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Financial Decision Making Essay

1251 words - 6 pages

RMIT
FINAL EXAMINATION

FACULTY OF BUSINESS
SCHOOL OF ECONOMICS AND FINANCE

BAFI-1100 FINANCIAL DECISION MAKING

FIRST SEMESTER 2004

DATE:

TIME:

INSTRUCTIONS:

1. This is a CLOSED BOOK EXAMINATION

2. The examination represents 60% of the assessment in this subject.

3. All answers are to be made on the examination paper.

4. All questions should be attempted; there is no choice between questions

5. The use of a calculator is permitted, however laptop computers are not permitted to be brought into the examination room.

6. Students are advised to show all workings for questions involving calculations.

Question 1.

(a) Consider ...view middle of the document...

a. What is each project's payback period?
b. What is each project's net present value?
c. What is each project's internal rate of return?
d. Fully explain the results of your analysis. Which project do you prefer?

a. 3.2years, 5 years
b. $12,656, $13,400
c. 17%, 15%

(3 + 3 + 2 = 8 marks)
Question 2

It is now January 1, 2001. O’Loughlin Dynamics Inc. (OLD) has just developed a solar panel capable of generating 200 percent more electricity than any solar panel currently on the market. As a result, OLD is expected to experience a 15 percent annual growth rate for the next 5 years. By the end of 5 years, other firms will have developed comparable technology, and OLD’s growth rate will slow to 5 percent per year indefinitely.

Stockholders require a return of 12 percent on OLD’s stock. The most recent annual dividend (Do), which was paid yesterday, was $1.75 per share.

a. Calculate OLD’s expected dividends for 2001, 2002, 2003, 2004, and 2005.
b. Calculate the value of the stock today, PO.
c. Calculate the expected dividend yield, the capital gains yield expected in 2001, and the expected total return for 2001. Also calculate these same three yields for 2006.
d. How might an investor's tax situation affect his or her decision to purchase stocks of companies in the early stages of their lives, when they are growing rapidly, versus stocks of older, more mature firms? When does OLD’s stock become "mature" in this example?
e Suppose your boss tells you she believes that OLD’s annual growth rate will be only 12 percent during the next 5 years and that the firm's normal growth rate will be only 4 percent. Without doing any calculations, what general effect would these growth rate changes have on the price of OLD’s stock?
f. Suppose your boss also tells you that she regards OLD as being quite risky. and that she believes the required rate of return should be 14 percent, not 12 percent. Again, without doing any calculations, how would the higher required rate of return affect the price of the stock, its capital gains yield, and its dividend yield? Again, assume that the firm's normal growth rate will be 4 percent.

a.
D2001 = $2.01.
D2002 = $2.31.
D2003 = $2.66.
D2004 = $3.06.
D2005 = $3.52.

b. $39.43

c. 2001
5.10%
6.90%

2006
7.00%
5.00%

(4 + 4 + 6 + 2 + 2 +2 = 20 marks)

Question 3

(a) What is business risk?

(b) What factors influence a firm's business...

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