Question No 1:
Sumi Inc. has policy of paying a Rs. 9 per share dividend every year. If this policy is to continue indefinitely, what will be the value of a share of stock at a 12% required rate of return?
Rs. 30
Rs. 45
Rs. 60
Rs. 75
Question No: 2
The XYZ Corporation is considering an investment that will cost Rs. 80,000 and have a useful life of 4 years. During the first 2 years, the net incremental after-tax cash flows are Rs. 25,000 per year and for the last two years they are Rs. 20,000 per year. What is the payback period for this investment ?
3.2 Years
3.5 Years
4.0 Years
Cannot be determined from the given information
Question No: 3
Which of the following statement is INCORRECT regarding a normal project ?
a)If the IRR of a project is greater than the discount rate, k, then its PI will be greater than 1
b)If the NPV of a project is greater than 0, then its PI will exceed 1
c)If the IRR of a project is 8%, its NPV, using a discount rate, k, greater than 8%, will be less than 0
d)If the PI of a project equals 0, then the project's initial cash outflow equals the PV of its cash flows
Q1. 75
9/0.12=75
Q2 3.5
Q3, If the PI of a project equals 0, then the project's initial cash outflow equals the PV of its cash flows.
Answer to Question No 1:
To calculate the value of a share of stock at a 12% required rate of return, we can use the Dividend Discount Model. According to the policy of Sumi Inc., the dividend per share is Rs. 9 per year.
The formula for the value of a share of stock using the Dividend Discount Model is:
Value of a share = Dividend per share / Required rate of return
Plugging in the values, we have:
Value of a share = 9 / 0.12
Calculating this, we get:
Value of a share = Rs. 75
Therefore, the correct answer is Rs. 75.
Answer to Question No 2:
To calculate the payback period for this investment, we need to determine the time it takes for the net incremental after-tax cash flows to recover the initial investment cost of Rs. 80,000.
The payback period is calculated by dividing the initial investment cost by the annual net incremental after-tax cash flow:
Payback period = Initial investment cost / Annual net incremental after-tax cash flow
For the first two years, the net incremental after-tax cash flow is Rs. 25,000 per year. For the last two years, it is Rs. 20,000 per year.
Calculating the payback period, we have:
Payback period = 80,000 / (25,000 + 25,000 + 20,000 + 20,000)
Payback period = 80,000 / 90,000
Payback period = 0.89 years
Since the payback period is less than 1 year, we need to convert it to months:
Payback period = 0.89 * 12 months
Payback period = 10.68 months
Therefore, the correct answer is Cannot be determined from the given information.
Answer to Question No 3:
The correct answer is d) If the PI of a project equals 0, then the project's initial cash outflow equals the PV of its cash flows.
The Profitability Index (PI) is calculated by dividing the present value of cash inflows by the present value of cash outflows.
If the PI of a project is 0, it means the present value of cash inflows is equal to the present value of cash outflows. Therefore, the project's initial cash outflow equals the PV of its cash flows.
The other statements are correct regarding a normal project:
a) If the IRR of a project is greater than the discount rate, k, then its PI will be greater than 1. This is because a higher IRR indicates a higher return on investment.
b) If the NPV of a project is greater than 0, then its PI will exceed 1. This is because a positive NPV indicates that the project's cash inflows exceed its cash outflows.
c) If the IRR of a project is 8%, its NPV, using a discount rate, k, greater than 8%, will be less than 0. This is because a higher discount rate reduces the present value of future cash flows, leading to a negative NPV.
Therefore, the incorrect statement is d) If the PI of a project equals 0, then the project's initial cash outflow equals the PV of its cash flows.