660 Final Assignment (Maruf)
660 Final Assignment (Maruf)
660 Final Assignment (Maruf)
Q . No -01 Villadella Pharmaceuticals Limited believes in a target capital structure of 40 percent debt and
60 percent equity. It has been a highly successful business generating a ROE of 32 percent. Current share p
Usually, 60 percent of the profits are returned to the shareholders as dividend. EPS for the latest year is Tk
company and its marginal tax rate is 30 percent.
Wd*Kd*(1-t)+We*Ke
WACC 17.49
Q No -02 2. Mazar Corporation applies Certainty Equivalent approach for evaluating high risk projects. The
following cash flows are estimated for one such high-risk project: Year 1 = Tk 88,000, Year 2 = Tk 95,000,
Year 3 = Tk 110,000, Year 4 = Tk 120,000, Year 5 = Tk 125,000, and Year 6 = Tk 105,000. The initial outlay
was estimated to be Tk 230,000. The following are the certainty equivalent coefficients for the six years:
.9, .9, .8, .8, .7, and .6. The WACC is 20 percent and the risk-free rate is 11 percent.
a. Determine the certainty equivalent NPV of the project.
b. Should the project be selected? Why? Provide proper interpretation of your decision.
c. What are the long-term effects of relying on one discount rate for all projects and no
adjustment is made for risk?
Certainty
Equivalent C.E Certainty
Year CF Equivalent CF
0 (230,000) 1 -230000
1 88,000 0.9 79200
2 95,000 0.9 85500
3 110,000 0.8 88000
4 120,000 0.8 96000
5 125,000 0.7 87500
6 105,000 0.6 63000
a. CE NPV $123,937.45
IRR 28.31%
b. The project should be accepted. CE NPV is a positive value.
Interpretation: NPV of CE is Positive which means it creates wealth after fully compensatin
Interpretation: IRR 28.31 % which is higher than 11% .So the project will accepted because t
after fully compensating for risk
c If a firm continues to invest in risky project based on one return rate the will fail to adjust the
risk. Usually savy investors want higher return from risky projects. Investment on these risky
projects based on one discount rate will ulitimately destroy wealth for the share holders.
Q No -03 3. Modernization of a production system will require purchasing and installing a new German machine.
The purchase price of the proposed new machine is Tk 9,80,000. Shipping and installation costs are
estimated to be Tk 2,00,000. It will take an additional Tk 72,000 to modify it for use in the production
plant. It will replace an old equipment that currently has a book value of Tk 35,000. It can be sold for
net of Tk 1,30,000 now. The new equipment will require an incremental investment of Tk 2,00,000 in
working capital. Marginal tax rate is 30 percent.
Determine the initial Outlay, IO, for the investment proposal.
Ans:
a If project size is different then capital budgeting decision is based on NPV of the projects. Small size project has
less. So for different size project we should decide based on NPV. We need to Choose Project with Highest N
b
b) Project with unequal life goes with below 2 process
1.Replacement Chain
Keep renewing the projects until both Projects end in The Same Year
Find the NPV on a common life basis. Project with Higher NPV is The better Value Creator
2.Equivalent Annual Annuity (EAA)/Annual Net Present Value (ANPV)
First find Regular one Cycle NPV
Second, Divide Above by Appropriate PVIFA. This is Equivalent Annual Annuity or ANPV.
c
c) When project risk is different Certainty equivalents are used to determine the best one
Certainty Equivalents are between 0 and 1.
Exchanges Risky Cash Flows for Risk-Free Flows. A risky Cash Flow of Taka 2,00,000 may be exchanged for a
implies Certainty Equivalent Factor of .8
Discount the Risk-free flows at risk-free rate
Q No -05
5. The new parts may be manufactured either with a German Machine or with an Swedish
Machine. The Initial Outflow and future flows are given below:
Year CF (German) CF (Swedish)
0 (180,000) (150,000)
1 25,000 40,000
2 37,500 45,000
3 45,000 50,000
4 70,000 55,000
5 90,000 60,000
6 110,000 60,000
7 125,000 70,000
a. Determine the IRR of the two projects.
b. Determine the Cross-over Rate.
c. Compute the NPVs of the two options using discount rate starting with 10% going up to 28%
using only even rates (that is, 10%, 12%, 14%….)
d. Draw the NPV profile of the two projects on the same graph showing the IRR and Cross-over
rates.
e. If the cost of capital is 18 percent, which machine should be selected? Fully explain.
Assume equal risk.
f. Discuss all the reasons why we prefer NPV to IRR
Ans Year CF(German) CF(Swedish) DIFF
0 (180,000) (150,000) (30,000)
1 25,000 40,000 (15,000)
2 37,500 45,000 (7,500)
3 45,000 50,000 (5,000)
4 70,000 55,000 15,000
5 90,000 60,000 30,000
6 110,000 60,000 50,000
7 125,000 70,000 55,000
a. IRR 25.04% 27.14%
$137,458.93
b. Cross over Rate 20.36%
c.
