Solution of Graded Activity for Pre Mid

Lecture # 9
Q1: What will be cost of equity if a company has paid a dividend of Rs. 4 at constant growth rate of 4% while stock’s current price is Rs. 60?
ke = ( D1 / P0 ) + g Where
D1 (Expected div.)= D0 (1+g)
ke = (4*1.04/60)+0.04 ke = 0.0693 + 0.04
ke = 0.1093 or 10.93%

Lecture # 12
Q2: Output level is 8,000 units with variable cost of Rs. 6 per unit and total fixed cost Rs. 60,000. If sale price is Rs. 9 per unit then what will be the profit / loss?
Total cost = Total FC + Total VC
Total cost = 60,000 + (6*8,000)
Total cost = 60,000 + 48,000 = Rs. 108,000
Total revenue = Sale price * Output level Total revenue = 9 * 8,000 = Rs. 72,000
Profit / loss = Total revenue – total cost = 72,000 – 108,000 = Rs. -36,000 There is a loss of Rs. 36,000

Lecture # 14
Q3. Suppose a portfolio consists of three projects A, B & C where each project requires an initial investment of Rs. 65,000. If present value of cash flows of projects A, B & C is Rs. 80,000, Rs. 73,000 and Rs. 82,000 then what will be ranking of each project based upon profitability index criterion?

Projects Initial Investment (Rs.) PV of cash flows (Rs.) PI = (PV/Initial Investment) Ranking A 65,000 80,000 1.23 2 B 65,000 73,000 1.12 3 C 65,000 82,000 1.26 1

Lecture # 15

Q4: There are two states of economy, Boom & Recession. Probability of occurrence of Boom is 45% while Recession is 55%. Suppose stock A expected return in Boom (state of economy) is 12% while in Recession is 7%. Stock B expected return in Boom (state of economy) is 20% while in Recession is 3%.
If an investor invests 70% in stock A and 30% in stock B then what is the total expected return of the portfolio?

Total Expected return (Stock A) = 0.120.45 + 0.070.55
Total Expected return (Stock A) = 5.4% + 3.85% = 9.25%

Total Expected return (Stock B) = 0.200.45 + 0.030.55
Total Expected return (Stock B) = 9% + 1.65% = 10.65%

Total Expected Return (portfolio) = 0.70 * 0.0925 + 0.30*0.1065
Total Expected Return (portfolio) = 0.06475 + 0.03195 = 0.0967 or 9.67%

Lecture # 18:

Q5: A capital structure consists of 10% preferred stock, 55% common equity and 40% debt. Company’s preferred stock is currently selling for Rs. 55 per share and paying dividend of Rs. 4. If cost of common equity is 15% and after tax cost of debt is 6% then what will be WACC?
Cost of preferred stock (Kps) = D / P
Kps = 4/55 = 7.27%

WACC=Wce * Kce + Wps * Kps + Wd Kd (1-T)
WACC= 0.550.15 + 0.100.0727+ 0.400.06 WACC= 0.0825 + 0.00727+ 0.024 = 0.1138 or 11.38%
Note: A solution with weightage of 5% of preferred stock will also be considered correct WACC=Wce * Kce + Wps * Kps + Wd Kd (1-T)
WACC= 0.550.15 + 0.0.050.0727+ 0.40*0.06
WACC= 0.0825 + 0.003635+ 0.024 = 0.1101 or 11.01%