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# Business Finance Tutorial Solutions [Complete] BU8201

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This 391 page Bundle was uploaded by Ace Notetaker on Sunday September 27, 2015. The Bundle belongs to BU8201 at Nanyang Technological University taught by in Summer 2015. Since its upload, it has received 1732 views. For similar materials see Business Finance in Finance at Nanyang Technological University.

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Date Created: 09/27/15

TUTORIAL QUESTIONS I have typed out laboriously the text of the tutorial questions instead of merely quoting the question number from the text to save all students the time of searching and also typing the questions for their tutorial presentation These questions are carefully selected to cover as much as possible the issues concepts applications taught during the lectures subject to tutorial time constraint of 1 hour These tutorial questions should help you in the recall review and application of principles and concepts learnt during the lectures and also to extend many of these Questions are also chosen to let students appreciate the practical nature of what they have learnt Students should be able to understand more deeply appreciate the topics even more and see numerous practical applications of finance knowledge after attempting these questions The tutorials cover theory and conceptual type questions prefixed by a Q and more application and calculation type questions prefixed by a P It is the same convention used in our textbook I have added extra questions when I believe that the textbook question is unable to bring out fully the importance or relevance of certain concepts There are some typos in the text questions which I have amended and I have also modified some questions to test critical thinking These amendments and modifications are highlighted in bold Where appropriate I have also changed the order of some questions and subquestions to facilitate a more logical development of concepts and principles To optimize learning unnecessary duplicate type of questions are avoided which is why sometimes the tutorial requires you to do only certain parts as they have already been covered in other tutorial questions Enjoy BU 8201 Tutorial 1 Questions Introduction to FM and Interest Rates Note to students All students should learn to write down the numerical working for Time Value of Money TVM and TVM related questions instead of just writing down the calculator steps For structured questions not MCQs in the exams students are required to write down the numerical working For example when calculating F V students should write F V PV 1 I N I 000 1 005 10 Students will be penalized in the exams if they write quotN 10 IYR 5 PMT 0 PV 1000 Find FVquot in Q11 P71 P7 17 If most investors expect the same cash ows from Companies A and B but are more con dent that A s cash ows will be close to their expected value which should have the higher stock price Explain What is a rm s intrinsic value Its current stock price Is the stock s true longrun value more closely related to its intrinsic value or its current price do a b and c only Yield curves The following yields on US Treasury securities were taken from a recent financial publication Term m 6 months 51 1 year 55 2 years 56 3 years 57 4 years 58 5 years 60 10 years 61 20 years 65 30 years 63 a Plot a yield curve based on these data b What type of yield curve is shown c What information does this graph tell you Interest rate premium A 5year Treasury bond has a 52 percent yield A 10year Treasury bond yields 64 percent and a 10year corporate bond yields 84 percent The market expects that in ation will average 25 percent over the next 10 years IP10 25 Assume that there is no maturity risk premium MRP 0 and that the annual real risk free rate r will remain constant over the next 10 years Hint Remember that the default risk premium and the liquidity premium are zero for Treasury securities DRP LP 0 A 5year corporate bond has the same default risk premium and liquidity premium as the 10year corporate bond described above What is the yield on this 5 year corporate bond P720 do a to e and f 3 and 4 only f1 and f2 need NOT be done Interest rate determination and yield curves a What effect would each of the following events likely have on the level of nominal interest rates 1 Households dramatically increase their savings rate 2 Corporations increase their demand for funds following an increase in investment opportunities 3 The government runs a larger than expected budget deficit 4 There is an increase in expected in ation b Suppose you are considering two possible investment opportunities for a 12year Treasury bond and a 7year Arated corporate bond The current real riskfree rate is 4 percent and in ation is expected to be 2 percent for the next 2 years 3 percent for the following 4 years and 4 percent thereafter The maturity risk premium is estimated by this formula MRP 002t 1 The liquidity premium for the corporate bond is estimated to be 03 percent You may determine the default risk premium DRP given the company s bond rating from the data given in the text it implies a corporate yield spread DRP LP of 098 Remember to subtract the bond s LP from the corporate spread to arrive at the bond s DRP What yield would you predict for each of these two investments c Given the following Treasury bond yield information from a recent financial publication construct a graph of the yield curve Maturity Rai 1 year 537 2 years 547 3 years 565 4 years 571 5 years 564 10 years 575 20 years 633 30 years 594 1 Based on the information above about the corporate bond that was given in part b calculate yields and then construct a new yield curve graph that shows both Treasury and the corporate bonds e Which part of the yield curve the left side or right side is likely to be the most volatile over time f Using the Treasury yield information in c above calculate the following rates 3 The 10year rate 10 years from now 4 The 10year rate 20 years from now BU 8201 Tutorial 2 Questions Time Value of Money Financial Markets Note to students All students should learn to write down the numerical working for Time Value of Money TVM and TVM related questions instead of just writing down the calculator steps For structured questions not MCQs in the exams students are required to write down the numerical working For example when calculating PVA students should write 1 1 11N 100148 001 PVA48 PMT 350 1329089 Students will be penalized in the exams if they write quotN 48 IYR I PMT 350 F V 0 Find PV from calculator which is the PVA to be found quot Qn 1 Effective Annual Rate Which of the following three banks would you place your deposit with What would be the value of your savings of 10000 be after 2 years with the selected bank Bank A nominal rate of 12 interest payable semiannually Bank B nominal rate of 12 interest payable quarterly Bank C periodic rate of 35 this rate is for 3 months P515 do a c and 1 only Future value of an annuity Find the future values of these ordinary annuities Compounding occurs once a year a 400 per year for 10 years at 10 percent 0 400 per year for 5 years at 0 percent d Rework parts a 0 assuming that they are annuities due Extra What do you observe concerning the answers when interest rate is 0 percent P527 PV and loan eligibility You have saved 4000 for a down payment on a new car The largest monthly payment you can afford is 350 The loan will have a 12 percent APR Annual Percentage Rate based on endofmonth payments What is the most expensive car you can afford if you finance it for 48 months For 60 months P532 do a and b only Reaching a financial goal Shan Chen and Shan Xia who are twins just received 30000 each for their 25th birthday They both have aspirations to become millionaires Each plans to make a 5000 contribution to her early retirement fund on her birthday beginning a year from today Shan Chen opened an account with the Asian Regional Bond Fund a mutual fund that invests in highquality bonds whose investors have earned 6 percent per year in the past Shan Xia invested in the First RenewableTech Fund which invests in small newly issued biotech stocks and whose investors on average have earned 20 percent per year in the fund s relatively short history 537 P542 a If the two women s funds earn the same returns in the future as in the past how old will each be when she becomes a millionaire b How large would Shan Chen s annual contributions have to be for her to become a millionaire at the same age as Shan Xia assuming their expected returns are realized Amortization schedule with a balloon payment You want to buy a house that costs 100000 You have 10000 for a down payment but your credit is such that mortgage companies will not lend you the required 90000 However the realtor persuades the seller to take a 90000 mortgage called a seller takeback mortgage at a rate of 7 percent provided the loan is paid off in full in 3 years You expect to inherit 100000 in 3 years but right now all you have is 10000 and you can only afford to make payments of no more than 7500 per year given your salary The loan would really call for monthly payments but assume endofyear annual payments to simplify things a If the loan were amortized over 3 years how large would each payment be Could you afford those payments b If the loan were amortized over 30 years what would each payment be and could you afford those payments c To satisfy the seller the 30year mortgage would be written as a balloon note which means that at the end of the 3rd year you would have to make the regular payment plus the remaining balance on the loan What would the loan balance be at the end of Year 3 and what would the balloon payment be Required annuity payments A father is now planning a savings program to put his daughter through college She is 13 she plans to enroll at the university in 5 years and she should graduate in 4 years Currently the annual cost for everything food clothing tuition books transportation and so forth is 15000 but these costs are expected to increase by 5 percent annually The college requires that this amount be paid at the start of the year She now has 7500 in a college savings account that pays 6 percent annually The father will make 6 equal annual deposits into her account the 1St deposit today and the 6th on the day she starts college How large must each of the 6 payments be Hintz Calculate the cost in ated at 5 percent for each year of college then find the total present value of those costs discounted at 6 percent as of the day she enters college Then find the compounded value of her initial 7500 on that same day The difference between the PV costs and the amount that would be in the savings account must be made up by the father s deposits so nd the 6 equal payments starting immediately that will compound to the required amount BU 8201 Tutorial 3 Questions Bonds and their Valution P99 P912 P917 P918 P921 Interest rate sensitivity An investor purchased the following 5 bonds Each of them had a par value of 1000 and an 8 percent yield to maturity on the purchase day Immediately after she purchased them interest rates fell and each then had a new YTM of 7 percent What is the percentage change in price for each bond after the decline in interest rates Fill in the following table and comment on your findings Price at 8 Price at 7 Change 10year 10 annual coupon 10year zero 5year zero 30year zero 100 perpetuity As the emphasis on this question is on the relationship between coupon and maturity ys YTM and there are too many calculations of price there is no need to show the formula method and calculator method for obtaining the price only for this question Thus only the nal calculated prices need to be presented in class Current yield capital gains yield and yield to maturity Shanghai Textile Pte Ltd has bonds outstanding with 9 years left to maturity The bonds have an 8 percent annual coupon rate and were issued 1 year ago at their par value of 1000 However due to changes in interest rates the bond s market price has fallen to 90140 The capital gains yield last year was 986 percent a What is the yield to maturity b For the coming year what is the expected current yield and the expected capital gains yield Hint Refer to Footnote 7 for the definition of the current yield and to Table 91 Will the actual realized yields be equal to the expected yields if interest rates change If not how will they differ 0 Bond valuation Bond X is noncallable has 20 years to maturity a 9 percent annual coupon and a 1000 par value Your required return on Bond X is 10 percent and if you buy it you plan to hold it for 5 years You and the market have expectations that in 5 years the yield to maturity on a 15 year bond with similar risk will be 85 percent How much should you be willing to pay for Bond X today Hint You will need to know how much the bond will be worth at the end of 5 years Bond valuation You are considering a 10year 1000 par value bond Its coupon rate is 9 percent and interest is paid semiannually If you require an effective annual interest rate not a nominal rate of 816 percent how much should you be willing to pay for the bond Yield to maturity and yield to call Golden Services has bonds outstanding with a 1000 face value and 10 years left until maturity They have an 11 percent annual coupon payment and their current price is 1175 The bonds may be called in 5 years at 109 percent of face value Call price 1090 999 What is the yield to maturity What is the yield to