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Question 1

Sam Strother and Shawna Tibbs are senior vice presidents of Mutual of Seattle. They are codirectors of the company’s pension fund management division, with Strother having responsibility for fixed income securities (primarily bonds) and Tibbs responsible for equity investments. A major new client, the Northwestern Municipal Alliance, has requested that Mutual Strother and Tibbs, who will make the actual presentation, have asked you to help them. To illustrate the common stock valuation process, Strother and Tibbs have asked you to

analyze the Temp Force Company, an employment agency that supplies word processor operators and computer programmers to businesses with temporarily heavy workloads. You are to answer the following questions.

  1. Assume that Temp Force has a beta coefficient of 1.2, that the risk-free rate (the yield on T-bonds) is 7.0%, and that the market risk premium is 5%. What is the required rate of return on the firm’s stock? (4 Marks)
  1. Assume that Temp Force is a constant growth company whose last dividend (D0, which was paid yesterday) was $2.00 and whose dividend is expected to grow indefinitely at a 6% rate.
  1. What is the firm’s expected dividend stream over the next 3 years? (6 Marks)
  2. What is the firm’s current stock price? (4 Marks)
  3. What is the stock’s expected value 1 year from now? (2 Marks)
  4. What are the expected dividend yield, the expected capital gains yield, and the expected total return during the first year? (8 Marks)

Question 2

John Black is considering to purchasing a land from Real Estate Ltd for $1,000,000. The terms of the agreement are, 10% down payment, and the balance is to be repaid at 20% interest for duration of five (5) years.

  1. If payment should be made at the beginning of each year, calculate the five (5) equal payments that would amortize this loan. (4 Marks)
  2. If payment should be made at the end of each year, calculate the five (5) equal payments that would amortize this loan. (4 Marks)
  3. Considering part (b), prepare the amortization schedule for this loan. (10 Marks)
  4. How much interest is paid over the life of the loan? (1 Mark)

Question 3

Gardial Fisheries is considering two mutually exclusive investments. The projects’ expected net cash flows are as follows:

Expected Net Cash Flows

Year Project A Project B

0 −$375 −$575

1 −300 190

2 −200 190

3 −100 190

4 600 190

5 600 190

6 926 190

7 −200 0

  1. Calculate the NPV if each project’s cost of capital is 12%, which project should be selected? (10 Marks)
  2. If the cost of capital is 18%, what project is the proper choice? (10 Marks)
  3. At a cost of capital of 12%, what is the discounted payback period for these two projects? (8 Marks)
  4. What is the profitability index for each project if the cost of capital is 12%? (4Marks)


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