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Toys World is experiencing huge growth and it is considering to undertake an additional investment. Currently they are analysing two projects: either to invest on

Toys World is experiencing huge growth and it is considering to undertake an additional investment. Currently they are analysing two projects: either to invest on "Books Division" or "Kids Clothing Division". The proposed new projects' cash flows forecast and other relevant information are as below:

"Books Division Project"

"Kids Clothing Division Project"

Beta

2.5

Beta

1.1

Year:

0

-$200,000

Year:

0

- $200,000

1

+$100,000

1

+$90,000

2

+$100,000

2

+$90,000

3

+$100,000

3

+$90,000

The current total market value of the Toys World company's shares is $250,000, ex dividends; and the company currently has 5,000 shares outstanding. The company has a beta of 1.5.

Toys World is an unlevered company i.e. 100% equity-based company. Toys World's dividends over last few years are:

Year Dividend (in $)
2017 3.7565
2018 4.1321
2019 4.5454
2020 (current year) 5.00

The annual return on five-year government bonds is currently 3% and the expected return on the ASX stock market index is 15%. Ignore tax.

Toys World usually evaluates all investment proposals with NPV, using the cost of equity capital as the discount rate.

Required:

(a) Calculate the growth rate of dividends using dividend growth model (DGM).

(b) Estimate this cost of equity i.e. the discount rate either by using DGM or CAPM (Capital asset pricing model).

(c) Using the above discount rate in part (b), calculate NPV and evaluate both projects for investment decision making purposes.

(d) Calculate each individual project's cost of equity (i.e. discount rate) applying CAPM.

(e) Recalculate the NPV for each proposal using each individual project's CAPM as the discount rate and re-evaluate your decision.

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