call if they are called in 5 years Which yield might investors expect to earn on these bonds and Why The bond s indenture indicates that the call provision gives the firm the right to call them at the end of each year beginning in Year 5 In Year 5 they may be called at 109 percent of face value but in each of the next 4 years the call percentage Will decline by 1 percent Thus in Year 6 they may be called at 108 percent of face value in Year 7 they may be called at 107 percent of face value and so on If the yield curve is horizontal and interest rates remain at their current level When is the latest that investors might expect the firm to call the bonds BU 8201 Tutorial 4 Questions Risk and Rates of Return Q87 Q88 If investors aversion to risk increased would the risk premium on a highbeta stock increase by more or less than that on a lowbeta stock Explain If a company s beta were to double would its required return also double P86 Expected returns Question is modified to test student ability to apply concept learnt P811 P814 P815 P816 P817 Is it reasonable that diversified investors regard Stock Y which has higher standard deviation of return and CV than Stock X as being less risky than Stock X Explain CAPM and required return Calculate the required rate of return for Manning Enterprises assuming that investors expect a 35 percent rate of in ation in the future The real riskfree rate is 25 percent and the market risk premium is 65 percent Manning has a beta of 17 and its realized rate of return has averaged 135 percent over the past 5 years Portfolio beta Suppose Mark held a diversified portfolio consisting of a 10000 investment in each of 10 different common stocks The portfolio s beta is 14 Now suppose Mark decided to sell one of the stocks in his portfolio with a beta of 09 for 10000 and to use these proceeds to buy another stock with a beta of 16 What would Mark s portfolio s new beta be CAPM and required return RMI Roys RMI has a beta of 175 while TMY Toys TMY s beta is 08 The riskfree rate is 5 percent and the required rate of return on an average stock is 115 percent The expected rate of in ation built into rRF falls by 2 percentage the real riskfree rate remains constant the required return on the market falls to 85 percent and all betas remain constant After all of these changes what will be the difference in the required returns for RMI and TMY CAPM and portfolio return A mutual fund manager has been managing a 10 million portfolio that has a beta of 15 and a required rate of return of 13 percent The current riskfree rate is 5 percent Assume that the manager receive another 2 million If the manager invests the money in a stock with a beta of 11 what will be the required return on your 12 million portfolio Portfolio beta A mutual fund manager has a 20 million portfolio with a beta of 15 The riskfree rate is 45 percent and the market risk premium is 55 percent The manager expects to receive an additional 5 million which she plans to invest in a number of stocks After investing the additional funds she wants the fund s required return to be 13 percent What should be the average beta of the new stocks added to the portfolio BU 8201 Tutorial 5 Questions Fin Statements and their Analysis Ratio Analysis P316 do a and b partial only and extra question d Financial statements cash ow and taxes Laiho Industries 2011 and 2012 balance sheets in thousands of dollars are shown below 2012 2011 Cash 102850 89725 Accounts receivable 103365 85527 Inventories 38444 34982 Total current assets 244659 210234 Net fixed assets 67165 42436 Total assets 311824 252670 Accounts payable 30761 23109 Accruals 30477 22656 Notes payable 16717 14217 Total current liabilities 77955 59982 Longterm debt 76264 63914 Total liabilities 154219 123896 Common stock 100000 90000 Retained earnings 57605 38774 Total common equity 157605 128774 Total liabilities and equity 311824 252670 a Sales for 2012 were 455150000 and EBITDA was 15 percent of sales Furthermore depreciation was 11 percent of net fixed assets interest was 8575000 the corporate tax rate was 40 percent and Laiho pays 40 percent of its net income as dividends The firm has no amortization expense Given this information construct the firm s 2012 net income statement b Construct the statement of retained earnings and statement of stockholders equity assume the increase in common stock in 2012 is due to additional paidin capital increase of 10000000 for the year ending Dec 31 2012 c Calculate the 2011 and 2012 net operating working capital NQWC and 2012 free cash flow d If Laiho increased its dividend payout ratio what effect would this have on US corporate taxes paid What effect would this have on taxes paid by the company s US shareholders P421 Balance sheet analysis Complete the balance sheet and sales information using the following financial data Debttoassets ratio 50 Current ratio 18x Total assets turnover 15x Days sales outstanding 365 daysa Gross profit margin on sales 25 Sales Cost of goods soldSales Inventory turnover ratio 5x a Calculation is based on a 365day year Balance Sheet Cash Accounts payable Accounts receivable Longterm debt 60000 Inventories Common stock Fixed assets Retained earnings 97500 Total liabilities and equity Cost of goods sold 300000 Total assets Sales P423 do a d b e only in stated order as it is more logical order a Du Pont analysis A firm has been experiencing ow profitability in recent years Perform an analysis of the firm s financial position using the extended Du Pont equation lease payments but has a 2 million sinking fund payment on its debt industry average ratios and the firm s financial statements are as follows Industry Average Ratios The firm has no The most recent 6x 3x 3 o 900 Current ratio 2x Fixed assets turnover Debttotal assets 30 Total assets turnover Times interest earned 7x Profit margin EBITDA coverage 9x Return on total assets Inventory turnover 10x Return on common equity 1286 Days sales 24 days outstandinga a Calculation is based on a 365day year Balance Sheet as of December 31 2012 Millions of Dollars Cash and equivalents 78 Accounts payable Net receivables 66 Notes payable Inventories 159 Other current liabilities Total current assets 303 Total current liabilities Longterm debt Total liabilities Gross fixed assets 225 Less depreciation 78 Common stock Net fixed assets 147 Retained earnings Total stockholders equ y Total assets 450 Total liabilities and equity Income Statement for Year Ended December 31 2008 Millions of Dollars Net sales 7950 Cost of goods sold 6600 Gross profit 1350 Selling expenses 735 EBITDA 615 Depreciation expense 120 Earnings before interest and taxes 495 EBID Interest expense 45 Earnings before taxes EBT 450 Taxes 40 180 Net income 270 Calculate the following ratios and compare them with the industry average 45 45 21 111 135 114 201 315 939 Current ratio Debt to Total Assets Times Interest Earned EBITDA coverage Inventory Turnover Fixed Asset Turnover Total Asset Turnover DSO Pro t Margin Return on Total Assets Return on common Equity Which specific accounts seem to be most out of line relative to other firms in the industry Construct a Du Pont equation and compare the company s component ratios to the industry average ratios What mainly accounts for the low profits of the firm If the firm had a pronounced seasonal sales pattern or if it grew rapidly during the year how might that affect the validity of your ratio analysis How might you correct for such potential problems BU 8201 Tutorial 6 Question Stocks and their Valuation Q102 Is the following equation correct for finding the value of a constant growth stock Explain D0 P0 r S g Q104 Two investors are evaluating GE s stock for possible purchase They agree on the expected value of D1 and also on the expected future dividend growth rate Further they agree on the riskiness of the stock However one investor normally holds stocks for 2 years while the other holds stocks for 10 years On the basis of the type of analysis done in this chapter should they both be willing to pay the same price for GE s stock Explain P108 Preferred stock valuation Drill Corporation issued perpetual preferred stock with a 5 percent annual dividend The stock currently yields 10 percent and its par value is 120 a What is the stock s value b Suppose interest rates rise and pull the preferred stock s yield up to 14 percent What is its new market value P1018 Only a b and c Nonconstant growth stock valuation Taussig Technologies Corporation 39I39I39C has been growing at a rate of 20 percent per year in recent years This same growth rate is expected to last for another 2 years then to decline to g 6 o a If D0 160 and r5 10 what is 39I39I39C s stock worth today What are its expected dividend and capital gains yields at this time that is during Year 1 b Now assume that 39I39I39C s period of supernormal growth is to last for 5 years rather than 2 years How would this affect the price dividend yield and capital gains yield Answer in words only c What will 39I39I39C s dividend and capital gains yields be once its period of supernormal growth ends Hint These values will be the same regardless of whether you examine the case of 2 or 5 years of supernormal growth the calculations are very easy P1019 Corporate valuation model Barrett Industries invests a large sum of money in RampD and as a result it retains and reinvests all of its earnings In other words Barrett does not pay any dividends and it has no plans to pay dividends in the near future A major pension fund is interested in purchasing Barrett s stock The pension fund manager has estimated Barrett s free cash flows for the next 4 years as follows 3 million 6 million 10 million and 15 million After the fourth year free cash flow is projected to grow at a constant 7 percent Barrett s WACC is 12 percent the market value of its debt and preferred stock totals 60 million and it has 10 million shares of common stock outstanding a What is the present value of the free cash flows projected during the next 4 years b What is the firm s horizonterminal or continuing value c What is the firm s total value today d What is an estimate of Barrett s price per share BU 8201 Tutorial 7 Questions Cost of Capital Q112 Assume that the riskfree rate increases but the market risk premium remains P113 P116 P1111 WACC and percentage of debt nancing constant What impact would this have on the cost of debt What impact would it have on the cost of equity Cost of common equity Percy Motors has a target capital structure of 40 percent debt and 60 percent common equity with no preferred stock The yield to maturity on the company s outstanding bonds is 9 percent and its tax rate is 40 percent Percy s CFO estimates that the company s WACC is 996 percent What is Percy s cost of common equity Cost of common equity The future earnings dividends and common stock price of Carpetto Technologies Inc are expected to grow at 7 percent per year Carpetto s common stock sells for 23 per share its last dividend was 200 and it will pay a dividend of 214 at the end of the current year a Using the DCF approach what is its cost of common equity b If the firm s beta is 16 the riskfree rate is 9 percent and the average return on the market is 13 percent what will be the firm s cost of common equity using the CAPM approach c If the firm s bonds earn a return of 12 percent based on the bondyieIdplusrisk premium approach what will be rs Use the midpoint of the risk premium range discussed in Section 1115 in your calculations d Assuming you have equal confidence in the inputs used for the three approaches what is your estimate of Carpetto s cost of common equity Hook Industries capital structure consists solely of debt and common equity It can issue debt at rd 11 and its common stock currently pays a 200 dividend per share D0 2 The stock s price is currently at 2475 its dividend is expected to grow at a constant rate of 7 percent per year its tax rate is 35 percent and its WACC is 1395 percent What percentage of the company s capital structure consists of debt P1117 Calculation of g and EPS Sidman Products common stock currently sells for 60 a share The firm is expected to earn 540 per share this year and to pay a yearend dividend of 360 and it finances only with common equity a If investors require a 9 percent return what is the expected growth rate b If Sidman reinvests retained earnings in projects whose average return is equal to the stock s expected rate of return what will be next year s EPS Hint g 1 Payout RatioROE P1119 a and b only Adjusting cost of capital for risk Ziege Systems is considering the following independent projects for the coming year REQUIRED RATE OF PROJECT INVESTMENT RETURN RISK A 4 million 140 High B 5 million 115 High C 3 million 95 Low D 2 million 90 Average E 6 million 125 High F 5 million 125 Average G 6 million 70 Low H 3 million 115 Low Ziege s WACC is 10 percent but it adjusts for risk by adding 2 percent to the WACC for highrisk projects and subtracting 2 percent for lowrisk projects a Which projects should Ziege accept if it faces no capital constraints b If Ziege can only invest a total of 13 million which projects should it accept and what would the dollar size of its capital budget be BU 8201 Tutorial 8 Questions Basics of Capital Budgeting Unequal Lives Projects P1214 Choosing mandatory projects on the basis of least cost Kim Inc must install a new air conditioning unit in its main plant Kim absolutely must install one or the other of the units otherwise the highly profitable plant would have to shut down Two units are available HCC and LCC for