Assume a two-period world, perfect certainty, and perfect capital market. A firm has an initial endowment of $81 million. The firm has identified the following available investment opportunities:

These are not divisible projects, which cannot be invested in a fraction (firm must invest 100 percent of each proposal or none of it). Assume that the average market rate of return is 11.4 percent.
(i) Which projects will the firm undertake to maximise the value of the firm?

(ii) If the firm undertakes projects that will maximise the value of the firm, how much money will it invest in period-0 (now)?

(iii) What period-0 dividend will be paid to shareholders (owners)?

(iv) Does the firm need borrowing in period 0? If yes, how much?
(v) What will the period-1 (next) dividend be?
(vi) What is the Present Value (PV) of period-1 returns from optimum investment in (ii)?

(vii) What is the Net Present Value (NPV) from optimum investment in (ii)?

(viii) How will the value of the firm change due to the decision of optimum investment in (ii)?
(ix) How would your answers from (i) to (viii) above change if the firm had an initial endowment of $19 million only?

 

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Period-0 Period-1 Proposal Outlay Return $9.24 $11.52 L million million $10.61 $13.13 M million million $13.40 $15.90 N million million $12.41 $13.57 million million $19.77 $22.62 Q million million P. Period-0 Period-1 Proposal Outlay Return $9.24 $11.52 L million million $10.61 $13.13 M million million $13.40 $15.90 N million million $12.41 $13.57 million million $19.77 $22.62 Q million million P.

Answer rating: 100% (QA)

The following table shows the initial investment and the percentage of return earned from each inves... View the full answer