Q No. 1As of Dec 01, 2020, Pfizer announced that the Federal Drug Administration has approved its new vaccine, COVID-19 VAC, for the treatment of Corona Virus. Imagine that you were working as a stock analyst for a large investment firm and Pfizer is one of the firms you are actively watching. On Dec 01, 2020, Pfizer’s stock price jumped rapidly, and your supervisor wants you to estimate the size of the cash flows necessary to support the jump in stock price. Therefore, he wants you to estimate the net cash flows the market had anticipated from the sale of the newly developed vaccine. He advises that you treat the value anticipated by the market as the NPV of selling the vaccine, then work backward from the NPV to determine the annual cash flows necessary to generate that value. Your supervisor thinks the best way to capture the value is to take the change in stock price from closing on 30th November 2020 to closing on 1st December 2020. Being a smart worker, you just smiled at your boss, trying to show that you understand this work very well. Being an inexperienced to the job, the only thing you understand is the NPV.The closing price of Pfizer (based on yahoo finance) was $ 38.31 on 30th November 2020 however, the price increased to $39.41 by the end of 1st December 2020 with overall 56,330,000 Shares outstanding in the market. The information is useful in calculating the increase in value of Pfizer due to announcement of this good news. Because the change in value represents the “expected” NPV of the project, you will have to find the annual net cash flows that would provide this NPV. For this analysis, you will need to estimate the cost of capital for the project.Assume that Pfizer’s bonds are trading in the market at the rate of $865.80 each (with the face value of $1000) and a coupon rate of 6% annually and currently, 1,000,000 bonds are actively being traded in the market with the maturity of 10 years. Assume Pfizer is listed in NYSE Stock Exchange and the beta of Pfizer is 0.8 and NYSE market premium is 8%. The U.S treasury securities are being traded at a risk-free rate of 3%. The federal tax rate is 30%.Assuming that firm only uses debt and equity to finance its projects, compute and use the weighted average cost of capital and the NPV to calculate the constant annual cash flow that provides this NPV. Compute cash flows for a) 5 years b) 10 years, and c) 15-year horizons.Q.No.2Three independent projects, each of which requires a RS 5 million investment are being considered for investment purpose by Sona Tea Company. The cost of capital and estimated internal rate of return (IRR) for these projects are shown below: ProjectCost of capitalIRR A16%20% B12%10% C8%9% Company’s capital structure involves only debt and equity financing with the ratio of 50% each. The estimated net income from the selected projects is expected to be RS 7,287,500. What should be the dividend payout ratio If Sona tea company estimate its dividends based on the residual dividend model? Q.No. 3You are hired as an analyst for Engro Corporation. During your first assignment, you are asked to perform a buy versus lease analysis on a newly developed machine. The machine cost Rs. 1,200,000 and if Engro decide to purchase it, a term loan can be obtained at a cost of 10%. The amount of the loan will be amortized in 4-year machine life (with the payments made at the end of each year). This is the special purpose machine and falls into MACRS 3-year class for depreciation purpose. The depreciation rates for this machine are 33%,45%,15%, and 7% for the next four years, respectively. The purchase of the machine will result in a maintenance cost of Rs. 25,000 payables at the beginning of each year. The residual salvage value of the machine is estimated to be Rs. 125,000 after its useful life of 4-years. Because of rapid changes in technology and uncertainty around residual value, a useful alternate is to arrange this machine through leasing. Orix leasing company has shown interest to give the machine at a 4-year lease, including its maintenance, for a total payment of Rs. 340,000 at the beginning of each year. Engro’s federal tax rate is 40%. The management has asked you to help by answering the following questions.a. Calculate the Engro’s present value cost of owning the machine (Hint: Calculate the present value of all the cashflows from year 0 to year 4). Explain the logic for the discount rate you used to find the PV.b. What is Engro’s present value cost of leasing the Machine? (Hint: Again, repeat what you did in case of owning the machine in part a). Is there any net advantage to leasing? Should Engro buy or lease the Machine? Explain
Oh no! Our experts couldn't answer your question.
Don't worry! We won't leave you hanging. Plus, we're giving you back one question for the inconvenience.
