Your Company Is Considering an Investment in One of Two

question 45

Multiple Choice

Your company is considering an investment in one of two mutually exclusive projects.Project 1 involves a labor intensive production process.Initial outlay for Project 1 is $1,495 with expected after-tax cash flows of $500 per year in years 1-5.Project 2 involves a capital intensive process,requiring an initial outlay of $6,704.After-tax cash flows for Project 2 are expected to be $2,000 per year for years 1-5.Your firm's discount rate is 10%.If your company is not subject to capital rationing,which project(s) should you take on?

• A) Project 1
• B) Project 2
• C) Projects 1 and 2
• D) Neither project is acceptable.

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Definitions:

Dividend Growth Model

A model that determines the current price of a stock as its dividend next period, divided by the discount rate, less the dividend growth rate.

Cost of Equity

The theoretical compensation a company provides to its shareholders for the risk they assume by investing their funds.

Beta

A measure of the volatility of a stock or portfolio compared to the volatility of the overall market.

Dividend Growth Model

A method of valuing a company's stock price by using predicted dividends and discounting them back to present value.