FOT expects to earn $2.7 million after tax next year and pay out $700,000 in div

Question

FOT expects to earn $2.7 million after tax next year and pay out $700,000 in dividends. Dividends are expected to be $1.05 a share during the coming year and are expected to grow at a constant rate of 10 percent a year for the foreseeable future. The current market price of FOT stock is $22 and up to $2 million in new equity can be raised for a floatation cost of 10 percent. If more than $2 million is sold then the flotation cost will be 15 percent. Up to $2 million in debt can be sold at par with a coupon rate of 10 percent. Any debt over $2 million will carry a 12 percent coupon rate and should be sold at par. If FOT has a marginal tax rate of 40 percent, in which projects should it invest?

Explanation / Answer

we select 1 , 2 and 4

Note:-

By reading this below lines carefully you able to know how to select any project on the basses of IRR and NPV so please read the following.

Key differences between the most popular methods, the NPV (Net Present Value) Method and IRR (Internal Rate of Return) Method, include:

• NPV is calculated in terms of currency while IRR is expressed in terms of the percentage return a firm expects the capital project to return;

• Academic evidence suggests that the NPV Method is preferred over other methods since it calculates additional wealth and the IRR Method does not;

• The IRR Method cannot be used to evaluate projects where there are changing cash flows (e.g., an initial outflow followed by in-flows and a later out-flow, such as may be required in the case of land reclamation by a mining firm);

• However, the IRR Method does have one significant advantage -- managers tend to better understand the concept of returns stated in percentages and find it easy to compare to the required cost of capital; and, finally,

• While both the NPV Method and the IRR Method are both DCF models and can even reach similar conclusions about a single project, the use of the IRR Method can lead to the belief that a smaller project with a shorter life and earlier cash inflows, is preferable to a larger project that will generate more cash.

• Applying NPV using different discount rates will result in different recommendations. The IRR method always gives the same recommendation.

This also helpful to you:

NPV is the total present value of cash flows (outflows/costs and inflows/revenues) from a particular project over a period of time. it is indicates that how much value an investment or project is able to add to the firm.
IRR is the rate of return at which NPV of all the cash flows from the project is zero. That is it indicates the efficiency of a project.

1 )NPV is used to choose the best project among the mutually exclusive projects
While IRR cannot be used to do so and used to decide the efficiency of a single project.

2) The IRR Method cannot be used to evaluate projects where there are changing cash flows.
3 )The IRR does not care about the reinvestment of the inflows from the project.
4) The IRR considers the rate of earnings and not the size of earnings from a project.

Note:

You not provide the projects details to select as I research and find it Thank you…

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