Strategic Financial Management-NMIMS Solution-June 19
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Q1. You are considering an investment project. The project has a life of three years.
Initial investment into a new machine, which would cost Rs.4,50,000.
Machine is to be depreciated to zero over three years (straight line depreciation) with no salvage value at the end.
Operating revenue is expected to be Rs. 6,00,000 per year.
Operating costs for raw materials expected to be Rs.3,00,000 per year.
Assume tax rate is 30% and the discount rate is 20%.
a. Compute after-tax cash flows every year.
b. Evaluate the project NPV. Would you accept the project? (10 Marks)
Q2. Compute the fair value of the following three stocks. Assume cost of equity to be 10%
Stock A is expected to pay a uniform dividend of Rs. 3.50 per share forever.
Stock B is expected to pay a dividend of Rs. 2.00 per share next year. Dividends are expected to grow at 5% YOY per year forever.
Stock C has paid a dividend of Rs. 2.50 per share in the current year. The dividend is expected to increase by Rs. 0.50 per year for the next three years. Thereafter, dividend is expected to remain constant. (10 Marks)
Q3. Rate of return on treasury bills (risk-free short-term government papers) is around 6%. The expected rate of return on a market portfolio is 14%. Applying the capital asset pricing model (CAPM), answer the following:
a. What is the expected rate of return on a stock with a beta of 0? Is it a risk-free investment? (5 Marks)
b. A stock currently trades at Rs. 60 per share. The stock is expected to pay a dividend of Rs. 5 per share next year and you expect to sell the share then for Rs. 65. You estimate the beta of the stock to be 0.8. Is the stock overpriced or underpriced? (5 Marks)