What is the expected return on the firms stock

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
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What is the expected return on the firms stock

Question 1
You are the CFO of a large, Danish company that manufactures bulletproof vests. You are appointed
by the board of directors to serve the interest of the shareholders. As the CFO, you are considering to
invest in the development of a new line of vests known as the Mariachi Vest. You know little about
company, except that it is a firm traded on Nasdaq OMX, and its stock is quite risky according to
the estimated beta of the firm, which is 1.60. Thus, the first thing you do when you start your analyses
is to look at the financial statements of the firm. You see that it is 75% financed by debt, and debt
holders require a 5% rate of return on their investment. The cost of constructing the plant for
developing the vest is DKK 50,000,000 upfront. The plant then would have an expected life of 10
years. The firm expects to sell 4000 vests a year till the plant closes down. All the expenditure made
for the plant today will be depreciated straight-line over 10 years (from year 1 to year 10) to a salvage
value of 10 million DKK, but they expect to sell the plant after 10 years for 15 million DKK. If it
works, it will generate DKK 7,000,000 per year for 10 years. Taxes are 21%. The interest on short-
term government bonds is 4%, while the overall Nasdaq OMX stock market returned 8% last year and
that is expected to continue. Also, importantly, you quickly realize that this project is a typical
investment project of your company ?.
the
Transcribed Image Text:Question 1 You are the CFO of a large, Danish company that manufactures bulletproof vests. You are appointed by the board of directors to serve the interest of the shareholders. As the CFO, you are considering to invest in the development of a new line of vests known as the Mariachi Vest. You know little about company, except that it is a firm traded on Nasdaq OMX, and its stock is quite risky according to the estimated beta of the firm, which is 1.60. Thus, the first thing you do when you start your analyses is to look at the financial statements of the firm. You see that it is 75% financed by debt, and debt holders require a 5% rate of return on their investment. The cost of constructing the plant for developing the vest is DKK 50,000,000 upfront. The plant then would have an expected life of 10 years. The firm expects to sell 4000 vests a year till the plant closes down. All the expenditure made for the plant today will be depreciated straight-line over 10 years (from year 1 to year 10) to a salvage value of 10 million DKK, but they expect to sell the plant after 10 years for 15 million DKK. If it works, it will generate DKK 7,000,000 per year for 10 years. Taxes are 21%. The interest on short- term government bonds is 4%, while the overall Nasdaq OMX stock market returned 8% last year and that is expected to continue. Also, importantly, you quickly realize that this project is a typical investment project of your company ?. the
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