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Accounting

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Name

Professor’s Name

Class

7 July 2017

Consider the following situations and answer the related questions:

• Your company has the opportunity to make an investment that promises to pay $24,000 after

6 years. If your company has a required return of 8.5% on this type of investment, what is the

maximum amount that the company should pay for the investment? Explain your answer.

o The max amount that the company should pay for the investment is $14,709.60.

We must take the present value of $24,000 in year 6. 24,000 *.6129 or

.6650/1.085. Due to the time value of money, the value of the money needs to

be valued at today’s prices. This is the max the company can purchase this

investment to receive a required return on 8.5%

• In the previous scenario, assume that your company negotiated a deal where it would pay

$12,000 for the investment and receive a payment of $24,000 at the end of 7 years. What is

the IRR on this investment? Should the company make the investment? Explain your

answer.

o The internal rate of return can be calculated using excel and the cash flows.

The cash flows are -12,000 in year 0 and 24,000 in year 7. The IRR= 10.41% The

company should make the investment if the cost of capital is less than 10.41%.

If the cost of capital is above the IRR, the company should not do it.

• Another investment opportunity available to your company involves the purchase of some

common stock from Zorp Corporation. The company has asked you to evaluate the stock,

which paid a dividend of $4.25 last year and is currently selling for $36 per share. If your

company decides to buy the stock, the stock will be held for 5 years and then sold. The

growth rate on the stock is constant at 3% per year, and your company's required return on

the stock would be 11%. What is the maximum price per share that your company should

pay for the stock?

o The formula used is P

= D

(1+g)/(r-g) = 4.25 * 1.03 /(0.11 - 0.03). When reducing

the equation, we get 4.3775/.08= $54.72. This is the maximum price the

company can pay with a required rate or return of 11% and with constant

growth of 3%.

o Considering the current stock price is $36, the company should buy stock.

• Zorp Corporation also has some bonds for sale that your company is considering. These

bonds have a $1,000 par value and will mature in 16 years. The coupon rate on the bonds is

5% paid annually, and they are currently selling for $987 each. The bonds are call protected

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Name Professor’s Name Class 7 July 2017 Consider the following situations and answer the related questions: • Your company has the opportunity to make an investment that promises to pay $24,000 after 6 years. If your company has a required return of 8.5% on this type of investment, what is the maximum amount that the company should pay for the investment? Explain your answer. o The max amount that the company should pay for the investment is $14,709.60. We must take the present value of $24,000 in year 6. 24,000 *.6129 or .6650/1.085. Due to the time value of money, the value of the money ...
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