Question 2

Your firm is 100% equity financed (you have no debt). The markets required rate of return for your firm is 7.4%. Currently, your firm generates an annual net cash flow of $1.5 million every year and is expected to produce the same amount forever. . Your firm pays 100% of its net cash flows in dividend, every year. You currently have 500,000 shares outstanding. (Show work/equation used for all parts)

Question 2.1 (10 points):

What is the value of one share of your firm?

Question 2.2 (10 points):

You have the opportunity to invest in a new project. The project will cost $400,000 today. You expect that it will generate an annual cash flow of $35,000 for 30 years starting next year, and then the projects cash flow will grow at a rate g of 3% per year. Using the markets required rate of return, should you invest in this project according to the net present value rule? Why?

Question 2.3 (10 points): What is the payback period for this project? If the maximum payback period in your firm is 11 years, should you invest in this project? Why? (Hint: Using excel to compute each annual cash flow might help you figure this question out.)

Question 2.4 (20 points):

If you decided to invest in the project discussed in question 2.2, what would be the value for one share of your firm right after you announce to the markets participants that you will invest in the project?