Rate 10% 12% 14% 16% 18% 20%
NPV(GR) 137,458.93 0.98 0.95 0.92 0.89 0.86
NPV(SW) 105,729.98 #VALUE! #VALUE! #VALUE! #VALUE! #VALUE!
150,000...
100,000...
Ans:
50,00... Ans:
100,000...
Ans:
50,00... Ans:
(50,00...
160,000...
140,000...
120,000...
At the 18% Required rate of return German eqipment should be selected. Because at 18% rate
NPV of the German machine is higher compared to Swidish machine.
e. 100,000...
IRR tends to produce higher value for smaller & riskier projects. In order to avoid this bias NPV is
80,000...
prefereed over IRR. if a business is always choosing high IRR projects, it is probably funding
f. more risky ventures & it is lossing its balance in its portfolios of assets. Ans:
60,000... Ans:
40,000...
Q No -06 20,000...
6. Andover Limited is planning to bid for an 8-year government contract. The contract will pay Tk
40,000 next year. The payment will increase by Tk 5,000 every year until the final year. The
equipment required
10% to supply
12% the14%
product16%
will require
18%an investment
20% of Tk 1,30,000 now, but it will
last for only four years. Therefore, if Andover Ltd. bids for the contract, it must plan to reinvest in
(20,000...
the same equipment in the 4th year, but equipment cost in the 4th year will increase to Tk 150,000.
There will be a net after-tax salvage value of Tk 30,000 at the end of the 8th year. The initial
(40,000...
investment of Tk 9,000 in net working capital will be returned.
a) Determine the IRR of the project.
b) Using a financing rate of 16 percent, determine the MIRR.
c) Determine the NPV of the project at 16 percent.
d) Make a recommendation statement about the bid.
6
Discount Rate 16%
Project
Year Project Inflow Outflow Net Flow
0 (130,000) (130,000)
1 40,000 40,000
2 45,000 45,000
3 50,000 50,000
4 55,000 (150,000) (95,000)
5 60,000 60,000
6 65,000 65,000
7 70,000 70,000
8 114,000 114,000 75000+30000+9000
a. IRR 22.05%
b. MIRR 18.39%
c. NPV 32,276.82
d. This project should be accepted because of positive NPV.
NPV high , IRR/MIRR higher then discount rate so
recommending to invest on this this project
Q No -07
7. Project X and Y are mutually exclusive, and it is reasonable to assume indefinite life for both
projects. X is a five-year project with a net present value of Tk 6,405.63. Project Y is a 7-year
project with a net present value of Tk 7,378.84. The NPV estimates are based on a discount
rate of 18 percent. Both projects are average risk projects.
a. Determine the equivalent annual annuity of the two projects.
b. Which project should be selected and why? (Must be the right reason).
Q No -08
8. The following table shows the risk classes of seven projects and the IRR estimates. The firm’s WACC
is 20 percent. The firm has a policy of adding 3 percent to WACC for increasing level of risk and deduct 3
percent for the decreasing level of risk. The company has a policy of classifying capital budgeting
projects in five risk groups, each group having a discount rate differential of 3 percent from the next
group. Identify which projects are to be accepted and which are to be rejected. Provide detailed
decision statement for projects individually.
Project Risk Class IRR
M Above Average 22.4 %
N Average 20.8 %
P Highest 30.9 %
Q Below Average 15.97%
R Average 20.9
S Lowest 14.8
T Above average 22.4
Ans: Required
Project Name IRR Risk Group Return Decision
M
22.40% Above Average 23% Reject
20.80% Average N 20% Accept
30.90% Highest P 26% Accept
Q
15.97% Below Average 17% Reject
20.90% Average R 20% Accept
14.80% Lowest S 14% Accept
T
22.40% Above average 23% Reject
Q No -09
9. Mandaloy Corporation is considering an investment for expansion of capacity. Currently
the annual revenue of the company is Tk 1,20,35,000. The investment will make Mandaloy a
company with an annual sales of Tk 2 crore. The initial Investment required is estimated at Tk
67,00,000 that includes investment in net working capital, shipping, and installation. The
equipment will have a life of 6 years. Cost of Goods sold is normally 45 percent. Cash
administration, selling and marketing cost, and all other indirect cost generally turn out to be
about 25 percent of revenue. The equipment is to be depreciated over 6 years using the
following rates: 20%, 32%, 19%, 12%, 11%, and 6 percent. Depreciable Basis is Tk 60,00,000.