high and low capital costs respectively HCC has a high capital cost but relatively low operating costs while LCC has a low capital cost but higher operating costs because it uses more electricity The units costs are shown below Kim s WACC is 7 percent EXPECTED NET CASH FLOWS YEAR HCC LCC 0 600000 100000 1 50000 175000 2 50000 175000 3 50000 175000 4 50000 175000 5 50000 175000 a Which unit would you recommend Explain b If Kim s controller wanted to know the IRRs of the two projects what would you tell him c If the WACC rose to 15 percent would this affect your recommendation Explain your answer and the reason why this result occurred P1217 Capital budgeting criteria Only need to calculate MIRR of Project A A company has 12 percent WACC and is considering two mutually exclusive investments that cannot be repeated with the following net cash flows EXPECTED NET CASH FLOWS YEAR PROJECT A PROJECT B 0 300 405 1 387 134 2 193 134 3 100 134 4 600 134 5 600 134 6 850 134 7 180 0 P1218 NPV and IRR A store has 5 years remaining on its lease in a mall Rent is 2000 per month 60 payments remain and the next payment is due in 1 month The mall s owner plans to sell the property in a year and wants rent at that time to be high so the property will appear more valuable Therefore the store has been offered a great deal owner s words on a new 5year lease The new lease calls for no rent for 9 months then payments of 2600 per month for the next 51 months The lease cannot be broken and the store s WACC is 12 percent or 1 percent per month a Should the new lease be accepted Hint Be sure to use 1 percent per month b If the storeowner decided to bargain with the mall s owner over the new lease payment what new lease payment would make the storeowner indifferent between the new and the old leases Hint Find FV of the old lease s original cost at t 9 then treat this as the PV of a 51period annuity whose payments represent the rent during months 10 to 60 c The storeowner is not sure of the 12 percent WACC it could be higher or lower At what nominal WACC would the storeowner be indifferent between the two leases Hint Calculate the differences between the two payment streams and then find its IRR P1223 do a b c d h only Capital budgeting criteria Your division is considering two projects Its WACC is 10 percent and the project s aftertax cash flows in millions of dollars would be h YEAR PROJECT A PROJECT B 0 30 30 1 5 20 2 10 10 3 15 8 4 20 6 Calculate the project s NPVs IRRs MIRRs regular paybacks and discounted paybacks Presentation Group need to present detail calculations for Project A only The group just need to provide final answer for Project B calculations as principles are the same If the two projects are independent which projects should be chosen If the two projects are mutually exclusive and the WACC is 10 percent which projects should be chosen Plot NPV profiles for the two projects using WACC of 5 10 15 20 o and using the IRR of the 2 projects Identify the projects IRRs on the graph Presentation Group need not show detail calculation just provide table of NPV vs WACC and plot the NPV profiles Now look at the regular and discounted paybacks when judged by the paybacks Which project looks better P1219 Multiple IRRs and MIRR a b only A mining company is deciding whether to open a strip mine which costs 2 million Cash inflows of 13 million would occur at the end of Year 1 The land must be returned to its natural state at a cost of 12 million payable at the end of Year 2 a Plot the project s NPV profile using WACC of 0 10 50 80 100 200 300 400 410 420 430 and 450 o Presentation Group just need to provide table of NPV vs WACC and do not need to show detail working of NPV for this part as similar calculations were covered in P1123 Should the project be accepted if WACC 10 If WACC 20 Explain your reasoning BU 8201 Tutorial 9 Questions Cash Flow Estimation amp Risk Analysis There are some calculations of NPV in this tutorial but NPV calculations are not the focus here Presentation group need not show the detail workings in order to arrive at the NPV They just need to provide the final NPV number when required The only exception is the NPV calculation for the replacement chain method in P13 13b as some important new concepts are illustrated there Q131 Operating cash flows rather than accounting income are listed in Table 131 Why do we focus on cash flows as opposed to net income in capital budgeting P132 Project cash flow Eisenhower Communications is trying to estimate the firstyear P1319 cash flow at Year 1 for a proposed project The financial staff has collected the following information on the project Sales revenues 10 million Operating costs excluding depreciation 7 million Depreciation 2 million Interest expense 2 million The company has a 40 percent tax rate and its WACC is 10 percent a b C What is the project s cash flow for the first year t 1 If the project would cannibalize other projects by 1 million of cash flow before taxes per year how would this change your answer to part a Ignore part b If the tax rate dropped to 30 percent how would that change your answer to part a New Project Analysis do a only need to calculate project s NPV and c only Holmes Manufacturing is considering a new machine that costs 250000 and would reduce pretax manufacturing costs by 90000 annually Holmes would use the 3year MACRS method to depreciate the machine and management thinks the machine would have a value of 23000 at the end of its 5year operating life The applicable depreciation rates are 33 45 15 and 7 percent as discussed in Appendix 13A Net Operating Working Capital would increase by 25000 initially but it would be recovered at the end of the project s 5year life Holmes marginal tax rate is 40 percent and a 10 percent WACC is appropriate for the project a Calculate the project s NPV c Suppose the CFO wants you to do a scenario analysis with different values for the cost savings the machine s salvage value and the net operating working capital NOWC requirement She asks you to use the following probabilities and values in the scenario analysis COST SALVAGE SCENARIO PROBABILITY SAVINGS VALUE NOWC Worst case 035 72000 18000 30000 Base case 035 90000 23000 25000 Best case 030 108000 28000 20000 You have calculated the Base Case NPV in a Calculate the project s expected NPV given that Best Case NPV is 8173379 and the Worst Case NPV is 766352 its standard deviation and its coefficient of variation Would you recommend that the project be accepted Why or why not P1313 Unequal Lives Haley s Graphic Designs Inc is considering two mutually exclusive projects Both require an initial investment of 10000 and are typical averagerisk projects for the firm Project A has an expected life of 2 years with aftertax cash inflows of 6000 and 8000 at the end of Years 1 and 2 respectively Project B has an expected life of 4 years with aftertax cash inflows of 4000 at the end of each of the next 4 years The firm s WACC is 10 percent a If the projects cannot be repeated which project should be selected if Haley uses NPV as its criterion for project selection b Assume the projects can be repeated and that there are no anticipated changes in the cash flows Use the replacement chain analysis to determine the NPV of the project selected c Make the same assumptions in part b Using the equivalent annual annuity EAA method what is the EAA of the project selected BU 8201 Tutorial 10 Questions Capital Structure and Leverage PIS5 Financial leverage effects Paci c Dana and MAAKL are identical except for their leverage ratios and interest rates they pay on debt Each has 20 million in invested capital has 4 million of EBIT and is in the 40 percent corporate tax bracket Pacific Dana however has a debttocapital ratio of 50 percent and pays 12 percent interest on its debt whereas MAAKL has 30 percent debttocapital ratio and pays only 10 percent interest on its debt Neither firm uses preferred stock in its capital structure a Calculate the return on invested capital ROIC for each firm b Calculate the rate of return on equity ROE for each firm 0 Observing that Pacific Dana has a higher ROE MAAKL s treasurer is thinking of raising the debttocapital ratio from 30 to 60 percent even though that would increase MAAKL s interest rate on all debt to 15 percent Calculate the new ROE for MAAKL PIS6 Do a b 1 only Breakeven analysis The Weaver Watch Company sells watches for 25 the fixed costs are 140000 and the variable costs are 15 per watch a What is the rm s gain or loss at sales of 8000 watches At 18000 watches b What is the breakeven point Illustrate by means of a chart d What would happen to the breakeven point if the selling price were raised to 31 but variable costs rose to 23 a unit PIS13 Recapitalization Currently Mega Flowers Inc has a capital structure consisting of 20 percent debt and 80 percent equity Mega s debt currently has an 8 percent yield to maturity The riskfree rate rRF is 5 percent and the market risk premium rM rRF is 6 percent Using the CAPM Mega estimates that its cost of equity is currently 125 percent The company has a 40 percent tax rate a What is Mega s current WACC b What is the current beta on Mega s common stock 0 What would Mega s beta be if the company had no debt in its capital structure That is what is Mega s unlevered beta bU Mega s nancial staff is considering changing its capital structure to 40 percent debt and 60 percent equity If the company went ahead with the proposed change the yield to maturity on the company s bonds would rise to 95 percent The proposed change will have no effect on the company s tax rate d What would be the company s new cost of equity if it adopted the proposed change in capital structure e What would be the company s new WACC if it adopted the proposed change in capital structure f Based on your answer to part 6 would you advise Mega to adopt the proposed change in capital structure Explain PIS16 WACC and Optimal Capital Structure do a b 1 only Eden Athletics is trying to determine its optimal capital structure which now consists of only debt and common equity The firm does not currently use preferred stock in its capital structure and it does not plan to do so in the future Its treasury staff has consulted with investment bankers On the basis of those discussions the staff has created the following table showing its debt cost at different levels EQUITY DEBTTO TO DEBTTO BEFORE CAPITAL CAPITAL EQUITY BOND TAX COST RATIo wd RATIo we RATIODE RATING OF DEBT rd 00 10 000 A 70 02 08 025 BBB 80 04 06 067 BB 100 06 04 150 C 120 08 02 400 D 150 Eden uses the CAPM to estimate its cost of common equity rs and estimates that the riskfree rate is 5 percent the market risk premium is 6 percent and its tax rate is 40 percent Eden estimates that if it had no debt its unlevered beta bU would be 12 a What is the rm s optimal capital structure and what would be its WACC at the optimal capital structure b If Eden s managers anticipate that the company s business risk will increase in the future what effect would this increase likely have on its target capital structure d Plot a graph of the aftertax cost of debt the cost of equity and the WACC versus 1 the debtcapital ratio and 2 the debtequity ratio BU 8201 Tutorial 11 Questions Dividends and Share Repurchase P162 Stock Split Pantai Medical s stock trades at 90 a share The company is contemplating a 3for2 stock split Assuming that the stock split will have no effect on the market value of its equity what will be the company s stock price following the stock split P164 Stock Split After a 5for1 stock split Iskandar Company paid a dividend of 075 per new share The presplit equivalent of this 075 DPS represents a 9 increase over last year s presplit dividend What was last year s dividend per share P167 Dividends Berjaya Sporting Company is prepared to report the following 2012 income statement shown in thousands of dollars Sales 15200 Operating costs including depreciation 11900 EBIT 3300 Interest 300 EBT 3000 Taxes 40 1200 Net Income 1800 Prior to reporting this income statement the company wants to determine its annual dividend The company has 500000 shares of stock outstanding and its stock trades at 48 per share a The company had a 40 dividend payout ratio in 2011 If Berjaya wants to maintain this payout ratio in 2012 what will be its pershare dividend in 2012 b If the company maintains this 40 payout ratio what will be the current dividend yield on the company s stock 0 The company reported net income of 15 million in 2011 Assume that the number of shares outstanding has remained constant What was the company s pershare dividend in 2011 1 As an alternative to maintaining the same dividend payout ratio Berj aya is considering maintaining the same pershare dividend in 2012 that it paid in 2011 If it chooses this policy what will be the company s dividend payout ratio in 2012 6 Assume that the company is interested in dramatically expanding its operations and that this expansion will require significant amounts of capital The company would like to avoid transactions costs involved in issuing new equity Given this scenario would it make more sense for the company to maintain a constant dividend payout ratio or to maintain the same pershare dividend Explain P168 Alternative dividend policies Royal Selangor Couture is expecting to pay an annual dividend per share of 075 out of annual earnings per share of 225 Currently Royal Selangor s stock is selling for 1250 per share Adhering to the company s target capital structure the rm has 10million in assets of which 40 is funded by debt Assume