Question

What is the payback period for Tangshan Mining company's new project if its initial after-tax cost is $5,000,000 and it is expected to provide after-tax operating cash inflows of $1,800,000 in year 1, $1,900,000 in year 2, $700,000 in year 3, and $1,800,000 in year 4?
Select one:
a. 1.33 years
b. 2.33 years
c. 4.33 years
d. 3.33 years

Which of the following is TRUE?
Select one:
a. The Gordon model assumes that the value of a share of stock equals the future value of the current price of share that it is expected to remain constant over an infinite time horizon.
b. The marginal cost of capital is a relevant cost of capital for evaluating a firm's future investment opportunities.
c. The Gordon model is based on the premise that the value of a share of stock is equal to the sum of all future dividends it is expected to provide over an infinite time horizon.
d. The cost of retained earnings will always equal the cost of preferred stock.

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Thank's
Abdul-Rahim Taysir

Answer 1

Hi

1) A payback period is the time be when a firm will recover its initial cost.

here initial cost =$5,000,000

Y1 cash flow = $1,800,000

Y2 cumulative cash flow = $1,800,000 + $1,900,000 = $3,700,000

Y3 cumulative cash flow = $3,700,000 + $700,000 = $4,400,000

y4 cumulative cash flow = $4,400,000 + $1,800,000 = $6,200,000

Hence payback period will be between 3 and 4 years

payback period = 3 + (5,000,000-4,400,000)/1,800,000

=3 + 600,000/180,000

=3 + 0.33 = 3.33 years

hence option d is correct.

2) A marginal cost of capital is weighted cost of capital for both shareholders and debt holders and it is a relevant cost of capital for evaluating a firm's future investment opportunities.

hence option b is true here.

Thanks