International Economics and Financial Decision Making-Part 2

Hello! i'm studying International Economics and Financial Decision Making but having difficulties solving this questions, any kind soul able to help me out? thanks!!

Question 1
Q1.a. The Duffers Brothers Inc. wants to set up a private cemetery business. According to the Chief Financial Officer, Shawn Levy, business is “looking bright”. As a result, the cemetery project will provide a net cash inflow of $180,000 for the firm during the first year, and the cash flows are projected to grow at a rate of 4% per year forever. The project requires initial outlays of $2.2 million.
If the company requires a return of 11% on such undertakings, should the cemetery business be started?
The company is somewhat unsure about the assumption of a growth rate of 4% in its cash flows. At what constant growth rate would the company break even if it still required a return of 11% of investment?
10 marks

Q1.b. Hello Sunshine Inc. is financed entirely by common stocks and has a beta of 1.0. Assume that the firm pays no taxes. The stock has a price-earning (PE) multiple of 10 and is priced to offer a 10% expected return. The company decides to repurchase half the common stocks and substitute an equal value of debt. Assume that the debt yields a risk-free of 5% and a beta of 0. Calculate the following:
The beta of the common stocks after refinancing
The required rate of return and risk premium on the common stocks before the refinancing
The required rate of return and risk premium on the common stocks after the refinancing
The required return on the debt
The required return on the company (i.e., stock and debt combined) after the refinancing
15 marks
Total 25 marks
Question 2
Q2.a. Consider the following scenario analysis.
Scenario
Probability
Rate of Return
Stocks
Bonds
Recession
0.20
-5%
+14%
Normal
0.60
+15
+8
Boom
0.20
+25
+4


Is it reasonable to assume that Treasury bonds will provide higher returns in recessions than booms? Explain your argument.
Calculate the expected rate of return and standard deviation for each investment?
Which investment would you prefer?
10 marks

Q2.b. The treasurer of Holmes & Holmes Co. has projected the cash flows of Project A, B, and C as follows:
Year
Project A
Project B
Project C
0
-$405,000
-$810,000
-$405,000
1
297,000
540,000
324,000
2
297,000
540,000
243,000


Suppose the relevant discount rate is 12% per year.
Compute the profitability index for each of the three projects.
Compute the Net Present Value (NPV) for the three projects.
Suppose these three projects are independent. Which project(s) should Holmes & Holmes accept based on the profitability index rule?
Suppose these three projects are mutually exclusive. Which project(s) should Holmes & Holmes accept based on the profitability index rule? Hint: Since the projects are mutually exclusive, choose the project with the highest PI, while taking into account the scales of the project. Consider also the incremental cash flows of the project when the scales of the projects are different.
Suppose the company’s budget for these projects is $810,000. The projects are not divisible. Which project(s) should Holmes & Holmes accept?
15 marks
Total 25 marks

Question 3
Q3.a. Peter Parker Inc. has no debt but can borrow at 5.9%. The firm’s Weighted Average Cost of Capital (WACC) is currently 9.20% and the tax rate is 21%.
What is the company’s cost of equity?
If the company converts to 25% debt, what will its cost of equity be?
If the company converts to 50% debt, what will its cost of equity be?
What is the company’s WACC in parts (ii) and part (iii)?

10 marks
Q3.b. Suppose your company needs to raise $65 million and you want to issue 20-year bonds for this purpose. Assume the required return on your bond issue will be 4.9%, and you’re evaluating two alternative issues: (1) a semi-annual coupon bond with a coupon rate of 4.9%; and (2) a zero-coupon bond. The tax rate is 21%. Both bonds will have a par value of $1,000.
How many of the coupon bonds would you need to issue to raise the $65 million? How many of the zeroes would you need to issue?
In 20 years, what will your company’s repayment be if you issue the coupon bonds? What if you issue the zeroes?
Based in your answers in parts (i) and (ii), provide explanations why would you ever want to issue the zeroes? To answer, calculate the firm’s after-tax cash outflows for the first year under the two scenarios. Assume the Tax Office’s amortization rules apply for the zero-coupon bonds.
Hint: (1) For the cash flow of the coupon bonds, we need to account for the tax deductibility of the interest payments. (2) For the zero-coupon bonds, the first-year interest payment is the difference in the price of the zero at the end of the year and the beginning of the year. The total cash flow for the zeroes will be the interest deduction for the year times the number of zeroes sold, times the tax rate.
15 marks
Total 25 marks

Question 4
Q4.a. Hawkins News Ltd. Has been growing at a rate of 20%, and you expect this growth rate in earnings and dividends to continue for another three years.
If the last dividend paid was $2, what will the next dividend be?
If the discount rate is 15% and the steady growth rate after three years is 4%, what should the stock price be today?
What is your prediction for the stock price in one year?
Show that the expected return equals the discount rate?

15 marks

Q4.b. Warwick Plc. Is considering a project that will result in initial after-tax cash savings of $2.9 million at the end of the first year, and these savings will grow at a rate of 2% per year indefinitely. The firm has a targeted debt-to-equity ratio of 0.75; a cost of equity of 10%; and after-tax cost of debt of 4.6%. The cost-saving proposal is somewhat riskier than the usual project the firm undertakes. Therefore, management uses the subjective approach and applies an adjustment factor of +3% for the cost of capital for such risky projects. Under what circumstances should Warwick Plc. take on the project?
10 marks
Total 25 marks