Part 1 -
The Allied Group intends to expand the company's operation by making significant investments in several opportunities available to the group. Accordingly, the group has identified a need for additional financing in preferred and new common stock and new bond issues. The risk-free rate for the company is 7%, and the appropriate tax rate is 40%. Also, the beta coefficient for the company is 1.3 and the market risk premium (Km) is 12.
New Debt
The company has been advised that new bonds can be sold on the market at par ($1000) with an annual coupon of 8%, for 30 years.
New Common Stock
Market analysis has determined that given the positive history of the firm, new common stock can be sold at $29 per share, with the last dividend being paid of $2.25 per share. The growth rate on any new common stock has been estimated at a constant rate of 15% per year for the next 3 years.
Preferred Stock
New Preferred Stock can be issued with an annual dividend of 10% of par and is paid annually and currently would sell for $90 per share.
Questions: Address all of the following questions in a brief but thorough manner.
- Calculated the dividend yield in each of the next three years correctly
- What would the dividend yield as a percentage (i.e., per dividend payment divided by the book value of a share of stock) today and a year from now if the growth rate is 12%?
- What is the after tax component cost as a percentage (e.g., interest rate) of new debt today?
Part 2-
The Allied Group is considering two investments. The first investment involves a packaging machine, which can be used to package garments for shipping orders to customers. The second possible investment would be a molding machine that would be used to mold the mannequin parts.
The first possible investment is the packaging machine, which will cost $14,000. The second investment, the molding machine, would cost $12,000. The expected cash flows for the two projects are given below and the cost of capital to the firm is 15%. Both machines will be unusable after five years and have no salvage value.
The net cash flows for the two possible projects are given in the following table:
Year Packaging Machine Molding Machine
0 ($14000) ($12,000)
1 4100 3200
2 3300 2800
3 2900 2800
4 2200 2200
5 1200 2200
Questions: Address all of the following questions in a brief but thorough manner.
- Calculate each project's payback period.
- Calculate the NPV for each project.
- Calculate the IRR for each project.
- If the two projects are independent of each other, which projects, if any, should be selected? Explain why or why not.
- If the two projects are mutually exclusive, which project, if any, should be selected? Explain why.