| Answer to question no 2 (b) (ii) | ||||
| IRR | ||||
| YEAR | $ MILLION | |||
| 0 | -700 | (INVENTORY+MACHINERY) | ||
| 1 | 230 | |||
| 2 | 300 | |||
| 3 | 300 | |||
| 4 | 300 | |||
| 5 | 400 | |||
| IRR | 30% | |||
| Answer to question no 2 (b) (iii) | ||||
| Payback | ||||
| Year | Beginning Balance | Net Cash Flows | Ending Balance | |
| Immediate cost of investment | 0 | -700 | -700 | |
| 1 | -700 | -370 | -1070 | |
| 2 | -1070 | 300 | -770 | |
| 3 | -770 | 300 | -470 | |
| 4 | -470 | 300 | -170 | |
| 5 | -170 | 400 | 230 | |
| payback Period | 4.425 | years | ||
WA.1.
(a) Time period given = 15 years.
Rate of interest compounded annually = 6%.
Amount Required = 5,000,000 $.
As per compound interest formula for computation of
amount receivable e on investment,
| Amount = P |
1 + |
R |
n |
||
|
100 |
where, Amount = amount received on investment,
P = total amount of investment made,
R = rate of compound interest annually,
n = number of years for which investment is made,
Thus, P = (Amount)/(1+R/100)raised by n.
so, P = (5,000,000 $)/(1+6/100) raised by 15.
=> P = 2,086,325 $.
Thus, amount to be set aside by Linda annually = P/15years.
= 2,086,325 $/15years
= 139,088.40 $ per annum.
(b) Earnings on investment for current year = $520,000.
Expected earnings on investment for next year = $790,000.
Rate of interest = 9%.
Therefore, amount of investment for current year= $520,000/0.09
= $5,777,778.
Amount of investment required for total earnings of $790,000
=($790,000 – $520,000)/0.09
= $3,000,000.
i) The maximum amount that Lily can consume today
= $5,777,778 + $5,20,000 – $3,000,000
= $3,297,778.
ii) If Lily decides to consume none of the earnings this year,
the amount she consume at the end of next year = [($5,777,778 + $5,20,000)*0.09 +
$5,777,778]
= $566,800 + $5,777,778
= $6,344,578 .
c) Loan amount, P = $1,500,000.
Loan period, n = 10 years.
Rate of interest at the commencement of loan, r1 = 7%.
Rate of interest after two years, r2 = 8%.
Total amount repayable over the period of the loan, A at 7% rate of interest
= P*[1+r1/100] raised by 10
= $1,500,000[ 1+7/100] raised by 7
= $2,408,672.
Thus, total repayment made after two years = ( $2,408,672/10)*2
= $481,734.40.
Principal amount of the loan repaid by two years = $1,500,000 *2/10
= $300,000.
Principal amount remaining unpaid by end of second year
= $1,500,000 – $300,000
= $1,200,000.
i) Quarterly repayments under Option A = {$1,200,000*(1+8/100)raised by 8}/[8*4]
= $69,410.
ii) Quarterly repayments under Option B = $2,408,672 /[10*4]
= $60,217.
Therefore, term of loan under Option B
= ($69,410per quarter) * (32 quarters)/ ($60,217 per quarter)
= 37 quarters or 9years and 3months.
d) As per Gordon’s Constant Growth Model ,
P = D/(Ke –g).
where, P = Price of the share
D = Dividend payable at the end of the year
Ke = Rate of discount of cash flows
g = constant rate of growth of dividends
Therefore, expected price of share of Sebastion Ltd.
= $2.76/(0.13-.06)
= $39.43 per share.
1.e) Time left on bond, t = 15 years.
Coupon rate of bond, I = 8%.
Par value of Bond, Pv = $1,000.
Current Market Price of Bond,
Pm = $966.38
Thus, yield to maturity =[ (Interest amount)+(Pm – Pv)/t]/[(Pm +Pv)/2]
= [$80 +($966.38-$1,000)/15]/[($966.38 + $1,000)/2]
= 7.91%.
