Newman Manufacturing is considering a takeover of Grips Tool. During the year just completed, Grips earned $4.25 per share and paid cash dividends of $2.25 per share. Grip' earnings and dividends are expected to grow at 25 percent per year for the next 3 years, after which they are expected to grow at 10 percent per year to infinity. What is the maximum price per common share Newman should pay for Grips if it has a required return of 15 percent on investments with risk characteristics similar to those of Grips' common shares?
Problem
Projects A and B are equal-risk alternatives for expanding the firm's capacity. The firm's cost of capital is 13 percent. The after-tax cash inflows for each project are shown in the following table.
|
|
Project A
|
Project B
|
|
Incremental cost
|
$80,000
|
$50,000
|
|
Year (t)
|
After tax cash inflows (CFt)
|
After tax cash inflows (CFt)
|
|
1
|
$15,000
|
$15,000
|
|
2
|
20,000
|
15,000
|
|
3
|
25,000
|
15,000
|
|
4
|
30,000
|
15,000
|
|
5
|
35,000
|
15,000
|
|
|
|
|
a. Calculate each project's payback period.
b. Calculate the net present value (NPV) for each project.
c. Calculate the internal rate of return (IRR) for each project using an NPV profile.
d. Summarize the preferences dictated by each measure, and indicate which project you would recommend. Explain why.