Question

1) An investment under consideration has a payback of six years and a cost of $866,000. Assume the cash flows are conventional.

If the required return is 12 percent, what is the worst-case NPV? (Do not round intermediate calculations. A negative answer should be indicated by a minus sign. Round your answer to 2 decimal places, e.g., 32.16.)

Worst-case NPV           $

2) East Side Corporation is expected to pay the following dividends over the next four years: $18, $14, $13, and $8.50. Afterward, the company pledges to maintain a constant 4 percent growth rate in dividends forever. If the required return on the stock is 14 percent, what is the current share price?

Answer 1

Answer to Question 1:

Initial Investment = $866,000
Payback Period = 6 years
Required Return = 12%

Worst case possible is that initial investment is recovered at the end of sixth year.

Cash Flows:
Year 0 = -$866,000
Year 1 - Year 5 = $0
Year 6 = $866,000

NPV = -$866,000 + $866,000/1.12^6
NPV = -$866,000 + $438,742.55
NPV = -$427,257.45

NPV of worst case is -$427,257.45

Answer to Question 2:

D1 = $18.00
D2 = $14.00
D3 = $13.00
D4 = $8.50

Growth Rate, g = 4%
Required Return, rs = 14%

D5 = D4 * (1 + g)
D5 = $8.50 * 1.04
D5 = $8.84

P4 = D5 / (rs - g)
P4 = $8.84 / (0.14 - 0.04)
P4 = $88.40

P0 = $18.00/1.14 + $14.00/1.14^2 + $13.00/1.14^3 + $8.50/1.14^4 + $88.40/1.14^4
P0 = $92.71

Current share price is $92.71