Capital Budgeting and Dividend Policies

Cramer Industries has identified several investment opportunities that will become available over the next three years and would like you to evaluate these projects.  They have asked that you use the NPV and IRR methods to determine if these independent projects are acceptable.  Each of these investments will occur one year apart and the cash flows will start one year after the investment is made.

Table-1:

Project

Cash Flows/Year

(in thousands)

Length of Project

Cost and Date when Cost is incurred

A  $ 2,300.00 5 years  $ 12,000.00 @t=1
B  $ 3,000.00 5 years  $ 17,000.00 @t=2
C  $ 2,800.00 5 years  $ 13,000.00 @t=3
D  $ 2,100.00 5 years  $ 15,000.00 @t=4

Cramer currently has 2,000,000 shares outstanding and pays a dividend of $2 per share.

With a high degree of certainty, Cramer has projected their income for the next four years as follows, which includes the annual cash flows from the investments selected above:

Table-2:

Year

Income After Taxes

1

 $6,000.00

2

 $8,000.00

3

 $5,000.00

4

 $7,000.00

Questions:

  1. What is the NPV for each project at the time the investment would be made? Explain your findings.
  2. What is the IRR for each project at the time the investment would be made?  Explain your findings
  3. Which investments should be selected?  Justify your conclusions.
  4. What will the dividends per share and the external financing required, if the current dividend per share is maintained?  Justify your conclusions.
  5. What will the dividends per share and the external financing required, if the dividend per share payout ratio of 50% is maintained?  Explain your answers.
  6. If the dividend policy is considered a residual decision, what will be the dividends per share and external financing requirement in each year?  Explain your answers.
  7. Under which policy will external financing be minimized?  Justify your conclusions.

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