You work for a manufacturing company and you are trying to decide between two projects. Table 1 shows the cash flows and the Internal Rate of Return (IRR) for each project.

 

You can undertake only one project. If your cost of capital is 8%, use the incremental IRR rule to make the correct decision. [10 marks]

 Zweite Pharma is a fast-growing company. The company forecasts that in the next three years its growth rates will be 30%, 28% and 24% respectively. After three years, the company expects a more stable growth of 8% that will last forever. Last week it declared a dividend of £1.67. The required rate of return is 14%.

i) Compute the dividends for the next three years and find their present value.

ii) Calculate the price of the shares at the end of year 3 when the firm settles to a constant growth.

iii) What is the current price of the shares?

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Table 1 Project A B Year End Cash Flows (£ Thousands) 1 2 0 -30 -80 15 39 20 52 IRR 10.4% 8.6% Table 1 Project A B Year End Cash Flows (£ Thousands) 1 2 0 -30 -80 15 39 20 52 IRR 10.4% 8.6%

Answer rating: 100% (QA)

SOLUTION Part 1 To make the correct decision using the incremental IRR rule we need to comp... View the full answer