1)Fruity Manufacturing Ltd’s dividend payout ratio is 35%. It is currently payin
ID: 2664857 • Letter: 1
Question
1)Fruity Manufacturing Ltd’s dividend payout ratio is 35%. It is currently payingan annual dividend of $1.30.
(i) What is Fruity Manufacturing Ltd’s Earning per Share (EPS)?
(ii) What is the market price of Fruity Manufacturing Ltd’s shares if its P/E
ratio is 14?
(iii) How much current income per share will the shareholders lose if Fruity
Manufacturing Ltd cuts its payout ratio to 20% and nothing else
changes?
2)M Ltd has found a gold vein in a remote area of Colorado. M’s management team is
now in the process of deciding whether the company should undertake this project.
To go ahead with the project, it must spend $900,000 to purchase new mining
equipment and pay $165,000 installation fee.
M Ltd is expecting to receive an annual cash flow of $350,000 over the 5-year life of
the project. The cost of capital of M Ltd is 14 percent.
Required
(a) Explain the following capital budgeting methods:
NPV, IRR, ARR, Payback and Discounted Payback
Discuss the strengths and weaknesses associated with each method.
(b) Calculate the NPV and IRR of this project. Show your workings.
(c) Should the project be undertaken?
Explanation / Answer
1.Fruity Manufacturing Ltd’s a)devidend per shar = $1.30 and its pay pou ratio =35% pay -out = Dps / Eps 35%= 1.30 / Eps Eps*35% = $1.30 Eps = $1.30/35% =3.714 b) Market price : here P/E Ratio = MPS/EPS 14 TIMES = MPS /3.714 MPS = 14*3.714 = $52 c) IF PAY OUT Ratio = 35% to 20% then, EPS = 1.30*20% =$6.5 the current income will los for each share would be= $6.5-$3.71 = $2.79 2) UNDER NPV APPROACH.. pv of year cash flows cash flow -1065000 -1065000 1 350000 307017.54 2 350000 269313.63 3 350000 236240.03 4 350000 207228.10 5 350000 181779.03 total cash fl 1201578.34 invest 1065000 NPV 136578.34 PROJECT CAN BE ACCEPTED ,BECAUSE IT HAS POSITIVE NPV.. IRR: year cash flows AT 19% 20% -1065000 1 350000 293574.9 291666.67 2 350000 246246.35 243055.56 3 350000 206547.86 202546.3 4 350000 173249.33 168788.58 5 350000 145319.02 140657.15 1064937.47 1046714.2 -1065000 -1065000 -62.53 -18285.75 PROJECT IRR CAN BE LIES BETWEEN 19 TO 20 THAT MIGHT 19.22% PROJECT CAN BE ACCEPTED DUE TO IT HAS HIGHER IRR THN IT S COST OF CAPITAL.. UNDER PAY BACK... year cash flows -1065000 1 350000 2 350000 3 350000 4 350000 5 350000 1750000 Pay back period slightly more than 3 years ACCEPTED..DUE TO BELOW LIFE SPAN dicounted pay back.... discounted to year cash flows 14% -1065000 1 350000 307017.54 2 350000 307017.54 3 350000 307017.54 4 350000 307017.54 5 350000 307017.54 1750000 1535087.72 Pay back period slightly more than 3 years and less than four years it might be 3.5 years ACCEEPTED.. Under ARR: year cash flows -1065000 1 350000 2 350000 3 350000 4 350000 5 350000 ARR= NI / BOOK VALUE 0.328638498 32.86% UNDER THIS ACCEPTED..BECAUSE IT HAS 32.86 ACCOUNTIN RETURN EHICH IS HIGHER THAN COST OF CAPITAL. Finally the project can be under take.... pv of year cash flows cash flow -1065000 -1065000 1 350000 307017.54 2 350000 269313.63 3 350000 236240.03 4 350000 207228.10 5 350000 181779.03 total cash fl 1201578.34 invest 1065000 NPV 136578.34
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