that the rm s book value of equity equals its market value In past years the firm has earned a return on equity ROE of 18 which is expected to continue this year and into the foreseeable future a Based on that information what longrun growth rate can the firm be expected to maintain Hint g Retention rate x ROE b What is the stock s required return 0 If the firm changed its dividend policy and paid an annual dividend of 150 per share financial analysts would predict that the change in policy will have no effect on the f1rm s stock price or ROE Therefore what must be the rm s new expected longrun growth rate and required return d Modified Question Suppose instead that the firm has decided to proceed with its original plan of disbursing 075 per share to shareholders but the firm intends to do so in the form of a stock dividend rather than a cash dividend The firm will allot new shares based on the current stock price of 1250 In other words for every 1250 in dividends due to shareholders a share of stock will be issued How many new shares of stock will be issued and by how much will the company s earnings per share be diluted 10 BU8201 Tutorial 1 Q1 gt If most investors expect the same cash flows from Companies A and B but are more confident that A s cash flows will be close to their expected value which should have the higher stock price Explain gt Ans Investors are more confident that A s cash flows will be more closer to their expected value Investors prefer company A amp drive its stock price up Company A has higher stock price Q1 gt Additional explanation Value of any asset is the present value of all the cash flows the asset is expected to produce Company A s cash flows are more certain 9Company A s cash flows are less risky 9They are discounted at lower rates 9 The sum of their present values will be higher and leading to higher stock price Ql l gt What is a firm s intrinsic value Its current stock price Is the stock s quottrue longrun value more closely related to its intrinsic value or its current price Ql39l gt Intrinsic value i an estimate of a stock s true value based on accurate risk and return data C can be estimated but not measured precisely gt Current price market price t the stock value based on perceived but possibly incorrect information as seen by the marginal investor gt True longrun value is more closely related to its intrinsic value P7 1 do a lo and c only Yield curves The following yields on US Treasury securities were taken from a recent financial publication Term Rate 6 months 51 1 year 55 2 years 56 3 years 57 4 years 58 5 years 60 10 years 61 20 years 65 30 years 63 a Plot a yield curve based on these data b What type of yield curve is shown c What information does this graph tell you P7 1a gt8 Interest Rate o 1 f 1 l O 5 1O 15 20 25 30 Years to Maturity P7 1 gt b an upward sloping yield curve with slight inversion from around 20 years gt c This yield curve tells us generally that either inflation is expected to increase or there is an increasing maturity risk premium P7 17 gt Interest rate premium A 5year Treasury bond has a 52 percent yield A 10year Treasury bond yields 64 percent and a 10year corporate bond yields 84 percent The market expects that inflation will average 25 percent over the next 10 years IP10 25 Assume that there is no maturity risk premium MRP O and that the annual real riskfree rate r will remain constant over the next 10 years Hint Remember that the default risk premium and the liquidity premium are zero for Treasury securities DRP LP O A 5year corporate bond has the same default risk premium and liquidity premium as the 10year corporate bond described above What is the yield on this 5year corporate bond P7 17 b Determinants of Interest Rates rrPlIRPDRPLP Syear Treasury bond rT5 r IP5 IRPT5 VV 10year Treasury bond rT10 r IP10 IVIRPT10 Note For Treasury securities DRP LP O V 10year corporate bond rC10 r IP10 IVIRPC10 DRPC10 LPC1O V 5year corporate bond rC5 r IP5 IVIRPC5 DRPC5 LPC5 rC5 rT5 52 rmO 64 rC10 84 IPLO 25 MRP O DRPC5 LPC5 DRPCO LPClO rC5 P7 17 1 rT10 rP10 64 r 25 9 r 39 2 rT5 r IP5 52 39 IP5 9 IP5 13 3 rC10 r IP10 DRPC10 LPC10 84 39 25 DRPC10 LPC10 9 DRPC10 LPC10 2 DRPC5 LPC5 DRPC10 LPC10 2 4 rC5 r IP5 DRPC5 LPC5 39 13 2 72 P7 20 a Interest rate determination and yield curves a What effect would each of the following events likely have on the level of nominal interest rates 1 Households dramatically increase their savings rate Ans increase the supply of money9 interest rates will dechne 2 Corporations increase their demand for funds following an increase in investment opportunities Ans increase the demand for funds 9 increase interest rates P7 20 a 3 The government runs a larger than expected budget deficit Ans the larger the federal deficit other things held constant the government will be competing with the private sectors for funds push up interest rate 4 There is an increase in expected inflation Ans increase inflation premium 9 increase interest rates P7 20 b b Suppose you are considering two possible investment opportunities for a 12year Treasury bond and a 7year A rated corporate bond The current real riskfree rate is 4 percent and inflation is expected to be 2 percent for the next 2 years 3 percent for the following 4 years and 4 percent thereafter The maturity risk premium is estimated by this formula MRP 01 t 1 The liquidity premium for the corporate bond is estimated to be 03 percent Finally you may determine the default risk premium given the company s bond rating from the data given in the text it implies a corporate yield spread DRPLP of 098 Remember to subtract the bond s LP from the corporate spread to arrive at the bond s DRP What yield would you predict for each of these two investments P7 20b gt 12year Treasury bond IP12 22 34 46246 3333 r12 r IP12 IVIRP12 4 3333 002121 7553 b 7year corporate Arated bond IP7 22 34 41241 2857 r7 r IP7 IVIRP7 DRP7 LP7 4 2857 00271 098 030 030 7957 P7 200 gt Given the following Treasury bond yield information from a recent financial publication construct a graph of the yield curve Maturity Rate 1 year 537 2 years 547 3 years 565 4 years 571 5 years 564 10 years 575 20 years 633 30 years 594 P7 20c gt Ans 7 6 5 4 339 239 139 Yield Curve 0 10 15 20 25 30 P7 20d gt d Based on the information above about the corporate bond that was given in part b calculate yields and then construct a new yield curve graph that shows both Treasury and the corporate bonds P73920d w gt real riskfree rate r f would be the same for the corporate and treasury bonds gt Inflation premium IP and maturity premium MRP t Without information to the contrary we would assume that the IP and IVIRP would be the same for bonds with the same maturities gt Liquidity premium LP and default risk premium DRP for corporate bond L We assume that LP and DRP are constant across maturities then we can use the LP and DRP 098 as determined above and add them to the Tbond yields to find the corporate yields P7 20d Years Treasury ACorporate Spread LP DRP 1 537 635 098 030 068 2 547 645 098 030 068 3 565 663 098 030 068 4 571 669 098 030 068 5 564 662 098 030 068 10 575 673 098 030 068 20 633 731 098 030 068 30 594 692 098 030 068 P7 20d Treasury and Corporate Yield Curves 8 6 M v 5 0 Treasury 4 A Corporate 3 2 1 0 I I I I I Note that if we constructed yield curves for corporate bonds with other ratings the higher the rating the lower the curves would be P7 20e Which part of the yield curve the left side or right side is likely to be the most volatile over time Ans Short term interest rates the left side of the yield curve are more volatile because gt the Fed operates mainly in the short term sector hence Federal Reserve intervention has its major effect here gt longterm interest rates reflect the average expected inflation rate over the next 20 to 30 years and this average does not change as radically as yeartoyear expectations P7 20f f Using the Treasury yield information in c above calculate the following rates 3 The 10year rate 10 years from now gt Pure expesgtsations theory A K A V l l I L 10 J2 V 633 1331 2 11 rm 1 w 1 00633 1 005511 gal x 1691ng P7 20f f 4 The 10year rate 20 years from now 633 x F A VH i O 20 J3 594 111 TM 11 m2 111 x 1 3354339339 11 0033 1 x 2 Im mZQmem 0262 mUgtgtCZU mOan 0262 M ZCIU NCngtUI 0262 w E lt rhuan 0262 LOmr IO 0262 9 memUn gt 0262 QMCZ gtm 5an CI Which of the following three banks would you place your deposit with What would be the value of your savings of 10000 be after 2 years with the selected bank gt Bonk A Nominol rote of 12 interest payable semi onnuoHy gt Bonk B Nominol rote of 12 interest payable quorterly gt Bonk C Perioclic rote of 35 this rote is for 3 months QUUESTIION ll Q1 Solutions Fvn 2 PV 1 Inom MMXN Bonk A nominal rote of 12 interest payable semionnuolly FV2S 10000 1 01222X2 2 1262480 Bonk B nominol rote of 12 interest payable quarterly FV2Q 10000 101244X2 2 1266770 Bonk C periodic rate of 35 this rate is for 3 months FVPER 10000 1 0035 4X2 2 1316810 Therefore we should place the deposit in Bonk C Q1 Solutions 012 Bank A EAR 1 T2 1 1236 012 Bank B EAR 1 Ty 1 1255 Bank c EAR 1 M135 4 1 ill135 CI Find the future values of these ordinary annuities Compounding occurs once a year gt 400 per year for 10 years at 10 gt 400 per year for 5 years at 0 CI Find the future values of these annui ries due Compounding occurs once a year gt 400 per year for 10 years at 10 gt 400 per year for 5 years at 0 QUUESTIIoN 2 Ordinary Annuity vs Annuity Due Annuity A series of equal payments at fixed intervals for a specified number of periods Ordinary Annuity An annuity whose payments occur at An annuity whose payments occur at the end of each period the beginning of each period Fi um D 1 2 3 a 1 2 3 m I i E 1 I I t 39 quot iPMlT PMT FMT Pm PM PM F39V nue Find the future values of these ordinary annuities Compounding occurs once a year a 400 per year for 10 years at 10 Payment amount 2 PMT 40000 Interest rate 210 No of periods 2 N 10 40000 40000 40000 40000 40000 40000 40000 40000 40000 40000 i 40000 44000 48400 53240 58564 64420 70862 77949 85743 94320 Formula approach 637397 0 1 2 3 4 5 6 7 8 9gt HI V V V V V V V V I Stepbvstep approach HI WAN MT1 1W EVAN 0w 1 040 1 g 1 4001109 4001108 4001101 400010O 94320 85743 44000 40000 637497 Find the future values of these ordinary annuities Compounding occurs once a year b 400 per year for 5 years at 0 Payment amount 2 PMT 40000 Interest rate 0 No of periods 2 N 5 o 1 2 3 4 5 4oooo 40000 40000 4oooo 4oooo gt Note In the case where interest rate is 0 FVAN PMT x N gt 40000 gt4oooo 40000 40000 gt4oooo S39ep39bv39s39ep appmacquot Formula approach 200000 quotI 4013 L 1 a T 14 1 it 4 w it r 1 Z 1101 4 E 1 1 3 000 undefined 40014 40003 40002 40001 400010O 40000 40000 40000 40000 40000 2000 F C n n U i ries d ue U U P M39Il39 FV DUE 400 per yer f l 39 10 yam r 10 lb 400 Pair yer fair 5 yam 1 Bragg if dug 12000 7101 Ex nr rm WHITEM39EE39I39 immune r WEE I I M15 Q2 Calculator Method Note Calculator must be in END mode for ordinary annuity Or39dti nary rth uiity WAN n a 1 2 393 II Iquot ll tPltt llT PMT PMT a Ordinary Annuity FVA10ord 400 per year for 10 years at 10 UYR PV N PMT FV b Ordinary Annuity FVA5ord 400 per year for 5years at 0 UYR PV N PMT FV Q2 Calculator Method Note Calculator must be in BEGIN mode for annuity due Annuity Due a I 1 z 3 I II I M l l t It PMT IPMIT PMHI39 F39Wnue a Annuity Due FVA10due 400 per year for 10 years at 10 N I YR PV PMT FV b Annuity Due FVA5due 400 per year for 5years at 0 N I YR PV PMT FV El You have saved 4000 for a clown payment on a new car The largest monthly payment you can afford is 350 The loan will have a l 2 percent APR Annual Percentage Rate based on enclofmonth payments What is the most expensive car you can afford if you finance it for 48 months For 60 months QM EST 01 3 You have saved 4000 for a down payment on a new car The largest monthly payment you can afford is 350 The loan will have a l 2 percent APR Annual Percentage Rate based on endofmonth payments What is the most expensive car you can afford if you finance it for 48 months 399 1I I2 45 47 4 I 1 4000 350 350 350 350 350 6 Present value of n nutty frmula N W FMTW 1 T ll parin ic39iinterestljmnthlwl 1 Fur maths j l PM l1 E 1 D ljf l affordable payment 1 1 1729039 Calculator method III N 48 Im rh 100 PMT 350 FV 0 Then III PV 1329089 Max affordable payment 1329089 4000 1729089 You have saved 4000 for a down payment on a new car The largest monthly payment you can afford is 350 The loan will have a l 2 percent APR Annual Percentage Rate based on enclofmonth payments What is the most expensive car you can afford if you finance it for 60 months For 60 months PVA 350 1 1 6 quot 001 1 00160 5131573426 Max affordable payment 551573426 4000 331973426 What car can he buy CI Shan Chen and Shan Xia who are twins iust received 30000 each for their 25Th birthday They both have aspirations to become millionaires Each plans to make a 5000 contribution to her early retirement fund on her birthday beginning a year from today Shan Chen opened an account with the Asian Regional Bond Fund a mutual fund that invests in highquality bonds whose investors have earned 6 percent per year in the past Shan Xia invested in the First RenewableTech Fund which invests in small newly issued biotech stocks and whose investors on average have earned 20 percent per in the fund s relatively short history a If the two women s funds earned the same returns in the future as in the past how old will each be when she becomes a millionaire b How large would Shan Chen s annual contributions have to be for her to become