Tax rate is 32 percent. Total terminal year non-operating cash flow at the end of the 6th year is
10,20,000.
(a) Determine the periodic cash flows for 6 years.
(b) After adjusting the final year business cash flows with terminal year non-operating cash
flows, determine the IRR and NPV of the project. Use a discount rate of 22 percent.
Assume average risk.
(c) State your decision.
Ans:
P Annual sale 20000000
Current revenue 12035000
Depreciable Basis 6,000,000
1 2 3 4 5
Sales Revenue 7,965,000 7,965,000 7,965,000 7,965,000 7,965,000
Cost of Goods
Sold 45% 3,584,250 3,584,250 3,584,250 3,584,250 3,584,250
Gross Profit 4,380,750 4,380,750 4,380,750 4,380,750 4,380,750
Operating Cash
cost 25% 1,991,250 1,991,250 1,991,250 1,991,250 1,991,250
Operating
Profit before
Dep. 2,389,500 2,389,500 2,389,500 2,389,500 2,389,500
Depreciation 1,200,000 1,920,000 1,140,000 720,000 660,000
Depreciation
1 2 3 4 5
0.20 0.32 0.19 0.12 0.11
Description 1 2 3 4 5
Book Value 6,000,000 4,800,000 2,880,000 1,740,000 1020000
Depreciation 1,200,000 1,920,000 1,140,000 720,000 660,000
Ending Book
Value 4,800,000 2,880,000 1,740,000 1,020,000 360,000
C Project should be rejected because it has negative NPV and IRR is also lower than the discount rate.
Here the IRR is lower than the discount rate . so project is not creating wealth.
The NPV also neagtive which means the project fail to create wealth .
Q No -10 10. Maskulka Corporation currently has a production volume of 400,000 per year which is
expected to go up by 15% next year. Fill up the blank cells and compute EPS.
Volume 400,000 460,000
Price per unit 50 50
Sales 20,000,000 23,000,000
Variable Cost 45% 9,000,000, …………….
Gross Profit 11,000,000 12,650,000
Fixed Cost 1,200,000 1,200,000
Depreciation 1,000,000 1,000,000
EBIT ………………, 10,450,000
Interest 2,500,000 2,500,000
EBT 6,300,000 7,950,000
Taxes 35% …………….., 2,782,500
Net Income 4,095,000, ……………..
Number of shares 900,000 900,000
EPS ………………….., ………………………
(Interpretation needed.)
a. Compute the Degree of Operating Leverage.
b. Compute the Degree of Financial Leverage.
c. Compute the Degree of Total Leverage
Q No -11
. Treemont Partners are in the business of building gas stations and selling the after 3
years of operation. Their required return on investments currently is 18 percent. A project in
the Ocaloosa neighborhood is expected to cost Tk 12,50,000. The net after-tax cash flow
expected in the first year is Tk 50,000. The project will be fully operational in the second year
and will generate Tk 1,28,000. The third year cash flow will increase by 40 percent, and after
that, the growth rate will match the expected inflation rate of 6 percent.
a. Determine the terminal value of the project at the end of the third year of operation.
b. Prepare a table of cash flows.
c. Determine the net present value of the project.
d. State a recommendation.
Ans:
a Terminal Value LCF*(1+g)/(K-g) NOCF
179200*1.06/(.18-.06) RR rate (k)
1,582,933.33
b. 3rd year CF 179,200 OCF-- 128000*1.4
Year CF
0 -1250000
1 50,000
2 128,000
TYCF 3 1,762,133 NOCF+OCF
c. NPV -43,210.76
IRR 16.55%
d. Project should be Declined for negative NPV. IRR is 16.55 % which is lower than the re
My recommendation about the project is not to run further, if continue the project may inc
Q. No-12 Shalala Corporation has a target capital structure of 40% debt, 60% equity. It also has a policy of ne
Currently, its capital structure consists of Tk 8,00,00,000 in Equity and Tk 3,00,00,000 in debt. Curr
The expected retained earnings for this year (not included in the above equity figure) is Tk 1,00,00
Tk 4,00,00,000 in new capital.
(a) What is the available debt capacity of Shalala using the debt ratio test?
(b) Assuming 13% interest cost on new debt, what is the available debt capacity using TIE Test?
Expected EBIT is Tk 3,00,00,000.