1.f) Share priced at the beginning of year, Pb = $19.50
Share priced at the end of year, Pe = $25.00
Dividend paid, D = $2.20 per share
i) Dividend yield = D/[(Pb + Pe)/2]
= $2.20/[($25+$19.50)/2]
= 0.098 or 9.80% .
ii) Capital Gain Yield = [(Pe-Pb)/Pb]*100
= [($25-$19.50)/($19.50)]*100
= 28.21%.
iii) Total rate of return for the year
= [D + (Pe – Pb)]/Pb*100
= [$2.2 + ($25.00-$19.50)]/($19.50)*100
= 39.49%.
Answer to Q 2
Cash Flow Statement (1st year)
$million
Sales of New Bag 390
Depreciation 120
Factory Rent (10)
Increase in account payable 20
Operating Cost (200)
Investment in inventory (100)
Machine (600)
———-
Cash Flow (370)
Cash Flow Statement (2nd year)
Sales of New Bag 390
Depreciation 120
Factory Rent (10)
Operating Cost (200)
———-
Cash Flow 300
Opening Balance of Cash Flow (370)
———–
Cash flow (70)
Cash Flow Statement (3rd year)
Sales of New Bag 390
Depreciation 120
Factory Rent (10)
Operating Cost (200)
———-
Cash Flow 300
Opening Balance of Cash Flow (70)
———–
Cash flow 230
Cash Flow Statement (4th year)
Sales of New Bag 390
Depreciation 120
Factory Rent (10)
Operating Cost (200)
———-
Cash Flow 300
Opening Balance of Cash Flow 230
———–
Cash flow 530
Cash Flow Statement (5th year)
Sales of New Bag 390
Depreciation 120
Factory Rent (10)
Operating Cost (200)
Sale of machine as Scrap 100
———-
Cash Flow 400
Opening Balance of Cash Flow 530
———–
Cash flow 930
Answer to question no 2 (b) (i)
(Cannot be calculated as discount rate figure is not provided)
Answer to question no 2 (b) (ii)
IRR (Please refer to excel Sheet-attached)
Answer to question no 2 (b) (iii)
Payback Period (Please refer to excel Sheet-attached)
Answer to question no 2 (b) (iv)
Present Value Index cannot be calculated as discount rate is not available
Answer to question no 2 (c)
The new project is a very good proposition for the company. The cash flow statement shows that the company will earn profit from the very beginning and it will reach at the positive cash flow in third year of its operation. It would be better to set up this plant. The company can go for other options but the plan is best suited for the company. The financial are in favour of that business plan.
Answer to question no 3(a)
Systematic risk:
The risk is associated to the whole stock market. The symmetric risk is also called undiversified risk, volatility or market risk. The overall effect of the market can be felt and it is not based on the performance of any single stock (Boatright, 2010).
The risk is related to the market performance and it cannot be mitigated by diversification. The risk can be mitigated through hedging and right asset allocation strategy.
Unsystematic risk.
The risk is associated with the industry or sector in the market. The risk is related to industry or nay sector of the stock market.
The risk can easily be mitigated by diversification of the portfolio. The risk is also called residual risk. The investors will be less affected if they can diversify their portfolio of holding stocks.
Ans. to question no 3 (b)
Well diversified portfolio is less risky because each of the shares works as complementary to each other. If one share is performing in the market the other share can make up the loss. The well diversified portfolio does not fact unsystematic risk. This can be better understood with an example say..
X shares is trading at $10 per share
The x share was bought at $12.50
y shares is trading at $20 per share
The x share was bought at $15
The profit in y share will make the overall portfolio of x and y share better.
Ans. to question no 3 (c)
(Please provide the required reference theory taught in the class otherwise solution cannot be provided)
Ans to question no 3 (d)
(Please provide the required formula taught in the class otherwise solution cannot be provided)
Ans to question no 3 (e)
(Please provide the required formula taught in the class otherwise solution cannot be provided)
Ans to question no. 4 (a)
Solution:
First we need to calculate the weights of debt and equity.
