1. This is an individual assignment. You are expected to complete it on your own without  copying  the  work  form  other  student(s)  and  without  allowing  other student(s) to copy your work. Please observe UIC’s academic honesty policy. Plagiarized work will receive 0.

2. Retain two decimal places for all values.

3. AI tools are not allowed in this assignment.

Q1 (10 marks).

Suppose a company has a beta of 1.1. The risk-free rate is 5.6% and the market risk premium is 6%. The current dividend of $2 is expected to grow at 5% indefinitely. The price of the stock is $40.

a. Estimate the value of the company’s stock. (6 marks)

b. Determine the constant dividend growth rate that would be required to justify the market price of $40. (4 marks)

Q2 (10 marks).

Wall Inc. forecasts that it will have the free cash flows (in millions) shown below. Assume the firm has zero non-operating assets.    If the weighted average cost of capital is 14% and the free cash flows are expected to continue growing at the same rate after Year 3 as from Year 2 to Year 3, what is the firm’s total corporate value, in millions?

Year                                       1                   2                    3

Free cash flow                      -$20.00          $48.00          $51.50

Q3 (10 marks)

Assume that Adams holds just one stock, Novo Coporation (NYSE: N), which he thinks has very little risk. Judy agrees that the stock is relatively safe, but  she wants to demonstrate that Adam’s risk would be even lower if he could be more diversified. Judy obtains the following returns data for Gemini (NYSE: G). Both stocks have had less variability than most other stocks over the past 5 years. Judy suggests Adams have aportfolio consisting 60% in N and the remainder in G.

Year Return for N Return for G

2018     22.00%          10.00%

a. Calculate the average rate of return for each stock during the past five years (2 marks)

b. Calculate the standard deviation of returns for each stock (2 marks)

c. If your Adams had held the portfolio, by how much would his stand-alone risk have been reduced based on the standard deviation? (6 marks)

Q4 (10 marks)

A mutual fund manager has a $60 million portfolio with a beta of 1.00. The risk-free   rate is 4%, and the market risk premium is 8.00%. The manager expects to receive an  additional $20 million which she plans to invest in additional stocks. After investing   the additional funds, she wants the fund's required and expected return to be 14.00%.  What must the average beta of the new stocks be to achieve the target required rate of return?

Q5 (10 marks)

Company A recently hired you as a consultant to estimate the company's WACC. You have obtained the following information. (1) The firm's noncallable bonds mature in 20 years, have an 8.00% annual coupon, a par value of $1,000, and a market price of $1,050.00. (2) The company's tax rate is 40%. (3) The risk-free rate is 4.50%, the market risk premium is 5.50%, and the stock's beta is 1.20. (4) The target capital structure consists of 35% debt and the balance is common equity. The firm does not expect to

issue any new common stock.

a. What is its WACC? (6 marks)

b. Comment on the following remark:

If expectations for long-term inflation rose, the percentage point increase in the cost of  equity would be greater than the increase in the interest rate on long-term debt. (4 marks)

Q6 (10 marks)

An all-equity firm is considering the following projects:

The T-bill rate is 3 percent, and the expected rate of return on the market is 10%.

a. Which project(s) should be accepted and which project(s) should be rejected ? (6 marks)

b. Which project(s) will be incorrectly accepted or rejected if the firm’s overall cost of capital of 8.5% were used as a hurdle rate? (4 marks)

Q7 (15 marks)

Westchester Corp. is evaluating two projects, Project X and Project Y, both of which have expected useful life of 5 years. Project X requires an initial outlay of $500 (all dollar amounts are in millions), and is expected to generate $200 cash flows each year during its useful life. Project Y requires an initial outlay of $5,000, and is expected to generate $1,800 each year during its useful life. The two projects are deemed to have the same level of risk; and the applicable cost of capital for projects of this level of risk is 15%.

a. Calculate the net present value (NPV) and the internal rate of return (IRR) for each project. (4 marks)

b. Assuming the projects are mutually exclusive, which one should you recommend based on NPV? (2 marks)

c. Assuming the projects are mutually exclusive, which one should you recommend based on IRR? (2 marks)

d.  Is  there  any  confliction  on  the  firm’s  capital  budgeting  decision?  Explain  the reason(s). (7 marks)

Q9 (10 marks)

Madura Inc. is considering a new project whose data are shown below. The equipment to be used would be depreciated by the straight-line method over its 5-year life and would have a zero-salvage value, and no new working capital would be required. Revenues and other operating costs are expected to be constant over the project's 5-year life. However, this project would compete with other Madura products and would reduce their pre-tax annual cash flows.    What is the project's NPV?