20) Choose any publicly traded common stock that pays a dividend. There are many sources for this information (Two are www.yahoo.com and www.reuters.com).
a. Please provide a copy of the stock information that you used. Please let me know when (date) and where (source) you obtained the data and the name of the corporation.
b. Fill in the following table. Beta is a measure of market risk. Calculate the italicized items.
Current Annual Dividend
Current Annual Earnings Per Share
Payout Rate= Dividend/EPS
Retention Rate = 1 – payout rate
Return on Equity or ROE
Analyst Estimate of Growth in Dividends
Growth = Retention Rate x ROE
Risk-free rate (10 year Treasury Bonds)
Current stock price
c. Use the capital asset pricing model (CAPM) to calculate the required return (r) demanded by investors. Use 5% as the market risk premium.
d. Use the dividend discount model (also known as the constant growth model) to estimate the price of the stock. Assume the current dividend has just been paid.
· How close are you to the current price?
· Some reasons why your calculation may differ from the current price: the model does not fit the firm; the estimates are incorrect or the market has mispriced the security. Discuss some of the difficulties your team had in using the constant growth model. In your team’s opinion, does this model work for your firm? Explain. Limit: ½ page.
2) (50) You need to examine an asset replacement decision for Bay Lin.
Bay Lin: Bay Lin Businesses is in the mining industry. They are considering replacing an old processing system with a new one. The planning horizon is 3 years. Jim Lee is reviewing the information on the old system. The old processing system currently generates $28 million in sales each year for 3 years. The cost of goods sold is 80% of sales. Fixed costs are $2 million per year for 3 years. The old equipment is fully depreciated, but can be sold today for $1,000,000.
The new system requires a new machine. It will cost $18,000,000 to be depreciated on a straight-line basis to a zero book value over 3 years. The new machine has a salvage value of $6,000,000 at the end of the 3 years. Because of the improved quality and quantity of the mined goods, sales will increase to 40 million per year for 3 years. Production efficiencies will reduce cost of goods sold to 55% of sales. Gem Lee estimates fixed costs of $2,500,000 per year to cover additional promotion and advertising of the new process. The new process will require working capital. The total investment in net working capital is $2,000,000 at time 0; 3 million at time 1; 1 million at time 2 and 0 at time 3 (Note here that the total is given rather than the change). All operations will cease at the end of year 3. The tax rate is 40%.
For either Bay Lin or the asset replacement of your choice, answer the following questions:
a) Find the free cash flow for each year. Be sure to estimate the horizon value OR the salvage value. You will have a horizon value if the new asset (or process) lasts longer than the planning horizon. You will have a salvage value if the new asset is sold at the end of the planning horizon.
b) Find the weighted average cost of capital (WACC). For Bay Lin, assume the firm will use $8 million in debt to buy the new machine. The rest of the financing is from equity. The debt has an interest rate of 6% and a three-year life, so interest expense is $480,000 per year. The beta on levered equity is 2.20. Use the 10-year Treasury bond for the risk-free rate and 5% as the market risk premium. They used their target capital structure to determine the financing for the project.
c) Find the IRR. Find the NPV of the project using the WACC?
d) Should the asset or process be replaced? Explain. Maximum length is ½ page.
e) What other considerations (or problems) are there in evaluating this decision? Maximum length is ½ page.