Market Value of Equity = 2,000,000 × $2.4 = $48,00,000
Market Value of Preference Share = 1,20,000 x $9.5 = $11,40,000
Market Value of Debt = 20,000 × $96.50 = $19,30,000
Total Market Value of Debt and Equity and preference share = $78,70,000
Weight of Equity = $48,00,000 / $78,70,000 = 61%
Weight of Debt = $19,30,000/ $78,70,000 = 24.52%
Weight of preference share = $11,40,000/ $78,70,000 = 14.48%
Weight of Debt can be calculated as 100% minus cost of equity = 100% − (61% + 14.48%) = 24.52%
Second step in our solution is to calculate the cost of equity. With the given data we can use capital asset pricing model (CAPM) to calculate cost of equity as follows:
Cost of Equity and preference 17%
Cost of Debt 9%
After tax cost of debt is hence 9% × ( 1 − 30% ) = 6.3%
And finally,
WACC = 24.52% × 17% + 75.48% × 6.3% = 8.93%
Ans. to question no. 4 (b)
The primary variables are to be determined for calculating weighted average cost of capital, and these primary variables are the relative debt and equity values, the cost of debt, and the cost of equity. The relative debt and equity values can be easily determined, while calculating the costs of debt and equity is not easy. There are three different methods the dividend growth model, the capital asset pricing model, and the bond yield plus risk premium method. All the calculations are based on estimation.
The calculation of cost of debt is easier in comparison to calculating cost of equity, but there are still problems that arise. The addition of default premium required to calculate cost of debt, the risk-free rate.
Ans. to question no. 5(i)
EBIT= $1,20,000
Tax Rate: 30%
EAT= $1,20,000 x 70% = $84,000
Cost of Capital = 16%
(Assuming that cost of capital i.e. dividend is equal to EAT and there is no retained earnings)
Market Value of the Company will be = $84,000/16% x 100=$5,25,000
The market value of the company shall be more than $ 5,25,000
(Otherwise Please Provide the required formula that is taught in the class, as the formula is not over internet)
Ans. to question no. 5(ii)
EBIT= $1,20,000
Interest= 12% on $ 3,00,000
Tax Rate: 30%
EAT= $1,20,000 – $36,000 x 70% = $58,800
Cost of Capital = 16%
(Assuming that cost of capital i.e. dividend is equal to EAT and there is no retained earnings)
Market Value of the Company will be = $58,800/16% x 100=$3,67,500
The market value of the company shall be more than $ 3,67,500
(Otherwise Please Provide me the required formula that is taught in the class, as the formula is not over internet)
Ans. to question no. 5(i)
Modigliani and Miller developed a theory capital structure which is based on the modern thinking.
In the Proposition I of Without Taxes:
Vu = VL
Where, Vu is the value of unlevered firm
VL is the value of levered firm.
The proposition suggests that a buyer wants to buy shares of a company, instead of buying L company the buyer should prefer buying U company and borrow the same amount of money that L does.
Proposition II of Without Taxes
re(Levered)=re (unlevered) + D/E (re(Unlevered)-rd)
where,
re is required rate of return on equity or cost of equity
rd is required rate of return on borrowings or cost of debt.
d/e is debt equity ratio
The higher debt equity ratio means higher side of profitability. There will be no transaction cost exists and individuals or corporations borrow at the same rate.
Ans. to question no. 5(ii)
With taxes
Proposition I
VL=VU+TCD
VL is the value of the levered firm
VU is the value of the unlevered firm
TCD assumes that debt is perpetual
Proposition II
re = ro + D/E (ro-rd) (1-tc)
re is required rate of return
ro cost of equity with no leverage
rd is cost of debt
te is tax rate D/E is debt equity ratio
Answer question no 6
(The study material related to this is required for answering these questions)
Reference:
Boatright, J. (2010). Finance ethics critical issues in theory and practice. Hoboken, N.J: Wiley.
