A.Stanford Electronics is considering expanding and would like to purchase a smaller firm, ABD electrical. Stanford's analyst projects that the merger will result in incremental net cash flows as follows:

YEARNET CASH FLOW

(In millions of dollars)

1$1.5

22.0

33.0

45.0

(Assume all cash flows occur at the end of the year.)

It is expected that cash flows will grow at a constant rate of 5% after year 4.

The acquisition would be made immediately if undertaken. ABD's post merger beta is estimated to be 1.5 and its post merger tax rate would be 40%. The risk free rate is 6 percent, and the market risk premium is 6%.

Required:

What is the value of ABD Electrical to Stanford Electronics.(12 marks)

B.The Keenan Company is considering three independent projects, each of which requires a $5 million investment. The estimated internal rate of return (IRR) and cost of capital for these projects is presented below:

Project A (High risk)Cost of Capital =16%: IRR = 20%

Project B (Medium Risk)Cost of Capital= 12%; IRR = 10%

Project C (Low Risk)Cost of Capital=8%:IRR =9%

(Project cost of capital vary because of the different level of risk)

The company's optimal capital structure calls for 50 percent debt and 50 percent common stock. Keenan expects to have net income of $7,287,500.

Required:

a)What is the payout ratio if the company bases its dividends on the residual model

(10 Marks)

b)As a stockholder, would you like to see your company declare a 100 percent stock dividend, or a two-for-one split, assuming that either action if feasible.(3 Marks)