Risk and Return

The company has a beta of 1.20, the risk-free rate of return is currently 10%, and the market return is 14%. The company plans to pay a dividend of $2.60 in the coming year and anticipates that its future dividends will increase at an annual consistent of 6% for the forseeable future.

Required:

a) Calculate the required return on the companys ordinary shares using the Capital Asset Pricing

Model (CAPM).

b) Estimate the value of the companys ordinary shares using the Constant-Growth Dividend Model

(Use the required rate of return calculated in part (a) ).

2. Weighted Average Cost of Capital (WACC)

The company has a capital structure based on current market values as follow:

Type

Weighting

Returns required by investors

Debt 50% Preference Shares 10% Ordinary Shares 40%

8%

10%

Calculated in part 1(a)

Required:

Calculate the companys after-tax WACC, assuming the firms marginal tax rate is 40%.

3. Capital Budgeting Projects

The Management of Giant Enterprises is evaluating two new chemical filtration systems of equal risk, to use in its plant. The companys cost of capital is 13%. The costs and the cash flows for these systems are shown below.

System 1

System 2

Initial Investment

Year

$800,000 $500,000

Cash inflows

1 $150,000 2 200,000 3 250,000 4 30,000 5 35,000

$150,000 $150,000 $150,000 $150,000 $150,000

Required:

a) Calculate each systems Payback Period.

b) Calculate the Net Present Value (NPV) for each system.

c) Indicate which system you would recommend, substantiating your reasons.

4. Bond Issue

In order to fund the new chemical filtration systems, the company is considering issuing a 5 year bond, with a face value of $1000 and a coupon rate of 11%, the interest rate for similar bonds is currently 9%. Required:

Calculate the current market price of the 5 year bond, assuming annual payments