Question

(a) How much should an investor pay now for a stock ex- pected to sell for $30 one year from now if: the stock offers a $2 divi- dend, dividends are taxed at 40%, capital gains are taxed at 20%, and a 15% after-tax return is expected on the investment?

(b) You have been assigned to evaluate a project for your firm that requires an initial investment of $200,000, is expected to last for 10 years, and is expected to produce after-tax net cash flows of $44,503 per year. If your firm’s required rate of return is 14 percent, should the project be accepted?

Answer 1

a

Purchase price = after-tax cash received after one year / (1+discount rate)

= (Sale proceeds + dividend - tax on dividend - tax on capital gains)/1.15

=($30 +2- $0.8 - ($30- purchase price)X15%)/1.15

Purchase price = ($31.2 - $4.5 + purchase price X0.15)/1.15

= $26.70

answer is $26.70

b

Particulars	Amount
Annual cash flows	$    44,503.00
× present value annuity factor	5.21612
Present value of cash inflows	$ 232,132.79
Less: investment	$(200,000.00)
NPV	$    32,132.79

Accept project as NPV is positive.