a millionaire at the same age as Shan Xia assuming their expected returns are realized QUUESTIION 4 Step 1 Distilling The Information II Shan Chen C and Shan Xia X each have PV 30 000 El PMTC PMTX 5000 s rar ring end of 25h year I IC is 6 and IX is 20 El Bo rh aim to have FV of 1 000 000 after n years a Fine nC and nX b Find PMTC if nC nX Step 2 Make Assumptions I C and X bo rh inves r 30 000 into their respective funds at The beginning of Their 25fh year I C and X will invest 5000 yearly starting from end of 25fh year Step 3 Draw Timeline 30000 5000 5000 5000 5000 5000 5000 No of payments 0 1 2 3 4 5 n Age 25 25 n Step 4 Solve the Problem Partial II Treat initial 30 000 as lump sum investment I Treat 5000 yearly payment as ordinary annuity II 1 000 000 FVA FV30 000 FVn PV 1 1n PMT FVAn I L Q x 1 000 000 1 000 000 FVA FV30 000 FVA FV30 000 FV 30 OOO1O6quotC FV 30 00012quotX FVA magma 1 FVA maznx 1 006 02 I Solving for TLC II Solving for nX 11C 2 3874 11X 2 1604 L c I Using financial calculator Input l 6 PV 30 000 PMT 5000 PV l 000 000 Output n 3874 X I Using financial calculator Input l 20 PV 30 000 PMT 5000 PV l 000 000 Output n 1604 Step 4 Solve the Problem Partial II Shcm Chen will be 64 years old when she makes her first million while Shcm Xic will be 42 years old II Shan Chen C and Shan Xia X each have PV 30 000 El PMTC PMTX 5GGGs rar ring end of 25h year I IC is 6 and IX is 20 El Bo rh aim to have FV of 1 000 000 after H years Weeml b Find PMTC if nC nX Step 4 Solve the Problem Pariah III PV 30 000 III IC 6 III FV 1000 000 El nC 16044 I Find PMTC Step 4 Solve the Problem Pariah 1 000 000 PMT 30 000 1061639044 O 066 10616044 1 El Solve for PMTC II Algebraic manipulation II Financial calculator Step 4 Solve the Problem Partlbl II Using financial calculator Input n 16044 6 PV 30 000 FV 1 000 000 Output PMT 35 82533 Step 4 Solve the Problem Pariah II Shcm Chen will have to invest 35 82533 mon rhly if she wants to be c millionaire at The some time as Shcm Xic at 6 earnings El You want to buy a house that costs 100000 You have 10000 for a down payment but your credit is such that mortgage companies will not lend you the required 90000 However the realtor persuades the seller to take a 90000 mortgage called a seller takeback mortgage at a rate of 7 percent provided the loan is paid off in full in 3 years You expect to inherit 100000 in 3 years but right now all you have is 10000 and you can only afford to make payments of no more than 7500 per year given your salary The loan would really call for monthly payments but assume endofyear annual payments to simplify things a If the loan were amortized over 3 years how large would each payment be Could you afford those payments b If the loan were amortized over 30 years what would each payment be and could you afford those payments c To satisfy the seller the 30years mortgage would be written as a balloon note which means that at the end of the 3rd year you would have to make the regular payment plus the remaining balance on the loan What would the loan balance be at the end of Year 3 and what would the balloon payment be QM EST 01 5 Question 5 II Mortgage 90 000 El In reres r 7 30 I Ccm dfford PMT of up to 7500 pd II Ordinary Annui ry PMT made at end of each period yedr Qn 537 a If the loan were amortized over 3 years how large would each payment be Could you afford those payments a PMT PVAN I 1 11 0N 90 000 0071 11 0073 34 29465 gt 7 500 10 000 III Unable to afford II Affordable only if 100 000 is inherited before the 15 PMT It is not clearly indicated when exactly we get the 1 00 000 Qn 537 lo If the loan were amortized over 30 years what would each payment be Could you afford those payments a PMT PVAN I 1 11 UN 2 90 000 007 1 11 0073 725278 lt 7500 I Able to afford even without the 10 000 capital or 100 000 windfall Qn 537 c To satisfy the seller the 30year mortgage would be written as a balloon note which means that at the end of the 3rd year you would have to make the regular payment plus the remaining balance on the loan at f1 513 53 quot 3 393 3 quot 3 a 3 A 393 o a 3 o A a 2 393 quot 3 3 3 3 3 c3 3 a 7 5343 quot g 3 quot lt3 U 0 oil U illo U 5W a HQ U or H U Q l U i o 0 to amp o1 U o M D U U i Ml o w i F7 95 9 9 95 93 9 s 93 9 u u 93 u u 95 91 9 95 9 93 9 95 f 95 9 95 V I Yearly payment 725278 I Number of payments left after 3 years 30 3 27 El Balance loan after 3 years PVAN PMTl l ll lN 725278 007 1 11o0727 86 93692 Qn 5 c What would The balloon E azmen r be I Balloon payment on 3rd year PMT PVAsrd year 725278 86 93692 94 18970 Qn 537 c Amortization Talole 90 000 725278 6300 95278 89 04722 2 89 04722 725278 623331 101947 88 02775 3 88 02775 94 18970 616194 88 02775 0 Qn 537 c Balloon Note Loan Principal Amount 90 000 Loan Balance After 86 93692 3 Years Annual Interest Rate 7 Total Principal Amount 90 000 INOM Paid by 3rel year Amortization Period 30 Total Interest Payable 18 69525 Years Years until Balloon 3 Balloon Payment 94 18970 Payment Yearly Payment 725278 Total Amount Payable 108 69525 El A father is now planning a savings program to put his daughter through college She is 13 she plans to enroll at the university in 5 years and she should graduate in 4 years Currently the annual cost is 15000 but these costs are expected to increase by 5 percent annually The college requires that this amount be paid at the start of the year She now has 7500 in a college savings account that pays 6 percent annually The father will make 6 equal annual deposits into her account the 15 deposit today and the 6quot on the day she starts college How large must each of the 6 payments be QUUESTIION 6 Important Concepts 1 Reference Point Present 1 2 3 4 5 6 7 8 Year 0 2 Inflation Cost affects how much a product will cost you Interest Rates affects how much you have to save Timeline v v Step 1 How much it Cost I 15000 I Fv4 Present 1 Year 0 W1 e Prim i e 1500 W2 2 VEEI it It a 1500 1 PW WEE1 m IH A 1 i i 1010 E a Note Compounding effect the presence of inflation rote at 5 beco use of Step 2 How much to Save PVC 191442 2010143 2110651 221618 I 2 Present 1 2 3 4 5 6 7 8 Year 0 FV1 1914422 N PVl 016 0 F695 1 43053967 Because of the difference 2 in interest rate and PVZ FV n 2 14 141707 inflation rate she needs 11 H360 to save less than what it 3 will cost her PV3 FV 211065 14037 03 n 0 1 4 PV4 W 2216133 2 1 390461 PV 2 PV W2 PV3 PV4 2 5641803 1Iquot if C 100 Step I amp 2 Using Calculator Sample Calculations Input for Step I not INPUT 5 5 15000 0 Sample Calculations Input for Step 2 not INPUT 5 19144223 6 0 Step 3 How much for Daddy 5641803 Present 1 2 3 4 5 6 7 8 Year 0 Note Because of her personal savings of 7500 daddy does not need to pay the full 5641803 PVDaddy PVC Savings 5641803 7500 PVDaddy 48918 03 Step 4 How much for 6 even PMT 4891803 The first of the 6 equal payments begin today Annuity Due PMT O l 2 3 4 5 6 7 8 If we write it in it s natural geometric form PMT PMT PMT PMT PMT PMT 489 83903 1006O 10061 10062 10063 10064 10065 Note 1 Where a PMT k 11 n N 6 Alternatively you can 1 1 1 consider this to first be an 5n PMT X 111139 PMT X Ll06w 48918OO3 Ordinary Annuity before km 1o06 doing the correction to PMT 938500 make it into an Annuity Due Step 4 Alternative Using Formulas Firstly PVA HE E Prl lfl rdimry SEcundlly BLUE tailing Lastly In 6 FFA rdm ry l l E 1 Step 4 Alternative Using Calculator EEE INPUT 6 6 4891803 0 CI Yearly fees for Singapore Citizen admitted in AY20i22013is7460 CI 2 Payments of 3730 a year gtPayments 6 months apart CIPayment Options 1 CPF Education Scheme 2 BankLoan 3 Cash REAL L lFlE SCIENARIKO CLIUUESTIKOYN General Timeline 3730 3730 3730 I C C C Year l l Of Study 0 1 2 3 4 Repayment O 1 2 24 36 n Comparison CPF Education Scheme OCBC Study Loan III NOM 25 III NOM 475 I Interest charged II Interest charged monthly at point of monthly upon withdrawal graduation E Starts when you are E Interest free during studying period of study Calculating Debt before Graduation PER monthly IPER Use FVA calculator lNo Because interest charged period monthly not same as money drawn period every months Debt 37301002083 Debt 7460 x 4 840 3730100208336 3730100208330 Calculating Debt before Graduation Debt 373003020342 I 37301m2036 I 373010020330 2110 37301i0020342 glen General Timeline CPF 3 18560 3730 OCBC 29 84000 3730 r3730 I Monthly Payments of 600 I I I 1111 Year Of Study 0 1 3 4 Repayment O 12 24 36 Calculating Debt EU on Graduation Assumption Both schemes will be considered as an Ordinary Annuity CPF Education Scheme OCBC Study Loan Debt 31 18560 Debt 2984000 PMT 600 PMT 600 Interestperiodic 02083 merestperiodic 03959 I I Input 02083 3118560 600 0 Input 03959 2984000 600 0 Output 5506 Output 5549 Bonds and theirValuation Tutorial Group 3 Presented by Alma Sator Eline Sophie Skogen Pamela Goh ShemuelTan Mehran Noorzaei Question Interest rate sensitivity An investor purchased the following 5 bonds Each of them had a par value of IOOO and an 8 percent yield to maturity on the purchase day Immediately after she purchased them interest rates fell and each then had a newYTM of 7 percent What is the percentage change in price for each bond after the decline in interest rates Fill in the following table and comment on your ndings Presenter Mehran Formulas used Annual Bond INT 1 M 1 11 dN V B m 1rdN Semi annual Bond INT2 1 M 1 1 1 m22N V b 1212 1 m22N f Formulas used For a perpetuity N is infinite Therefore INT 1 M VB 2 1 N N I39d 1 rd 1 rd For a zero coupon bond no periodic payments are made Therefore I T 1 M VB N 1 N N I39d 1 rd 1 rd N Question Results and conclusions e 7 IO year O I 3420 2l07 675 4 annual coupon IO year zero 463 l 9 50835 975 5 year zero 68058 7299 476 30 year zero 9938 I3 I 37 32 l 9 IOO perpetuity 250 42857 429 When rates fall a bonds price increase and when rates rise a bonds value decreases Longer maturity means higher change asYTM fluctuates because of time laps as one can see in the 5 IO and 30 year zero coupon bonds Price at 8 Price at 7 change 39O39Yea 3901 annual 3420 I2 I O7 675 coupon IOyear zero 463 I9 50835 975 Low coupon bond is more sensitive to interest rates change 9Low coupon bond has high interest rate risk Price at 8 Price at 7 change 5year zero 68058 7 299 476 IOyear zero 463 9 50835 975 30year zero 9938 3 37 3220 Price at 8 Price at 7 change IOyear O annual coupon I 3420 2O7 675 00 perpetuity 25000 42857 43 Longterm bond is more sensitive to interest rate change 9 Longterm bond has high interest rate risk Question 2 Current yield capital gains yield and yield to maturity Shanghai Textile Pte Ltd has bonds outstanding with 9 years left to maturityThe bonds have an 8 percent annual coupon rate and were issued year ago at their par value of 000 However due to changes in interest rates the bond s market price has fallen to 90 40The capital gains yield last year was 986 percent a What is the yield to maturity b For the coming year what is the expected current yield and the expected capital gains yield Hint Refer to Footnote 7 for the definition of the current yield and to Table 9 c Will the actual realized yields be equal to the expected yields if interest rates change If not how will they differ Presenter Shemuel a What is the yield to maturity V INT 1 1 M b rd 1rdN 1rdN 9014 80 1 1 1000 I rd 1Td9 1Td9 We ha V6 no choice but to use the nan cial calcula t01 llmmIm N PMT FV YR PV Output b For the coming year what is the expected current yield and the expected capital gains yield 2 ways to solve this question lSt method Assumption The yield curve remains the same after the 2nd year Annual eeupen payment 80 Current priee 910140 Expected CY 008875 8875 Current yield And We already know that the YTM 9691 So Expected CGYYTMCY 29691 8875 0816 b For the coming year what is the expected current yield and the expected capital gains yield Method Uszhg the farmuza 1000 V02 Z Bing the n 012 calcula 01 I mmm N PMT FV YR PV 9088 Output b For the coming year what is the expected current yield and the expected capital gains yield V 0d cont d Annual Change price Capital gains yil C GY Expat i822 82 Big pric c Will the actual realized yields be equal to the expected yields if interest rates change If not how will they differ Annual coupon payment 1 NT Current Yield CY Current price 39 Currentyield W17 no Z Chen e e V617 I39ftb e mierest rs tes Change because and P0 remam e same I I A H Annuulchungeinrice P1 P0 Cui tul Gums Yield CGY 2 1 Beginning price P0 39 Capital gems yield will 61233 e T 13 because change m mterest re re WI ca use a change m e end ofyear price P1 c Will the actual realized yields be equal to the expected yields if interest rates change If not how will they differ Example lf h terest r tes in crease P1 will decrease T h erefere reltzed CGY will decrease Usrhg formal YTM CY CGY CY constant a decrease rid realised CGY will ca use realised to decrease A cttial realtzedytelds will not be equal to the erpectedytelds If terest rates change lfr h terest rates rise the a ctual realized yields will be less than the erpectedytelds and Vice versa Question 3 0 Bond valuation Bond X is noncallable has 20 years to maturity a 9 percent annual coupon and a l 000 par vaueYour required return on Bond X is IO percent and if you buy it you plan to hold it for 5 yearsYou and the market have expectations that in 5 years the yield to maturity on a l5year bond with similar risk will be 85 percent 0 How much should you be willing to pay for Bond X today Presenter Alma Question 3 INT 1 M VB 2 1 N E N I d 1 rd 1 rd V1315 90 1 1 15 1000 15 1085 1 0085 1 0085 104152 N IIYR PV PMT FV Output I 04 52 1 39 1 1 1 1 1 1 1 1 1 1 1 1 Question 3 INT 1 M 1 VB 