Question 3 (15 Points)

i.Explain the concept of dividend policy with an example.

ii.Discuss the dividend irrelevance theory with underlying assumptions by Modigliani and Miller.

iii.Your parents prefer high dividend paying stocks, while you prefer no-dividend stocks - explain the possible reasons for the differences in choice.

iv.Explain the following concepts with an example;

a.Signaling hypothesis

b.Clientele effects

c.Catering theory

v.You are the CEO of "I am the top 1%" Corporation, which has a capital structure of 60% equity and 40% debt. The estimated net income of your company is $600K. Your capital budget is $800K for the coming year. If you follow the residual dividend models, how much dividend you can pay and what is your pay-out ratio? What happens to dividend when estimated net income is $400K or $800K?

vi.Discuss the advantages and disadvantages of Residual dividend policy.

vii.What are the steps you consider in setting your dividend policy?

viii.Explain the concept of DRIP with an example.

ix.Discuss the differences between the stock split and stock dividends.

x.Discuss the concept of share repurchases. What are the advantages and disadvantages of share-repurchase?

Question 1 (15 Points)

"BLACKFRIDAY" company is planning an expansion of its existing production capacity. The firm hired you as a consultant for the expansion project. Since you are a savvy project manager, you first decided to estimate the firm's cost of capital based on the available data.

Data:

Tax Rate: 40%

Bond: Coupon rate 12%, Maturity Years 15, Present value $1150

Preferred Stock: Dividend rate 10%, Par Value $100, Present Value $111 Common Stock: Market price $50, D₀=$4.20, Dividend growth 5%, Beta 1.2, Treasury Bond yield 7%, Market risk premium 6%. When the firm uses Bond-yield+Premium method, the risk premium is 4%.

Capital structure of ABC is as follows;

oDebt 30%, Common Equity 60%, Preferred Stock 10%

Next, you asked your assistant "Mr.COUPON" to give his opinion on the following burning questions;

i.What sources of capital you should consider for WACC? Should the sources be before tax? Should the costs be historical?

ii.What is the BLACKFRIDAY's Cost of Bond? What is the after-tax Cost of Bond to be used in WACC?

iii.What is the cost of the firm's preferred stock?

iv.Calculate Cost of Equity of using CAPM and Bond-yield+Premium method, and DCF methods.

v.What is your final Cost of Equity?

vi.Do you agree that the cost of new equity is cheaper than the cost of retained earnings? Why?

vii.What is flotation cost and how do you adjust it?

viii.If the flotation cost of new stock issue is 10%, what is the estimated cost of equity considering the 10% flotation cost under DCF method you calculated in question iv above?

ix.What are the components of the WACC you calculated above to be blamed for higher WACC? What can be done to reduce the WACC further?

x.Should you use this WACC for all the projects? Why and why not?

Question 2 (20 points)

"Bankrupt" Corporation is in a deep financial crisis. You are one of the financial avengers "Bankrupt" is desperately seeking help from. CEO of the company informed you that he is considering the two risky projects "Thanos" and "Loki" to protect the firm from financial collapse. Both projects have similar risk characteristics. Bankrupt's WACC is 11%. The initial investments for both the projects are $200 million.Cashflow from the projects are as follows;

Year1234

Thanos10M60M80M160M

Loki70M50M20M 160M

Now, your job is to explain the following questions in great detail so that the CEO understands your plans to protect the firm.

i.Explain the concept of capital budgeting decisions. How it is different from the firm's investing decisions.

ii.Explain the concepts of independent and mutually exclusive projects

iii.What is NPV -explain with an example?

iv.Calculate NPV for both the projects and show the steps

v.Explain your decision when Thanos and Loki are mutually exclusive, and when they are independent.

vi.WACC has increased to 15%. What change you will see in NPV?

vii.What is IRR and how it is different from NPV? What is the IRR for Thanos and Loki? Based on IRR which project you should accept?

viii.How is IRR identical to Bond's YTM?

ix.WACC has increased to 15%. What change you will see in IRR? Is it good for the firm?

x.What is the reinvestment assumption for NPV and IRR? Why NPV is better than IRR?

xi.Find the MIRR for both projects and explain the difference with IRR.

xii.Is MIRR a better measure than NPV? Why and why not?

xiii.Calculate the pay-back and discounted pay-back for both the project. Discuss the differences between the two methods.

Question 3 (15 Points)

i.Explain the concept of dividend policy with an example.

ii.Discuss the dividend irrelevance theory with underlying assumptions by Modigliani and Miller.

iii.Your parents prefer high dividend paying stocks, while you prefer no-dividend stocks - explain the possible reasons for the differences in choice.

iv.Explain the following concepts with an example;

a.Signaling hypothesis

b.Clientele effects

c.Catering theory

v.You are the CEO of "I am the top 1%" Corporation, which has a capital structure of 60% equity and 40% debt. The estimated net income of your company is $600K. Your capital budget is $800K for the coming year. If you follow the residual dividend models, how much dividend you can pay and what is your pay-out ratio? What happens to dividend when estimated net income is $400K or $800K?

vi.Discuss the advantages and disadvantages of Residual dividend policy.

vii.What are the steps you consider in setting your dividend policy?

viii.Explain the concept of DRIP with an example.

ix.Discuss the differences between the stock split and stock dividends.

x.Discuss the concept of share repurchases. What are the advantages and disadvantages of share-repurchase?