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ECON 2I03 (10)


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McMaster University
Usman Hannan

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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