QUESTION 14

1). A stock is currently traded at 35 AED per share. The systematic risk of the stock is 1.8 and the markets return is 12%. Stock last dividends is 2 AED per share and the growth rate of dividends is estimated at 9%. the risk-free rate is 10%.

Question 1: Estimate the fair price of the stock. Show calculations. Question 2: Do you buy the stock at the price of 40 AED per share if the risk-free is 10%? Explain your decision. Question 3: What is your total return if you would buy the stock at the current price and would sell it at its fair price? Please explain. Question 4: Do you think that the market for that stock is efficient for the particular time under study? Please explain. Question 5: Is it ethical to earn returns higher than markets return? Please explain. [10, 5]; [the first number in the brackets refers to points with explanation, and the second number refers to points without explanation]

2). A firm has to choose between two investments, A or B. Both Investments have an initial cost of 10,000 AED and a life of 5 years. The expected return of investment A is 7%. The financing for investment A will be done by issuing debt with a cost before tax 7% and the flat tax rate is 35%. Project B has an expected return of 19% and will be financed by issuing stocks with a cost of 13%. The firms capital structure is 40% debt and 60% equity. The manager has the option to implement investment A or Investment B, which one is more profitable, or to accept both projects if the weighted average cost of capital is lower than the risk-free rate of 7%. (a). What would her decision be for investment A and investment B if the Investments are considered separately? (b). What is the weighted average cost of capital if the Investments are considered together? (c). Justify managers final decision. (d). Justify the decision of the manager in terms of ethicality. [10, 3]; [the first number in the brackets refers to points with explanation, and the second number refers to points without explanation]