Q No. 1
As of Dec 01, 2020, Pfizer announced that the Federal Drug Administration has approved its new vaccine, COVID-19 VAC, for the treatment of Corona Virus. Imagine that you were working as a stock analyst for a large investment firm and Pfizer is one of the firms you are actively watching. On Dec 01, 2020, Pfizer’s stock price jumped rapidly, and your supervisor wants you to estimate the size of the cash flows necessary to support the jump in stock price. Therefore, he wants you to estimate the net cash flows the market had anticipated from the sale of the newly developed vaccine. He advises that you treat the value anticipated by the market as the NPV of selling the vaccine, then work backward from the NPV to determine the annual cash flows necessary to generate that value. Your supervisor thinks the best way to capture the value is to take the change in stock price from closing on 30th November 2020 to closing on 1st December 2020. Being a smart worker, you just smiled at your boss, trying to show that you understand this work very well. Being an inexperienced to the job, the only thing you understand is the NPV.
The closing price of Pfizer (based on yahoo finance) was $ 38.31 on 30th November 2020 however, the price increased to $39.41 by the end of 1st December 2020 with overall 56,330,000 Shares outstanding in the market.
The information is useful in calculating the increase in value of Pfizer due to announcement of this good news. Because the change in value represents the “expected” NPV of the project, you will have to find the annual net cash flows that would provide this NPV. For this analysis, you will need to estimate the cost of capital for the project.
Assume that Pfizer’s bonds are trading in the market at the rate of $865.80 each (with the face value of $1000) and a coupon rate of 6% annually and currently, 1,000,000 bonds are actively being traded in the market with the maturity of 10 years. Assume Pfizer is listed in NYSE Stock Exchange and the beta of Pfizer is 0.8 and NYSE market premium is 8%. The U.S treasury securities are being traded at a risk-free rate of 3%. The federal tax rate is 30%.
Assuming that firm only uses debt and equity to finance its projects, compute and use the weighted average cost of capital and the NPV to calculate the constant annual cash flow that provides this NPV. Compute cash flows for a) 5 years b) 10 years, and c) 15-year horizons.
Q.No.2
Three independent projects, each of which requires a RS 5 million investment are being considered for investment purpose by Sona Tea Company. The cost of capital and estimated internal rate of return (IRR) for these projects are shown below:
Project
Cost of capital
IRR
A
16%
20%
B
12%
10%
C
8%
9%
Company’s capital structure involves only debt and equity financing with the ratio of 50% each. The estimated net income from the selected projects is expected to be RS 7,287,500. What should be the dividend payout ratio If Sona tea company estimate its dividends based on the residual dividend model?
Q.No. 3
You are hired as an analyst for Engro Corporation. During your first assignment, you are asked to perform a buy versus lease analysis on a newly developed machine. The machine cost Rs. 1,200,000 and if Engro decide to purchase it, a term loan can be obtained at a cost of 10%. The amount of the loan will be amortized in 4-year machine life (with the payments made at the end of each year). This is the special purpose machine and falls into MACRS 3-year class for depreciation purpose. The depreciation rates for this machine are 33%,45%,15%, and 7% for the next four years, respectively. The purchase of the machine will result in a maintenance cost of Rs. 25,000 payables at the beginning of each year. The residual salvage value of the machine is estimated to be Rs. 125,000 after its useful life of 4-years.
Because of rapid changes in technology and uncertainty around residual value, a useful alternate is to arrange this machine through leasing. Orix leasing company has shown interest to give the machine at a 4-year lease, including its maintenance, for a total payment of Rs. 340,000 at the beginning of each year. Engro’s federal tax rate is 40%. The management has asked you to help by answering the following questions.
a. Calculate the Engro’s present value cost of owning the machine (Hint: Calculate the present value of all the cashflows from year 0 to year 4). Explain the logic for the discount rate you used to find the PV.
b. What is Engro’s present value cost of leasing the Machine? (Hint: Again, repeat what you did in case of owning the machine in part a). Is there any net advantage to leasing? Should Engro buy or lease the Machine? Explain
