Finance Firm XYZ has two lines of business, organizedas two divisions, A and B. DivisionA generates a risk-free cash flow. It will produce $3 millionin free cash flow next year and it will grow at 2% each year thereafterforever. The second line of business, run by Division B, is risky. It expects to generate a cash flow of $2 million next year and will grow at a rate of 4%. Currently, the total market value of XYZ is $120 million.The risk-free interest rate is 5%. What is the cost of capital for the secondline of business? Assume the company comesacross a new technology that can improvethe Division B’s profitability. It requires an initial investment of $5 million and will increase next year’s cash flow by $1.1 million as well as future cash flows so that their growth rate stays at 4%. If the management decides to take on this new technology, what will the marketvalue of XYZ now be?
Finance Firm XYZ has two lines of business, organizedas two divisions, A and B. DivisionA generates a risk-free cash flow. It will produce $3 millionin free cash flow next year and it will grow at 2% each year thereafterforever. The second line of business, run by Division B, is risky. It expects to generate a cash flow of $2 million next year and will grow at a rate of 4%. Currently, the total market value of XYZ is $120 million.The risk-free interest rate is 5%. What is the cost of capital for the secondline of business? Assume the company comesacross a new technology that can improvethe Division B’s profitability. It requires an initial investment of $5 million and will increase next year’s cash flow by $1.1 million as well as future cash flows so that their growth rate stays at 4%. If the management decides to take on this new technology, what will the marketvalue of XYZ now be?
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Finance
- Firm XYZ has two lines of business, organizedas two divisions, A and
B. DivisionA generates a risk-
business, run by Division B, is risky. It expects to generate a cash flow of $2 million next year and will grow at a rate of 4%. Currently, the total market value of XYZ is
$120 million.The risk-free interest rate is 5%.
- What is the cost of capital for the secondline of business?
- Assume the company comesacross a new technology that can improvethe Division B’s profitability. It requires an initial investment of $5 million and will increase next year’s cash flow by $1.1 million as well as future cash flows so that their growth rate stays at 4%. If the management decides to take on this new technology, what will the marketvalue of XYZ now be?
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