(c) How much new debt can Shalala add and still stay within the policy limits of its capital structure
Ans:
Total Capital
Current Equity 80000000
Retained Earning 10000000
Current Long term Debt 30000000
Unknown New Capital 40000000
TIE 6
EBIT 30000000
Interest 11% 3300000
Allowable Interest 5000000
Interest Slack 1700000
Q. No-13 Sinclair Corporation has approached its investment banker to raise Tk 2,50,000 in new capital. Th
they need to carry an interest rate of 14 percent. Alternatively, the amount may be raised by selling shares
Currently, Sinclair has 72,000 shares outstanding and has debt amounting to Tk 9,00,000 carrying an interes
(a) Prepare a table showing the EPS values assuming (A) Tk 2,50,000 is raised by selling new comm
(b) Prepare a table showing the EPS values assuming (B) Tk 2,50,000 is raised by selling new bonds
(c) Compute the indifference point.
(d) Draw a chart and identify the range where equity issue is preferred to debt issue.
Present Situation
No. Share 72000
Debt Amonut 900000
Interest Cost 12% 108000
Option 1 Option 2
Share 72000
Current Debt 900000
New Debt 250000
ROE*(1-DPO)
projects. The
Year 2 = Tk 95,000,
0. The initial outlay
nts for the six years:
0.11
a positive value.
lth after fully compensating for risk
ect will accepted because the project creates wealth
German machine.
ation costs are
n the production
t can be sold for
of Tk 2,00,000 in
ects. Small size project has higher IRR , though the project value is
oose Project with Highest NPV. NPV must be positive.
e Creator
r ANPV.
best one
t will pay Tk
3,584,250
4380750
1,991,250
2,389,500
360,000
2,029,500
649,440
1,380,060
360,000
1,740,060
6
0.06
6
360,000
360,000
e discount rate.
18.00%
F-- 128000*1.4
hich is lower than the required return so the project failed to wealth creation.
ontinue the project may incur loss or failed to create wealth.
ess capacity
TIE
6
0,000 in new capital. The investment banker advised Sinclair that if new bonds are issued,
be raised by selling shares each share netting Tk 16.
9,00,000 carrying an interest rate of 12 percent. Tax rate is 30 percent.
ed by selling new common shares. Use EBIT values of Tk 2,50,000 and Tk 3,50,000.
ed by selling new bonds. Use EBIT values of Tk 2,50,000 and Tk 3,50,000.
debt issue.
Price per share 16
Raise Amount 250000
No. of Share 15625
Total No. of Share 87625
Option 2
350000
108000
242000
72600
169400
87625
1.93
Question No-13
Question No-13 Sinclair Corporation has approached its investment banker to raise Tk 2,50,0
they need to carry an interest rate of 14 percent. Alternatively, the amount may be
Currently, Sinclair has 72,000 shares outstanding and has debt amounting to Tk 9,0
(a) Prepare a table showing the EPS values assuming (A) Tk 2,50,000 is raised
(b) Prepare a table showing the EPS values assuming (B) Tk 2,50,000 is raised
(c) Compute the indifference point.
(d) Draw a chart and identify the range where equity issue is preferred to de
Present Situation
No. Share
Debt Amonut
Interest Cost 12%
Option 1
Share
Current Debt
New Debt
Interest prior
New Interest In new
14%
debt
Total Interest
Page 23
Question No-13
EBIT-143000 = EBIT-108000
1 1.217
EBIT-108000 = 1.217 EBIT - 174031
.217EBIT = 174031-108000
.217EBIT = 66031
EBIT = 304,290.32
Option 1
EBIT 250,000
Interest 143,000
EBT 107,000
tax 30% 32,100
net income 74,900
No. of Share 72,000
EPS 1.04
12.00
10.00
8.00
6.00
Equity option is
better
4.00
2.00
0.00
Page 24
Question No-13
s investment banker to raise Tk 2,50,000 in new capital. The investment banker advised Sinclair that if new bonds are issued,
ercent. Alternatively, the amount may be raised by selling shares each share netting Tk 16.
anding and has debt amounting to Tk 9,00,000 carrying an interest rate of 12 percent. Tax rate is 30 percent.
ues assuming (A) Tk 2,50,000 is raised by selling new common shares. Use EBIT values of Tk 2,50,000 and Tk 3,50,000.
ues assuming (B) Tk 2,50,000 is raised by selling new bonds. Use EBIT values of Tk 2,50,000 and Tk 3,50,000.
250,000
72,000
900,000
108,000
Option 2
72,000 Price per share 16
900,000 Raise Amount 250,000
250,000 No. of Share 15,625
Total No. of Share 87,625
108,000
Interest 108,000
143,000
Page 25
Question No-13
1.2170139 divived by 72000 both side
174031 =1.217*143000
Indifference Point
Bond option is
better
Page 26
Question No-13
and Tk 3,50,000.
Page 27
Question No-13
rence point then the bond issue option is prefered if expected EBIT is less than Indefference point then stock issue/Equity option is better
yment, the bond issue option is prefered if EBIT is greater than Indefference point amount if Expected EBIT is less than Indefference point
Page 28
Question No-13
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