2 1 N E N Id 1 rd 1 rd 1 1 41 2 VB 2 9O 1 5 E O 5 5 010 1010 1 010 vB 98787 IE N IIYR PV PMT FV Output 98787 Question 4 Bond Valuation You are considering a lOyear l 000 par value bond Its coupon rate is 9 percent and interest is paid semiannually If you require an effective annual interest rate not a nominal rate of 8 l 6 percent then how much should you be willing to pay for the bond Presenter Pamela Question 4 0 Step I Calculate Effective Annual Rate EAR the annual rate of interest actually being earned accounting for compounding EAR NOMMM 0086 I INOMIZ2 NOMl2 O4 39 INOM 8 0 Step 2 Calculate semiannual bond value multiply years by 2 divide nominal rate by 2 and divide annual coupon by 2 vb l06795 Question 4 INT2 1 M Vb 1 I d2 1 I d22N 1 I d2 2N 902 1 1 1000 10082210 10082210 Vb a 0082 106795 N20 IIY4 PMT45 FV000 input II um N PMT FV YR PV output 06795 6 Question 5 Yield To Maturity and Yield To Call 0 Golden Services has bonds outstanding with a l 000 face value and IO years left until maturityThey have an I l percent annual coupon payment and their current price is l 75The bonds may be called in 5 years at O9 percent of face value Call price 090 a What is the yield to maturity b What is the yield to call if they are called in 5 years c Which yield might investors expect to earn on these bonds and why d The bonds indenture indicates that the call provision gives the firm the right to call them at the end of each year beginning in Year 5 In Year 5 they may be called at O9 percent of face value but in each of the next 4 years the call percentage will decline by l percent Thus in Year 6 they may be called at O8 percent of face value in Year 7 they may be called at O7 percent of face value and so on If the yield curve is horizontal and interest rates remain at their current level when is the latest that investors might expect the firm to call the bonds Presenter Eline a What is the Yield to maturity VB 2 INT 1 1 N i M N I d 1rd 1rd 1175 2 Eu 1 10 100010 I39d I39d rd 2 835 N YR PV PMT FV OUtPUt 835 i l bWhat is the yield to call if they are called in 5 years a INT 1 C 11 39 a nee ng 1 N p N I d 1 rd 1 rd 1 1 1 1 1175 O1 51 0905 I39d 1 rd 1 I d Id 2 813 input quotmm N IYR PV PMT FV output 8 3 c Which yield might investors expect to earn on these bonds and why Solution The bonds are selling at a premium which indicates that interest rates have fallen since the bonds were originally issued Assuming that interest rates do not change from the present level investors would expect to earn the yield to call quot j 4 w A 392 it K I i 39 quotl i m l It 2 us I i f l A mn l l n mm Bi I i i M 1mmILnj11ILn1H1mnAAnj nAAnmmnjIn nJ1muILnj11ILn1H1mnAAnj nAAnmmn n mmnn nmmnu d The bonds indenture indicates that the call provision gives the firm the right to call them at the end of each year beginning in Year 5 In Year 5 they may be called at O9 percent of face value but in each of the next 4 years the call percentage will decline by l percent Thus in Year 6 they may be called at O8 percent of face value in Year 7 they may be called at O7 percent of face value and so on If the yield curve is horizontal and interest rates remain at their current level when is the latest that investors might expect the firm to call the bonds Callable bondprice l 1 NH can p ceN Y39I39C 1YTC 1YTC 1175 1 1 61 1080 6 Y39I39C 1YTC 1YTC Therefore we know that on the 6th year when YTC ltYTM at 835 the YTC6 8267 firm would call back the bonds so they can issue new ones at a lower If N7 the YTC7 837 price input n I75 m I080 N lYR PV PMT FV output 827 w THANK YQU QR NW Emma 3 39 Tutorial 4 Business Finance Mabel Tan Lim Wan Ting Choo Han Kiat K0 WeiTing NG ZHEN YANG IVAN Summary Stand Alone Stock Portfolio Final Value Initial Value riniean of returns of diff companies Return Ti 2 F mal Value n n n fp 2 ijj piltri Expected Return 1 quot 2 Ti pl j1 i1 i1 Tl A 2 n Up rp pi Standard Deviation 0 201 z pl j i1 V i1 0 CVp 7 0 rp CoefftCtent 0f Var1at10nCV Tl CAPMampSML Equationmi rRF rm erbi p 2 2 J J i1 Stand Alone Risk 2 Market Risk Diversifiable Risk Q8 7 f investors aversion to risk increased would the ris rernium on a high beta stock increase by more or 1e than that on a low beta stock Explain rii ED A SML ld Rikg hi ow bhigh39 Therefore the market risk premium of the high beta stock will increase m than that of a low beta stock Risk aversion increase gt risk premium increase gt slope of SML increase Beta measures the volatility of a stock relative to market changes High beta stock Will carry more market risk than a low beta stock 187 Stock risk premium market risk premium X beta r1 rRF m rRF bi If risk aversion increases the slope of the SML Will increase and so will the market risk premium rM rRF If beta is loW say 05 then the product rM rRF bi Will be small stock risk premium will increase by only half the increase in market risk premium If beta is large say 2 then its stock risk premium Will rise by twice the increase in market risk premium 188 If a company s beta were to double would it required return also double required Rate 0 Returns Ti VHF 4 Tm TRFjb39i ew Required Rate 0quot Returns THF T Fjbi Ti Tm TEFDbi TRF Tm rRFjbi Tm TRF 4 Tm TRFjb39i Tm VHF bi Tm bi Alternative method 39 TM 2 Tm Te bt Ti Tr TRF Z 2 TRF Hence ri 75 2 ri when rRF 75 0 As beta doubled the required 7quoti TRF bi 7quotm TRF 2 r r Zbi l RF 7 m TRF 2n t 201 TRF return would not double P8 6 Expected returns Is it reasonable that diversified investors regard Stock Y which has higher standard deviation of return and CV than Stock X as being less risky than Stock X Explain Stock Y s CV amp o gt Stock X s CV amp G Total risk Standalone risk Market Risk Diversifiable Risk Factors that measures total risk of individual stock 6 CV Market risk Cannot be eliminated Dependent on value of beta Bi Diversifiable risk Risk that can be eliminated through diversification Stand alone risk is not important to a well diversified investor They are concerned With the market risk If stock Y has a lower beta than stock X it will be less risky for diversified investors P8 ll Calculate the required rate of return for Manning Enterprises assuming that investors expect a 35 percent rate of in ation in the future The real riskfree rate is 25 percent and the market risk premium is 65 percent Manning has a beta of 17 and its realized rate of return has averaged 135 percent over the past 5 years 35 percent rate of in ation in the future Real riskfree rate is 25 percent Market risk premium is 65 percent Beta of 17 Realized rate of return has averaged 135 percent over the past 5 years Information 9595 Useful Equations Listing out the given variables r 25 Rpm 55 D 35 Bi 17 Market Risk Premium RPm rm rRF Nominal RiskFree Rate rRF r P r Required Rate of Return Ti 2 rRF i Tm TRFE IP Rpm 25 35 6517 1705 Ti P8 l4 Suppose Mark held a diversified portfolio consisting of a 10000 investment in each of 10 different common stocks The portfolio s beta is 14 Now suppose Mark decided to sell one of the stocks in his portfolio with a beta of 09 for 10000 and to use these proceeds to buy another stock with a beta of 16 What would Mark s portfolio s new beta be Since investment in each stock is 10000 stocks in the portfolio is of equal weightage Portfolio beta bp Wslbsl Wszbsz Ws10bs10 weightage for 1 stock 110 010 l39 l39 010bs10 Sell one stock with beta 09 for 10000 l39 01013le l 14 X O10O9 X 131 Buy another stock with proceeds 10000 with beta 16 Bpnew X W 10newb10new Bpnew 131 O1016 Bpnew P815 RMI Roys RMI has a beta of 175 While TMY Toys TMY s beta is 08 The riskfree rate is 5 and the required rate of return on an average stock is 115 The expected rate of in ation built into rRF falls by 2 the real riskfree rate remains constant the required return on the market falls to 85 and all betas remain constant After all of these changes What will be the difference in the required returns for RMI and TMY Information extracted BEFORE AFTER bRMI 175 175 bTMY 080 080 rRFrgtxlt IP 5 5 2 3 IM 115 85 Number Substitution Ri rRF RPMbi Difference in 1 i for RMI 5 115 5175 3 85 3175 375 1 1 BEFORE AFTER A Difference in 1 i for TMY 5 115 5O80 3 85 3O80 28 After all changes the difference in the required returns for RIVII and TIVIY will be 39 12625 74 5225 rRMI rRF rMrRFbRIVII 3 85 3175 12625 rTMYz rRF rMrRFbTIVIY 3 85 3O8 74 P8 16 A mutual fund manager has been managing a 10 million portfolio that has a beta of 15 and a required rate of return of 13 percent The current riskfree rate is 5 percent Assume that the manager receive another 2 million If the manager invests the money in a stock with a beta of 11 What Will be the required return on your 12 million portfolio 10 million portfolio Beta of 15 Required rate of return of 13 percent Risk free rate is 5 percent Invests another 2 million in a stock Assuming all stocks belong to the same market Information 991 91 Beta of 11 Ti TRF 1 rIO 13 13 5 RPm 15 3 r 5 r1 5 533 as 11 1087 39 RF 39 J Tl Tap j1 2 12 a g 13 1087 126 P8 l7 A mutual fund manager has a 20 million portfolio with a beta of 15 The risk free rate is 45 percent and the market risk premium is 55 percent The manager expects to receive an additional 5 million which she plans to invest in a number of stocks After investing the additional funds she wants the fund s required return to be 13 percent What should be the average beta of the new stocks added to the portfolio 20 million portfolio Beta of 15 Risk free rate is 45 percent Market risk premium is 55 percent Invests another 5 million in stocks Wants the fund s required return to be 13 percent Assuming all stocks belong to the same market 1 o 2 Information 3 4 5 6 1 lap 15 2 rRF 45 3 RPm 55 4 Target ri 13 Ti TRF 73929 1 W177 1 Tl 4 1 I 13 E 45 55 as 15 E 45 55 b b 173 P817 Alternative method After additional investments are made for the entire fund to have an expected return of 13 the portfolio must have a beta f 15455 as shown below 13 45 55b b 15455 P817 Alternative method cont Since the fund s beta is a weighted average of the betas of all the individual investments we can calculate the required beta on the additional investments as follows 15455 08 15 02 X 15455 12 02 X X 17275 The average beta of the new stocks should be 17275 BU INE FINANCE TUTRIAL 5 Financial Statements and Their Analysis Ratio Analysis P34 6 FHNANCHAL STATEMENTS CASH FLGW AN TAXES Laiho Industries 2011 and 2012 balance sheets Unit thousands of dollars 2012 2011 Cash 102850 89725 Accounts receivable 103365 85527 Inventories 38444 34982 Total current assets 244659 210234 Net fixed assets 67165 42436 Total assets 31 1824 252670 Accounts payable 30761 23109 Accruals 30477 22656 Notes payable 16717 14217 Total current liabilities 77955 59982 Longterm debt 76264 63914 Total liabilities 154219 123896 Common stock 100000 90000 Retained earnings 57605 38774 Total common equity 157605 128774 Total liabilities and equity 311824 252670 P346 A Sales for 2012 were 455150000 and EBITDA was 15 percent of sales Furthermore depreciation was 1 1 percent of net fixed assets interest was 8575000 the corporate tax rate was 40 percent and Laiho pays 40 percent of its net income out in dividends The firm has no amortization expense Given this information construct the firm s 201 2 net income statement P346 A Workings before we construct the net income statement III EBITDA 15 x Net Sales 015 x 44515000 6827250 III Depreciation Expense 1 1 x Net Fixed Assets 011 x 67165 738815 P346 A Workings continued III Operation cost except depreciation Net sales EBITDA 45515000 6827250 38687750 III EBIT EBITDA Depreciation expense 6827250 738815 6088435 P346 A III EBT EBIT Interest expense 6088435 857500 5230935 III Taxes 40 x EBT 040 x 5230935 2092374 III Net income EBT Taxes 5230935 2092374 3138561 P316 A Laiho Industries 2012 net income statement Unit thousands of dollars 000 Net sales 45515000 Less operation cost except depreciation 38687750 Earnings before interest taxes and depreciation EBITDA 6827250 Less depreciation and amortization 738815 Earnings before interest and taxes EBIT 6088435 Less interest expense 857500 Earnings before taxes EBT 5230935 Less taxes 40 2092374 Net income 3138561 P346 lt3 Construct the statement of retained earnings and statement of stockholders equity assume the increase in common stock in 2012 is due to additional paidin capital increase of 10000000 for the year ending Dec 31 2012 P346 5 Laiho pays 40 of its net income out in dividends III Dividends 40 x Net Income 04 x 3138561 2 1255424 III Increase in retained earnings Net Income Dividends 3138561 1255424 1883137 This can be calculated also by using the formula retained earnings12 retained earningsH 0316 H Statement of retained earnings year ending 31122012 Unit thousands of dollars 000 Retained earnings at 112012 Net income Less dividends paid Retained earnings at 31 122012 Note Decimals are removed for simplicity 38774 31385 70159 12554 57605 0316 H Statement of stockholders Unit thousands of dollars equity 000 Balance at 112012 Additional paidin capital Increase in retained earnings Balance at 31122012 1 28774 1 0000 138774 18831 157605 P346 C Calculate the 2011 and 2012 net operating working capital NOWC and 2012 cash flow 036 6 Net operating working capital NOWC Current assets Account payable Accruals 2011 210234 23109 22656 164469 2012 244659 30761 30477 183421 P316 C Free Cash Flow FCF EBIT1T Yearly Depreciation and Amortization Capital expenditures ANOWC Extracting the information EBIT 6088435 T 04 Yearly depn and amor 738815 Capital expenditure 67165 42436738815 3211715 ANOWC 183421164469 18592 FCF 60884351O4 738815 3211715 18952 715039 negative