Two-stage DCF model Compost Science Inc. (CSI) is in the business of converting Boston’s sewage sludge into fertilizer. The business is not in itself very profitable. However, to induce CSI to remain in business, the Metropolitan District Commission (MDC) has agreed to pay whatever amount is necessary to yield CSI a 10% book
- a. Suppose CSI continues on this growth trend. What is the expected long-run
rate of return from purchasing the stock at $100? What part of the $100 price is attributable to the present value of growth opportunities? - b. Now the MDC announces a plan for CSI to treat Cambridge sewage. CSI’s plant will, therefore, be expanded gradually over five years. This means that CSI will have to reinvest 80% of its earnings for five years. Starting in year 6, however, it will again be able to pay out 60% of earnings. What will be CSI’s stock price once this announcement is made and its consequences for CSI are known?
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Chapter 4 Solutions
PRIN.OF CORPORATE FINANCE
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- Softek Corporation forms a separate legal entity, Startek, to develop new technology. The entity is funded by $2,000,000 in outside equity and $26,000,000 in debt. Softek guarantees Startek's debt. The entity is expected to generate the following cash flows at the end of two years: Cash Flow Probability $14,520,000 0.50 42,350,000 0.20 60,500,000 0.30 A discount rate of 10 percent is appropriate. Required Assume qualitative analysis of Startek's VIE status is inconclusive. Quantitatively analyze whether Startek is a variable interest entity. Instructions: Use negative signs with your answers, when appropriate. • Enter $ answers in millions ($11,000,000 equals $11 million). • Enter Probability answers using decimals. Expected Present Cash Flow Value Probability Expected Investment Residual Expected Fair Value Returns S PV Gains $ $ Expected Lossesarrow_forwardRome Corporation invests in the research and development department and will not pay dividends for the next several years. Venetian Industries is interested in acquiring shares of Rome Corporation. Venetian's CEO has estimated Rome's available cash flows for the next 3 years: $7 million, $9 million, and $12 million. After the third year, available cash flow is expected to grow by 5% on a steady basis. Rome Corporation's weighted average cost of capital (WACC) is 7%, the market value of its debt and preferred stock totals $60 million. Rome Corporation has $22 million of non-operating assets and 9 million shares of common stock outstanding. Calculate the present value of expected available cash flows for the next 3 years. Determine the market value of Rome Corporation's operations. Calculate an estimate of the price per share of Rome Corporation.arrow_forwardThe president of United Semiconductor Corporation made this statement in thecompany’s annual report:“United’s primary goal is to increase the value of thecommon stockholders’equity over time.”Later in the report, the following announcements were made: a.The company contributed $1.5 million to the symphony orchestra in SanFrancisco, its headquarters city. b.United is spending $500 million to open a new plant in Mexico. No revenueswill be produced by the plant for four years, so earnings will be depressedduring this period versus what they would have been had the company notopened the new plant. c.The company is increasing its relative use of debt. Assets were formerlyfinanced with 35 percent debt and 65 percent equity; henceforth, the financ-ing mix will be 50–50. d.The company uses a great deal of electricity in its manufacturing operations,and it generates most of this power itself. United plans to utilize nuclear fuelrather than coal to produce electricity in the future. e.The…arrow_forward
- Assume that you have just been hired as business manager of CampusDeli (CD), which is located adjacent to the campus. Sales were $1,100,000 last year, variable costs were 60% of sales, and fixed costs were $40,000. Therefore, EBIT totaled $400,000. Because the university’senrollment is capped, EBIT is expected to be constant over time. Because no expansion capital is required, CD distributes all earnings as dividends. Invested capial is $2 million, and 80,000 shares are oulstanding. The management group owns about 50% of the stock, which is traded in the over-thecounter market.CD currently has no debt—it is an all-equity firm—and its 80,000 shares outstanding sell at a price of $25 per share, which is also the book value. The firm's federal-plus-state tax rate is 40%. On the basis of statements made in your finance text, you believe that CD's shareholders would be better off if some debt financing were used. When you suggested this to your new boss, she encouraged you to pursue the…arrow_forwardA CEO has placed you in charge of a new investment opportunity to borrow $5 billion dollars to create a new subsidiary of MCI called MillerCare Insurance. Estimates indicate that in seven years, MillerCare Insurance and its assets will be valued at $8 billion. The best offer for the loan sits at 12 percent. 1. Should you take the loan and borrow the capital needed to create MillerCare Insurance? How do you know? ELABORATE.arrow_forwardRustic Campsites, Incorporated, is trying to decide between the following two alternatives to finance its new $34 million gaming center. a. Issue $34 million, 6% note. b. Issue 1 million shares of common stock for $34 per share with expected annual dividends of $2.04 per share. Required: 1. Assuming the note or shares of stock are issued at the beginning of the year, complete the income statement for each alternative. 2. Answer the following questions for the current year: (a) By how much are interest payments higher if issuing the note? (b) By how much are dividend payments higher by issuing stock? (c) Which alternative results in higher earnings per share? Complete this question by entering your answers in the tabs below. Required 1 Required 2 Assuming the note or shares of stock are issued at the beginning of the year, complete the income statement for each alternative. (Enter your answers in dollars, not millions (ie, $5.5 million should be entered as 5,500,000). Round your…arrow_forward
- EBK CONTEMPORARY FINANCIAL MANAGEMENTFinanceISBN:9781337514835Author:MOYERPublisher:CENGAGE LEARNING - CONSIGNMENT