1. Time value of money (15 points) You have just turned 30 years old, have just received your MBA and have accepted your first job. Now, you must decide how much money to put in your retirement plan. The plan works as follows. Every dollar in the plan earns 7% per year. You cannot make withdrawals until you retire on your 65th birthday. After that point, you can make withdrawals as you see fit. You decide that you will plan to live to 100 and work until you turn 65. You estimate that to live comfortably in retirement, you will need $100,000 per year starting at the end of the first year of retirement and ending on your 100th birthday.
You will contribute the same amount to the plan at the end of every year that your work. How much do you need to contribute each year to fund your retirement? 2. Stock pricing (20 points) Colgate-Palmolive Co. has just paid an annual dividend of $0. 96. Analysts are predicting an 11% per year growth rate in earnings over the next five years. After that, Colgate’s earnings are expected to grow at the current industry average of 5. 2% per year. If Colgate’s equity cost of capital is 8. 5% per year and its dividend payout ratio remains constant, what price does the dividend-discount model predict Colgate should sell for? 3.
Bond pricing (15 points) Consider a 30-year bond with a 10% coupon rate (annual payments) and a $1000 face value. 1. What is the initial price of this bond if it has a 5% yield to maturity? (5 points) 2. What will the price be immediately before and after the first coupon is paid (10 points) 4. NPV (25 points) A proposed cost savings device has an installed cost of $480,000. The device will be depreciated straight-line to zero over its five year life. The required initial net working capital investment is $35,000 (which will be recovered at the end of the project), the marginal tax rate is 35%, and the discount rate is 12%.
The device has an estimated year 5 salvage value of $80,000. What level of pretax cost savings do we require for this project to be profitable? 5. IRR (25 points) Your firm is contemplating the purchase of a new $850,000 computer based order entry system. The system will be depreciated straight line to zero over its five-year life. It will be worth $150,000 at the end of that time. You will save $350,000 before taxes per year in order processing costs and you will be able to reduce working capital by $125,000. If the tax rate is 35%, what is the IRR for this project?