Question 4

Part A

River Inc. is considering buying a new ship at the cost of $497 million. The firm wants to operate it for a period of 20 years. It is expected that the ship will earn an annual cash flow of $71.1 million and has a cost of capital of 12.5 percent.

Required:

1. Prepare the NPV profile of the investment.

2. Calculate the IRR and identify it on the graph.

3. Should the firm invest?

4. How far could the estimated cost of capital be before the investment decision of the firm would change?

Part B

Nisocom Industries is planning to distribute a dividend of $3 per share this year. It has an equity cost of capital of 10 percent. Moreover, its earnings are expected to grow at an annual rate of 4 percent.

Required:

1. What is the share price of Nisocom industries if it is assumed that the company has a constant expected growth rate and dividend payout rate and that it does not repurchase or issue shares?

2. If we assume that it pays $1 as a dividend this year and utilize the remaining $2 per share for the share buyback, then what is the share price of the company keeping the total payout rate constant?

3. Next, calculate the expected growth rates of earnings and dividends per share if the company maintains the total payout and dividend rate calculated in part b.