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= D
4
/k
s
- g
= $2.3667/(0.17 - 0.15)
= $118.335.
P
0
=
1.17
$1.05
+
) (1.17
$1.47
2
+
) (1.17
$118.335 + $2.058
3
= $77.14.
(d) If the stock is currently trading at $70, would you recommend its purchase? Why?
Buy: stock is underpriced by the market.
Page 7
Question 3
The ECG Development Co. is considering a project with the following after-tax operating cash flows (in
millions of dollars):
Project
Year Cash Flow
0 -$300
1 125
2 75
3 200
4 100
Assuming that the project has a WACC of 10%, please answer the following questions. Hint: Please show
your complete set-up for each part to receive full credit.
(20 marks)
(a) Compute and very briefly explain the meaning of the projects IRR.
CF
0
= -300; CF
1
= 125; CF
2
= 75; CF
3
= 200; CF
4
= 100; and then solve for
IRR = 23.42%.
(b) Compute and very briefly explain the meaning of the projects NPV.
CF
0
= -300; CF
1
= 125; CF
2
= 75; CF
3
= 200; CF
4
= 100; I/YR = 10; and solve for
NPV = 94.18 = $94.18 million.
(c) Compute and very briefly explain the meaning of the projects discounted payback period.
Find the PVs of the cash flows using the firms 10% WACC.
Discounted
Year Cash Flow Cash Flow @ 10% Cumulative PV
0 -$300 -$300.00 -$300.00
1 125 125/1.10 = 113.64 -186.36
2 75 75/(1.10)
2
= 61.98 -124.38
3 200 200/(1.10)
3
= 150.26 +25.88
4 100 100/(1.10)
4
= 68.30 +94.18
Therefore, the projects discounted payback is 2 +
26 . 150 $
38 . 124 $
= 2.83 years.
(d) Compute and very briefly explain the meaning of the projects Modified IRR (MIRR).
To calculate the MIRR, we need to find the PV of all the outflows and the FV of all the inflows.
The discount rate that equates the two is the MIRR.
PV of inflows FV of outflows
-$300 $125 1.10
3
= $166.375
$ 75 1.10
2
= 90.750
$200 1.10
1
= 220.000
$100 1.10
0
= 100.000
$577.125
N = 4; PV = -300; PMT = 0; FV = 577.125; and then solve for I/YR = MIRR = 17.77%.
(e) Should the project be accepted? Please justify your answer with the appropriate arguments.
How would acceptance or rejection of the project affect the shareholders of the firm? Explain.
Accept, +NPV, IRR and MIRR>WACC, adds to shareholder wealth.