Capital Budgeting Concept Review and Critical Thinking question 2 Supplementary

Question

Capital Budgeting Concept Review and Critical Thinking question 2 Supplementary Problems (Required) Supplementary Problem 1. You are the owner of A Rinky Dink Company and you have been very successful in your business undertakings and the company has been able to grow at a modest rate of 2%. You expect that the company will be able to sustain this growth rate into future. The company has just paid its most recent dividend of $4.50 and you have calculated that investors in the past have required a 13 percent rate of return. Calculate the expected value of the share in the market today? You observe that the current market price for the company shares is $35.31. Calculate the expected return that investors are expecting now. Explain what happened. A new long term project is being considered by the company. However, the project will increase the risk associated with the company and the required rate of return will increase and investors will require a 15 percent rate of return on their investment. However, the new project will provide growth of 15 percent per year for the next 5 years and then growth will return to its normal rate of 2 percent. Should the company invest in this new project? Assuming the company takes on the project (even if you recommended that you don't take on the project in ), calculate the rate of increase or decrease from the current stock price in the market for the company's common shares.

Explanation / Answer

current dividend 4.5 growth rate 2% expected dividend 4.59 required rate of return 13% A price of share 41.7272727 current market price 35.31 B expected return 12.9991504 percent C required rate of return is 13% while expected return decreased to 12.99% 0r almost 13% D 0 4.5 1 5.175 2 5.95125 3 6.843938 4 7.870528 5 9.051107 6 9.232129 price of share 71.01638 expected return 0.701918 70.19% company should invest in new project because rate of return is 70% while cost of capital is 15% e increase in rate of share price 0.701918 70.19%

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