cash flow P346 go If Laiho increased its dividend payout ratio what effect would this have on US corporate taxes paid What effect would this have on taxes paid by the company s US shareholders P346 go Dividend payout ratio Dividends Net Income As the dividend is given out after corporate taxes is paid So a change in rate of dividend will not affect the corporate taxes However US shareholders need to pay more taxes as their personal income rises P42 ALANCE SHEET ANALYSS Complete the balance sheet and sales information using the following financial data EIEIEIEIEIEI Debt ratio 50 Current ratio 18x Total assets turnover 15x Days sales outstanding 365 Gross profit margin on sales 25 Inventory turnover ratio 5x Note Calculation is based on a 365day year P42 Equations Required CI Debt ratio total debt total assets CI Total debt total current liability long term debt CI Current ratio current asset current liability CI Total assets turnover sales total assets CI Days sales outstanding account receivables average sales perday CI Gross profit margin on sales sales COGS sales CI Inventory turnover sales inventory P421 Workings Total assets turnover sales total assets 15 sales 300000 Sales 450000 Gross profit margin on sales Sales COGS Sales 025 450000 cost of good sold 450000 Cost of good sold 337500 Inventory turnover sales inventory 5x 450000 inventory Inventory 90000 P421 Workings 050 account receivable average sales per day 365 account receivable 450000 365 Account receivable 45000 Current ratio current asset current liability 18 current asset 90000 Current asset 162000 Current asset cash account receivable inventory 162000 cash 45000 90000 Cash 27000 P421 Workings Debt ratio total debt total assets 05 total debt 300000 Total debt 150000 Total debt total current liability long term debt 150000 total current liability 60000 Total current liability 90000 Total current liability accounts payable short borrowings accruals Accounts payable 90000 Note Here we assume accounts payable total current liability as short term borrowings and accruals aren t stated in the balance sheet P421 Workings Total liabilities and equity total assets Total liabilities and equity 300000 Common stock retained earnings total debts total liabilities and equity Common stock 97500 150000 300000 Common stock 52500 Current assets fixed assets total assets 162000 fixed assets 300000 Fixed assets 138000 Completed Balance Sheet Cash 27000 Accounts payable 90000 Accounts 45000 Longterm debt 60000 receivable Inventories 90000 Common stock 52500 Fixed assets 138000 Retained earnings 97500 Total assets 300000 Total liabilities and 300000 equity Sales 450000 Cost of goods sold 337500 P423 H Calculate the following ratios and compare them with the industry average 1 Current ratio 2 Debt to Total Assets 3 Times Interest Earned 4 EBITDA coverage not in lecture notes 5 Inventory Turnover 6 Fixed Asset Turnover 7 Total Asset Turnover 8 D50 9 Profit Margin 10 Return on Total Assets 11 Return on Common Equity P423 A lt Firm s Industries Current ratio current 556 current 303 1 11 27x 2x liability Debt t T tal Total debt total asset 135450 30 30 Assets Times Interest EBIT interest 49 54 5 11X 7X Earned expense EBITDA lease payment EBITDA coverage int principle 611 95x 9x payment lease payment Inventory Sales inventory 795159 5x 10x TUrnover Fixed Asset Sales net fixed asset 795 147 54x 6x TUrnover TatalAsset Sales total asset 795450 18 3x TUrnover DSO Rece vables average 66 795365 30days 24days sales per day Profit Margin Net income sales 27795 34 3 Return on Total Net income total 0 o Assets assets 27450 6 9 Return on Net income total 0 0 Common Equity common equity 27315 83961 1186 P423 H Which specific accounts seem to be most out of the line relative to other firms in the same industry Accounts Formula Firm Industry Arguments average Inventories Sales Ex 10x By reducing inventories more Turnover Inventories funds can be used to repay debt This reduces interest charges for the debt which help to improves profits and strengthen debt po on Fixed Asset Net Sales 541x 6x There might be excess investment Turnover Net Fixed in fixed assets indicating there is Assets excess capacity Reducing excess investment may improve profit of firm P423 H Construct a Du pont equation and compare the company s component rotios to the industry average ratios What mainly accounts for the low profits of the firms Du Pont equation ROE Profit Margin x Total Assets Turnover x Equity Multiplier 39 T 1A ROE Net mcome X Sales X ota ssets Sales Total assets Equity Firm s ROE 27795 x 795450 x 450315 3396 x 1777 x 1429 8624 P423 Industry s ROE 3 x 3 x Equity Multiplier Equity Multiplier 1286 3 3 1429 P423 H Comparisons Profit Total Assets Equity ROE Margin Turnover Multiplier Firm 3396 1777 1429 8624 Industry 3 3 1429 1286 Average Firm gt Firm lt Firm Firm lt Industry Ave Industry Ave Industry Ave Industry Ave Analysis of the extended Du Pont equation and the set of ratios shows that the turnover ratio of sales to assets is quite low Either sales should be higher given the present level of assets or the firm is carrying more assets than it needs to support its sales P423 E If the firm had a pronounced seasonal sales pattern or if it grew rapidly during the year how might that affect the validity of your ratio analysis How might you correct for such potential problems P423 E El If the firm had a sharp seasonal sales pattern or if it grew rapidly during the year many ratios might be distorted Ratios involving cash receivables inventories and current liabilities as well as those based on sales profits and common equity could be biased CI Possible solution Use average figure instead of endofperiod figure CI For example the inventory turnover ratio for a food processor will be radically different if the balance sheet figure used for inventory is the one just before versus just after the close of the canning season This problem can be mitigated by using monthly averages for inventory and receivables when calculating turnover ratios Textbook Page 124 TUTORIAL 6 STOCKS AND THEIR VALUATION PRESENTED BY WONG KENG KHANG WEE BENG HWEE 2102 IS THE FOLLOWING THE CORRECT EQUATION FOR FINDING THE VALUE OF A CONSTANT GROWTH STOCK EXPLAIN DO P0 r S 8 Solution The value of a stock is the present value of the future dividends expected to be generated by the stock The dividends of the stock is expected to grow forever at a constant rate 9 D1 D2 11 1 11 2 D3 1Doo n 2 3 00 W5 1561 Heal 9 Do1 9 D01 9 Po 11 1 11 2 12 3 11O Wong Keng Khdng D0191D0192D0193 D019OO 1TS 1 1rs 2 1TS 3 17 S 00 O This is a sum of Geometric Progression where D 1 1 FIrst Term 0 0 m1 1rS 1 Common Roho k g 1rs D1 D1 0 1TS 1TS Pnce1k 11g 1Ts 1g 1TS 1rs P D1 Do1g O rs 9 rs g Thus The equorion given is nor correct Wong Kong Khomg CQIOAr TWO INVESTORS ARE EVALUATING GE S STOCK FOR POSSIBLE PURCHASE THEY AGREE ON THE EXPECTED VALUE OF D1 AND ALSO ON THE EXPECTED FUTURE DIVIDEND GROWTH RATE FURTHER THEY AGREE ON THE RISKINESS OF THE STOCK HOWEVER ONE INVESTOR NORMALLY HOLDS STOCKS FOR 2 YEARS WHILE THE OTHER HOLDS FOR IO YEARS ON THE BASIS OF THE TYPE OF ANALYSIS DONE IN THIS CHAPTER SHOULD THEY BOTH BE WILLING TO PAY THE SAME PRICE FOR GE S STOCK EXPLAIN Wee Beng Hwee 7 L774 Lia Lia Lea of V r v 771ii4 Liar 77 7 7 v7 a E quotrr v le iiu Lia r 77 7 7 L77 774L774 L73 L73 dig Lea lea 77 v 7 l u u J u l L J M q L L J l r l l r 7 l 7 l r 7 ll l is i W ml 77 W i ll ll l l l l l l L l l l l L rel l l l l l 7 7 s l w l s s l ll ri l f u 7397 Iii l ri l r7777 ri39x 7 39 Iii l ri l 7 77 7 rij 7i39 39rijr71 77 Iii l V r7 7 7 39 L77 7 7 r7 7 39 39 r 7 39 V 74 39 l l ll l l m m l r u u r l quot D u u u l J 39 u ll l l l ll i J l l i ll f l ljll j 7 rij rij 7 1 r397 if r r ri ri 71 i If The invesTor holds The sTocllt unTo infiniTy D1 D2 D00 mmquot39lt1rsgtw D 1 r S g 2 If The invesTor holds The sTocllt for N years and Then sells iT D1 D2 Sale Price mm 39lt1rsgtw P0 P0 P0 However because The sale price To The currenT invesTor depends on The dividends some fuTure invesTor expecTs and ThaT invesTor s expecTed sale price is also dependenT on some fuTure dividends and so forTh Therefore regardless The holding years of The sTock The inTrinsic value of The sTock is The sum of all The fuTure dividend flows In The end This formula holds D When invesTing individuol invesTors evoluoTes The sToclt s inTrinsic volue by considering The deTerminonTs of The sTock s sole price which ore The following sTock s riskinesslrsl which decides The rs The exloecTed growTh roTe of The dividendslg ond The exloecTed volue of dividend in The nexT oeriodlDlL I39s rRF quot39 rM39rRF bi As These deTerminonTs ore soid To be ogreed on olreody by boTh invesTors Their evoluoTion of The sTock s inTrinsic volue is The some regordless of Their holding Time of The sTock Hence boTh invesTors would be willing To poy The some price for GE s sToclt 2108 PREFERRED STOCK VALUATION DRILL CORPORATION ISSUED PERPETUAL PREFERRED STOCK WITH A 5 PERCENT ANNUAL DIVIDEND THE STOCK CURRENTLY YIELDS 10 PERCENT AND ITS PAR VALUE IS 120 A what is the stock s value Annual Dividend 5 D 5xPar Pa 2 Di 005x120 11 39 H 6 P E 39 39 unm I Required Return r5 010 Growth Rate 9 0 Gilber r Lee B Suppose interest rates rise and pull the preferred stock s yield up to 14 percent What is its new market value Annual Dividend 5 D 5 x Par 005 x 120 Required Return r5 014 Growth Rate 9 0 Gilbert Lee Pa 1 1395 39 E P a it 114 r 4L P1018 NONCONSTANT GROWTH STOCK VALUATION Tdussig Technologies Corporation TTC has been growing at a rate of 20 percent per year in recent years This some growth rate is expected to lost for another 2 years then to decline to gn 6 0 It Do 160 and rs 10 what is TTC s stock worth today What are its expected dividend and capital gains yields at this time that is during Year 18 Sun Shengmei P1018 NONCONSTANT GROWTH STOCK VALUATION A g 20 1 g 20 gn6 gn6 4 2 Do16 D1 D rs10 3 D 2 3 D4 D1 Do1g161201920 D2 D11 gDo1 g2 1 61 20 22304 After 2 years 9 changes to 6 D3 D2 1gn 2304162442 Sun Shengmei P1018 NONCONSTANT GROWTH STOCK VALUATION A 0 1 2 3 4 I I I I I I I I I I Do16 D1 D2 D3 D4 rs10 1920 2304 2442 1746 lt 1 904lt lt D1 D2 DN DN1 DN2 D00 P0 1 r91 1 r32 1 rs 1 rSN1 1 rSN2 1 r900 Sun Shengmei P1018 NONCONSTANT GROWTH STOCK VALUATION A INTRINSIC VALUE D D D D D D00 P0 1 1 2 2 N N N1Vl N2N2 1 rs 1 rs 1 rs 1 rs 1 rs 1 rs D1 D2 DN 1 DN1 DN2 Doo 1r51 1rs2 1rSN 1rSN 1r51 1rs2 1rs D1 D2 DN 1 P 7 91 7 92 1rsN1rsN N gtPV of Horizontal value DN1 PN gt Horizontal Value rS gn N2 D3 D2 1 gn 2304162442 rS1O 9 6 P2 D3 rS gn 244210661050 PO 1920110 2304110211102610505411 Sun Shengmei P1018 NONCONSTANT GROWTH STOCK VALUATION A EXPECTED DIVIDEND AND CAPITAL GAINS YIELD Expected Dividend Yield D1 Po Do1g Po 19205411 355 Atheimmehys YieldrsDividend Yield 10355 Capide Gains Yield 155170 P0 1 P1 D2 P2 P2 Dsrs gnZ4e4e21O661050 11 S1 11 S1 2304110 1 I1061050 5760 2 P1 2 D2 1 rs 610502304110 5760 So Capital Gains Yield5760 411 5411 645 Sun Shengmei PIG1803 THE SUPERNORMAL GROWTH IS TO LAST FOR 5 YRS HOW WOULD THIS AFFECT PRICE DIVIDEND YIELD AND CAPITAL GAINS YIELD Since the supernormal growth will last for 5 years instead of 2 years the dividend flow from the 3rd 4 5h will be much more than the previous situation with other years dividends the same as before The intrinsic value is the present value of all future cash flows Now future cash flow increases so the intrinsic value of the stock will increase In market equilibrium the current market stock price equals to its intrinsic value Therefore we expect the stock price to increase Based on the formula when Po increases the expected dividend yields will decrease and the expected capital gains yield will increase Sun Shengmei P1018B PROVE THE ANSWER ABOVE BY CALCULATION D1 Dz DN 1 0 1rs1 1rs2 1rSN 1rSN PN N DN 1 21 N PN 11 S 1rSN D1 1g 1 rS g 1rs 1 N Hwy PN D6 D0 1g51gn rS gn T s gquot 16120516106 105505 P5 50 P0 1921020112115 1115 105505 75975 Expected dividend yield D1 Po 192075975253 Expected Capital Gains YieldrsDividend Yield10253747 Sun Shengmei P1018C WHAT WILL TTC39S DIVIDEND AND CAPITAL GAINS YIELD BE ONCE ITS PERIOD OF SUPERNORMAL GROWTH ENDS Once the supernormal growth ends the stock will experience constant growth If so we can use the conclusion from the constant growth model since the following 2 conditions are satisfied 1 rs is bigger than gm 2 gn is expected t be constant forever Therefore Expected Capital Gains Yield gn6 Expected Dividend Yield rs Expected Capital Gains Yield 106 4 Sun Shengmei Q1019 CORPORATE VALUATION MODEL Barreff lndusfries invesfs a large sum of money infa RampD and as a resulf if refains and reinvesfs all of ifs earnings ln afner wards Barreff daes naf pay any dividends and if has no plans fa pay dividends in fne near fufure A major pension fund is inferesfed in purchasing Barreff s slack The pension fund manager has esfimafed Barreff s free cash flows far The nexf 4 years as follows 3 million 6 million 1 0 million and 15 million Affer fne faurfn year free cash flow is prajecfed fa graw af cansfanf 7 percenf Barreff s WACC is 12 percenf fne marlltef value of ifs delaf and preferred sfacllt fafals 60 million and if has 10 million shares of common sfacllt aufsfanding Qiu Zhe A WHAT IS THE PRESENT VALUE OF THE FREE CASH FLOWS PROJECTED DURING THE NEXT 4 YEARS 2 3 4 5 I WACC12 I I 39 F F g7 3mllllon 6mllllon iOmIIIIon 15mllllon Discounted 1 time I Discounted 2 times Discounted 3 times Discounted 4 times PV of FCF is sum of all the future free cash flow discounted to the present value D1 D2 D3 D4 1WACC1 1WACC2 1WACC3 1WACC4 3 6 10 15 10121 10122 10123 10124 