% per year. What is their estimate for the value of DEF’s stock? 

Question 2: 

Your boss has asked you to analyze two projects. Project A has a cost of $1,000,000 and the required rate of return on the project is 12%. Project B has a cost of $2,500,000 and the required rate of return on the project is 15%. The expected cash flow from the assets associated with each project are shown in the table below. For each project you are to calculate

a)    the exact Payback Period

b)   the discounted Payback Period.

c)    the IRR

d)    the NPV

e)    the Profitability Index

The company requires that all projects have a payback period of less than 2 years. The company requires that projects have a discount payback period of less than 3 years.

Finally for each of the two projects you are to make a recommendation regarding whether the project should be undertaken.

 

Project A Expected Cash Flows

Project B Expected Cash Flows

Year 1

$50,000

$500,000

Year 2

$250,000

$1,000,000

Year 3

$750,000

$1,250,000

Year 4

$1,500,000

$800,000

Year 5

$3,000,000

 

Question 3: You have been asked to calculate your firm's Weighted Average Cost of Capital. Your firm has 1,000,000 common shares outstanding. The common stock sells today for $40 per share.

The firm has 550,000 preferred shares outstanding the preferred shares sell for $90 each. The preferred shares just paid a dividend of $2 per share. Dividends are paid quarterly.

The company has 3500 bonds outstanding. The bonds have a face value of the $1,000, 30 years to maturity and a coupon rate of 6%. Coupons are paid annually. The bonds sell for $950.

The company's tax rate is 35%. The risk-free rate is 4%, the expected return on the market is 11% and the company's equity has a beta of 1.5.

What is the company's WACC?




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