Question 2 (20 pionts)

You  are interested in purchasing the common stock of Azure Corporation. The firm  recently paid a dividend of $2.80 per share. It expects its earnings—and  hence its dividends—to grow at a rate of 6.8% for the foreseeable future.  Currently, similar-risk stocks have required returns of 7.2%.

To Do:

a. Given the data above, calculate  the present value of this security. Use the constant-growth model to find the  stock value.
    b. One year later,  your broker offers to sell you additional shares of Azure at $84.
    The most recent dividend paid was $2.92, and the expected growth rate for  earnings remains at 6.8%. If you determine that the appropriate risk premium  is 7.02% and you observe that the risk-free rate, RF, is currently 4.98%,  what is the firm’s current required return, rAzure?
    c. Applying  constant-growth model, determine the value of the stock using the new  dividend and required return from part b.
    d. Given your  calculation in part c, would you buy the additional shares from your broker  at $73 per share? Explain.

Question 3 (20 pionts)

Jane is considering investing  in three different stocks or creating three distinct twostock portfolios.  Jane considers herself to be a rather conservative investor. She is able to  obtain forecasted returns for the three securities for the years 2013 through  2019. The data are as follows:

Stock B

Stock C

10%

12%

11%

14%

8%

10%

12%

11%

10%

9%

15%

9%

15%

10%

In  any of the possible two-stock portfolios, the weight of each stock in the  portfolio will be 50%. The three possible portfolio combinations are AB, AC,  and BC.

To Do:

Create  a spreadsheet similar to Tables 8.6 and 8.7 in Chapter 8 to answer the following:
    a. Calculate the  expected return for each individual stock.
    b. Calculate the  standard deviation for each individual stock.
    c. Calculate the  expected returns for portfolio AB, AC, and BC.
    d. Calculate the  standard deviations for portfolios AB, AC, and BC.
    e. Would you  recommend that Jane invest in the single stock A or the portfolio consisting  of stocks A and B? Explain your answer from a risk–return viewpoint.
    f. Would you  recommend that Jane invest in the single stock B or the portfolio consisting  of stocks B and C? Explain your answer from a risk–return viewpoint.

Question 4 (20 pionts)

Nova  Corporation is interested in measuring the cost of each specific type of  capital as well as the weighted average cost of capital. Historically, the  firm has raised capital in the following manner:

The  tax rate of the firm is currently 40%. The needed financial information and  data are as follows:
   
    Debt Nova can raise debt by  selling $1,000-par-value, 6.5% coupon interest rate, 10-year bonds on which  annual interest payments will be made. To sell the issue, an average discount  of $20 per bond needs to be given. There is an associated flotation cost of 2%  of par value.
   
    Preferred stock  Preferred stock can be sold under the following terms: The security has a par  value of $100 per share, the annual dividend rate is 6% of the par value, and  the flotation cost is expected to be $4 per share. The preferred stock is  expected to sell for $102 before cost considerations.
   
    Common stock The  current price of Nova’s common stock is $35 per share. The cash dividend is  expected to be $3.25 per share next year. The firm’s dividends have grown at  an annual rate of 5%, and it is expected that the dividend will continue at  this rate for the foreseeable future. The flotation costs are expected to be  approximately $2 per share. Nova can sell new common stock under these  terms.
   
    Retained earnings The firm expects to have  available $100,000 of retained earnings in the coming year. Once these  retained earnings are exhausted, the firm will use new common stock as the  form of common stock equity financing. (Note: When measuring this cost, the  firm does not concern itself with the tax bracket or brokerage fees of  owners.)

To Do:

Create  a spreadsheet to answer the following questions:
    a. Calculate the after-tax  cost of debt.
    b. Calculate the cost  of preferred stock.
    c. Calculate the cost  of retained earnings.
    d. Calculate the cost  of new common stock.
    e. Calculate the  firm’s weighted average cost of capital using retained earnings and the  capital structure weights shown in the table above.
    f. Calculate the  firm’s weighted average cost of capital using new common stock and the  capital structure weights shown in the table above.

Question 5 (20 pionts)

The  Drillago Company is involved in searching for locations in which to drill for  oil.The firm’s current project requires an initial investment of $15 million  and has an estimated life of 10 years. The expected future cash inflows for  the project are as shown in the following table:

The firm’s current cost of capital is 13%.

To Do:

Create  a spreadsheet to answer the following:
    a. Calculate the project’s  net present value (NPV). Is the project acceptable under the NPV technique?  Explain.
    b. Calculate the  project’s internal rate of return (IRR). Is the project acceptable under the  IRR technique? Explain.
    c. In this case, did  the two methods produce the same results? Generally, is there a preference  between the NPV and IRR techniques? Explain.
    d. Calculate the  payback period for the project. If the firm usually accepts projectsthat have  payback periods between 1 and 7 years, is this project acceptable?