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Lecture

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McMaster University

Economics

ECON 2I03

Usman Hannan

Winter

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Ch 6: Valuing Stocks
Spider Gold Mine is decreasing next year’s dividend from $10 to $4 per share. The
forecast stock price next year is $106. Equally risky stocks of other companies offer
expected rate of return of 10%. Next 2 questions.
1) What should Spider’s common stock sell for?
a) $100
b) $105
c) $110
d) $5
e)$101
Ans: a) 100
Checkpoint: 6.3
2) Jaguar wants to out-beat the market. He has done a ‘fundamental analysis’ of Spider
Corp’s stock and thinks the stock is undervalued. Jaguar may be right if:
a) Spider stocks have increased in price last week and the market is weak-form
efficient.
b) Behavioral financial theory is applicable in the market..
c) The stock market in general showing signs of overconfidence by shareholders
right now.
d) The market has semi-strong form efficiency.
Ans: b)
Leture
3) Lion Stock will pay a dividend this year of $2.40 per share. Its dividend yield is 8
percent. At what price is the stock selling?
a) $2.4
b) $24
c) $30
d) $31
e) $32
Ans: c) $30
Problem 2
Donkey & Donkey Inc. is a declining industry. Its sales, earnings and dividends are
shrinking at a rate of 10% per year. r = 15% and Di1 = $3.
4) What is the present value of a share?
a) $8
b) $9
c) $10
d) $11
e) $12
1 Ans: e) $12
Ch 7, Problem 17
5) You got $ 1 million that you can invest in Bermuda for either one of two projects with
the following payoffs:
Project 1: $2 Million after one year.
Project 2: $300,000 as long as you can imagine.
These investments are not risky, and safe securities are yielding 7.5%.
The best one?
a) You should use the IRR criterion to decide which project to chose.
b) Using NPV criterion, you should invest in Project 1
c) Using NPV criterion, you should invest in Project 2
d) You will invest in the same project whether you use the IRR or the NPV criterion.
Ans: c) Using NPV criterion, you should invest in Project 2
Checkpoint 7.5
Gulti corp. is thinking of building a Coal-fired power plant for $2.2 billion. The plant will
produce a cash flow of $300 million a year for 15 years. But then the plant must be
decommissioned after that (in year 15) at the cost of $900 million. Next 2 questions.
6) What is the project’s NPV if the discount rate is 6%?
a) $0.338 billion
b) $0.624 billion
c) $0.228 billion
d) $$0.524 billion
e) $0.448 billion
Ans: a)
7) What is the project’s NPV if the discount rate is 16%?
a) $0.338 billion
b) $0.624 billion
c) $0.228 billion
d) $$0.524 billion
e) $0.448 billion
Ans: b)
Don is thinking of investing in a software project that costs $10,000. This project
provides a cash flow of $3000 in years 1 and 2 and $5000 in years 3 and 4. Don thinks
the discount rate is 10%. Next 3 questions.
8) NPV of the project =
a) $2,178.25
b) $2,278.25
2 c) $2,378.25
d) $2,478.25
Ans: c
Ch 8, Problem 12
9) Profitability index of the project:
a) .2375
b) .2376
c) .2377
d) .2378
e) .2379
Ans: d)
Ch 8, Problem 12
10) If Don has three other projects in hand aside the one above (four projects in total)
and he has $10,000 to invest, then to decide which project to pursue, he should
calculate
a) Equivalent annual cost
b) Profitability index
c) IRR
d) NPV
Ans: b) Profitability index
Problem 12 and Lecture
11)
Year Cash Flow
0 $ 100
1 -65

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