241123 million QiuZhe B WHAT IS THE FIRM S HORIZONTERMINAL OR CONTINUING VALUE 2 3 4 5 I WACC12 I I I I I I g 3milion 6million 10million 15million FCFS FCF5 WACC gFCF TV4 Horizon value or Terminal Value represents value of firm at The point That growth becomes constant FCF5 FCF4 x 1 g 15 x 1 007 1605 million FCF5 1605 TV 4 WACC gFCF 012 007 321 million Qiu Zhe C WHAT IS THE FIRM S TOTAL VALUE TODAY 1 2 3 4 5 I WACC12 I 3milion 6million 10million 15million g TV4 3 1121 lt 1122 lt 10 mlt 15 1124 321 1124 FIRM S TOTAL VALUE is sum of nonconstont growth free cosh flows onol oonstont growth free cosh flows discounted to present volue Qiu Zhe F irm s total value today FCFl FCF2 FCF3 FCF4 TV4 1WACC1 1WACC2 1WACC3 1WACC4 1WACC4 3 6 10 15 321 1 0121 1 0122 1 0123 1 0124 1 0124 26786 47832 71178953282040013 52281137 Million Qiu Zhe D WHAT IS AN ESTIMATE OF BARRETT S PRICE PER SHARE MV of common stock 2 MV of firm MV offirm s debt and preferred stock 2 2281137 60 1681137 million Price per Share 2 M V of common stock Number of Shares outstanding 1681137 10 1681 Qiu Zhe BU8201 TUTORIAL 7 COST OF CAPITAL NICOLE LOW NI OI LEE YING YING SIM KAE WANQ WONG PUI YEE ONG KIM SIANG Q112 Assume that the riskfree rate increases but the market risk premium remains constant What impact would this have on the cost of debt What impact would it have on the cost of equity Q112 rdrRFPMRPDRPLP rRF T rdT gt cost of debt increases rs I RF RPIVI constant rRF T rST gt cost of equity increases Nicole Low Ni Qi P113 Cost of common equity Percy Motors has a target capital structure of 40 percent debt and 60 percent common equity with no preferred stock The yield to maturity on the company s outstanding bonds is 9 percent and its tax rate is 40 percent Percy s CFO estimates that the company s WACC is 996 percent What is Percy s cost of common equity Nicole Low Ni Qi P113 WACC wdrd1T wprlo wcrS No preferred stock WACC wdrd1T wcrS Given information Wd 04 Wc 06 YTM on outstanding longterm debt rCl 9 T 04 WACC 996 Nicole Low Ni Qi P113 04 9 1 O4 06 rs 996 I 13 o Nicole Low Ni Qi P116 Cost of common equity The future earnings dividends and common stock price of Carpetto Technologies Inc are expected to grow at 7 percent per year Carpetto s common stock sells for 23 per share its last dividend was 200 and it will pay a dividend of 214 at the end of the current year a Using the DCF approach what is its cost of common equity b lithe firm s beta is 16 the riskfree rate is 9 percent and the average return on the market is 13 percent what will be the firm s cost of common equity using the CAPM approach c If the firm s bonds earn a return of 12 percent based on the bond yieldplusrisk premium approach what will be rs Use the midpoint of the risk premium range discussed in Section 1115 in your calculations d Assuming you have equal confidence in the inputs used for the three approaches what is your estimate of Carpetto s cost of common equ y P1 16A Using the DCF approach what is its cost of common equity r Q S P0 g rs 23 rs P1 163 If the firm s beta is 16 the riskfree rate is 9 percent and the average return on the market is 13 percent what will be the firm s cost of common equity using the CAPM approach rs rRFrM rRFb rs 913 916 VS 2 P1 166 If the firm s bonds earn a return of 12 percent based on the bondyieldplusrisk premium approach what will be rs Use the midpoint of the risk premium range discussed in Section 1115 in your calculations VSZVd l RP 7512416 P1 16D Assuming yeu have equal eenfidenee in the inute u ered fer the three eppreeehee what is your estimate at Cerpetteie Best of eemmen equity retailiregb lire r 1e30ee15ee Heme 3 1549n1 lil P1111 WACC and percentage of debt financing Hook lndustries capital structure consists solely of debt and common equity It can issue debt at r0 11 and its common stock currently pays a 2 dividend per share D0 2 The stock s price is currently at 2475 its dividend is expected to grow at a constant rate of 7 its tax rate is 35 and its WACC is 1395 What percentage of the company s capital structure consists of debt P1111 WACC wdr JI 1T wprp wcrS Given D0 g 7 P0 2475 reI 11 T 35 WACC 1395 P1111 IDCIF methd II 2 1T f j Ems Hi Tgfn II 114 milFE i 151m d pfn II 1 Tpfn P1111 Since the company structure only consists of debt and common equity w0 wc 1 and wIo 0 Hence for this company WACC w0 r0 1T wIo rIo wc rS P1111 Substitute the values into the formula 01395 wd0111035 1 wd 0156465 01395 0084965 wGI 0156465 0084965 wGI 0016965 weI 019967 20 Therefore the company s capital structure consists of 20 debt P1117 Sidman Products39 common stock currently sells for 60 a share The firm is expected to earn 540 per share this year and to pay a yearend dividend of 360 and it finances only with common equity Wong Pui Yee P1 1 1 7a If investors require a 9 percent return what is the expected growth rate DCF Method rs D1Po 9 009 360 60 g g 003 g3 o The expected growth rate will be 3 Wong Pui Yee P1 1 1 7b If Sidman reinvests retained earnings in projects whose average return is equal to the stock39s expected rate of return what will be next year39s EPS Hint g 1 Payout RatioROE Expected Growth Rate 9 1 Payout Ratio ROE Payout Ratio Dividend per share Earnings per share ROE Net Income Total Common Equity 9 1 360540 540 60 003 Next year39s EPS This year39s EPS 1 9 540 1 003 5562 Next year39s EPS will be 5562 Wong Pui Yee P1119 g and g Ziege Systems is considering the following independent projects for the coming year Project Required Rate of Risk Investment Return A 4 mil 140 High B 5mil 115 High C 3mil 95 Low D 2mil 90 Average E 6mil 125 High F 5mil 125 Average G 6mil 70 Low H 3mil 11 5 Low Ong Kim Siang P1119 g and g Ziege s WACC is 10 but it adjusts for risk by adding 2 to the WACC for highrisk projects and subtracting 2 for low risk projects Ziege39s adjusting cast nf capital fur risk 1M 7 W 3E 12 i far l E IIConclusion Ziege should accept 3 E project ACEFH it without capital 5 constraints H m a 5 39 FtiskL Hi kavg HiskH Ftish Ong Kim Siang P1119 g and g If Ziege can only invest a total of 13 million which projects should it accept and what would be the dollar size of its capital budgetbe Fiank Project Fiequired Adjusted Expected Expected rate investment WA 00 return of profit 1 H 3 mil 8 115 35 2 F 5 mil 10 125 25 3 A 4 mil 12 14 2 4 C quot fquot 2 15 Conclusmn AFH gives the largest 5 E 05 expected profit and the total Expected ra investment required is 12million capital budget which is within the budget of 13 million Ong Kim Siang THANK WM ow2mmm nzgtznm Amcmwo 3813 H0 ZgtIgtmltgt ltnm mmm b 02m Agt IC gtltZ ltCZgtmUlt gtlt ltltgt ngtCugt gtC2Zgt P155 Financial Leverage Effects Pacific Dana and IVIAAKL are identical except for their leverage ratios and interest rates they pay on debt Each has 20 million in invested capital has 4 million of EBIT and is in the 40 percent corporate tax bracket Pacific Dana however has a debttocapital ratio of 50 and pays 12 percent interest on its debt whereas IVIAAKL has 30 percent debttocapital ratio and pays only 10 percent on its debt Neither firm uses preferred stock in its capital structure Nathasya Michell Information Extracted MAA L Assets 20000000 20000000 EBIT 4000000 4000000 Tax 40 40 Debt 10000000 6000000 Interest 1200000 600000 Total Equity 10000000 14000000 Nathasya Michell 3 Calculate the return on invested capital ROIC for each firm Nathasya Michell ROIC measures the aftertax return that the company provides for all its investors Pacific Dana and MAAKL 1 1 EJiT 1 39ili RIIIEZ a g a go Intreetr 5111113115 cpl 4 it m4 an f 112 f 12 Nathasya Michell b Calculate the rate of return on equity ROE for each firm Nathasya Michell Niel 11 me 1 11 Tamil Eq witty Hence in order to find ROE we must first find the Net income EBIT nterest EBT Taxes Net Income 4000000 1200000 2800000 1 120000 1680000 4000000 600000 3400000 1360000 2040000 Nathasya Michell LL u Wet mama E W m Tuts ill Equity Pacific Elana iE 1annnnna r 1 nn l a f LE 1 r r 1 r r n 1 x r v7 a 3451 i i 1 14 i i 1 146 Nathasya Michell c Observing that Pacific Dana has a higher ROE MAAKL s treasurer is thinking of raising the debttocapital ratio from 30 to 60 percent even though that would increase MAAKL s interest rate on all debt to 15 percent Calculate the new ROE for MAAKL Nathasya Michell After changes Debt 2000000006 12000000 Interest 12000000015 1800000 Total Equity 20000000 12000000 8000000 The new Net Income is MAAKL EBIT 4000000 nte rest 1800000 EBT 2200000 Taxes 880000 Net Income 1320000 Nathasya Michell 1 Nail Incnme New R E m L a T t Eqmtty 1321 i i LE5 1a5w Nathasya Michell P156 Breakeven Analysis The Weaver Watch Company sells watches for 25 the fixed costs are 140000 and the variable costs are 15 per watch Jessica a What is the firm s gain or loss at sales of 8000 watches At 18000 watches Jessica P 25 Fixed Cost 140000 Variable Cost 15watch When Q 8000 Total Revenue P x Q 25 x 8000 200000 Total Cost Fixed Cost Variable Cost x Quantity 140000 15 x 8000 260000 Profit TR TC 200000 260000 60000 The firm s loss at sales of 8000 watches is 60000 Jessica Price 25 Fixed Cost 140000 Variable Cost 15watch When Quantity 18000 Total Revenue Price x Quantity 25 x 18000 450000 Total Cost Fixed Cost Variable Cost x Quantity 140000 15 x 18000 410000 Profit Total Revenue Total Cost 450000 410000 40000 The firm s gain at sales of 18000 watches is 40000 Jessica b What is the breakeven point Illustrate by means of a Chart Jessica Breakeven point is the point where total revenue is equal to total cost Taking Breakeven Point to be QBE Breakeven TR TC P x QBE FC VC x QBE ZSQBE 140000 15QBE 10QBE 140000 QBE 14000 Breakeven Point QBE 14000 TR and TC 25 x 14000 350000 Jessica Dollar S 390 H000 9 booo 0900 Rumor mac flde Ontmoo Sales Jessica d What would happen to the breakeven point if the selling price were raised to 3 1 but variable costs rose to 23 a unit Jessica Price 31 Fixed Cost 140000 Variable Cost 23watch TR TC 310BE 140000 230BE 8 140000 QBE 17500 The breakeven point will increase Jessica P1513 Recapitalization Currently Mega Flowers Inc has a capital structure consisting of 20 percent debt and 80 percent equity IVIega s debt currently has an 8 percent yield to maturity The risk free rate rRF is 5 percent and the market risk premium rIVI rRF is 6 percent Using the CAPIVI Mega estimates that its cost of equity is currently 125 percent The company has a 40 percent tax rate Ong Kar Hui a What is Mega s current WACC Given rd 85 rS 125 T40 DebtD 20 EquityE 80 WACC DC x rd 1T EC x rs 20100 x 0081O4 SO100 x 0125 01096 1096 Ong Kar Hui b What is the current beta 0n Mega s common stock Given rlvl rRF 6 rRF 5 rS 125 rs rRF quot39 rM rRF bL 0125 005 0061 bL 125 Ong Kar Hui C What would Mega s beta be if the company had no debt in its capital structure That is what is Mega s unlevered beta bU IoL IoU 1 1T gtlt DE 125bU 1 104 gtlt 2080 125 115 IoU IoU 1087 Ong Kar Hui lVIega s financial staff is considering changing its capital structure to 40 percent debt and 60 percent equity If the company went ahead with the proposed change the yield to maturity on the company s bonds would rise to 95 percent The proposed change will have no effect on the company s tax rate Alvin Yundary Tay DA 40 EA 60 r0 95 T 40 bu 1087 unlevered beta rRF 5 riskfree rate rIVI rRF 6 Market risk premium Alvin Yundary Tay d What would be the company s new cost of equity if it adopted the proposed Change in capital structure Alvin Yundary Tay rS Using Hamada Equation bL bU1 1 T x DE bL 10871 1 04 x 04 06 bL 15218 By CAPIVI rs rRF quot39 rIVl rRF bL rS rRF erl rRF x bL rs 005 006 x 15218 rs 0141308 1413 The company s new cost of equity 1413 Alvin Yundary Tay e What would be the company s new WACC if it adopted the proposed change in capital structure Alvin Yundary Tay WACC WACC DA x rdx 1 T EA x rS WACC 04 X 0095 X 1 04 06 X 01413 WACC 010758 1076 The company s new WACC 1076 Alvin Yundary Tay f Based on your answer to part e would you advise Mega to adopt the proposed Change in capital structure Explain Alvin Yundary Tay Yes we would advise Mega to adopt the proposed change in capital structure The old WACC from 3a 1096 The new WACC from 3e 1076 from 3e Old WACC gt New WACC A Low WACC is better because it gives lower cost which can optimize the capital structure Alvin Yundary Tay P1516 WACC and Optimal Capital Structure Eden Athletics is trying to determine its optimal capital structure which now consists of only debt and common equity The firm does not currently use preferred stock in its capital structure and it does not plan to do so in the future ts treasury staff has consulted with Investment bankers and on the basis of those discussions has created the following table showing its debt cost at different levels Wita Claudia Aurina Debt to Equity to Debt to Before Capital Capital Equity Tax Cost Ratio wd Ratio we Ratio of Debt DE rd 00 10 000 A 70 02 08 025 BBB 80 04 06 067 BB 100 06 04 150 C 120 08 02 400 D 150 Wita Claudia Aurina Confdu Eden uses the CAPM to estimate its cost of common equity rs The company estimates that the riskfree rate is 5 percent the market risk premium is 6 percent and its tax rate is 40 percent Eden estimates that if it had no debt its quotunleveredquot beta bU would be 12 Wita Claudia Aurina a What is the firm s optimal capital structure and what would be its WACC at the optimal capital structure Wita Claudia Aurina Given T 40 rRF 5 b 12 rMrRF 60 Using the Hamada equation bL bU1 1 TDE Using the CAPIVI rs rRF quot39 rM rRFbL WACC wd rd1 T WC rs Wita Claudia Aurina Calculations 1W 000 100 000 700 420 120 1220 1220 020 080 025 800 480 138 1328 1158 040 060 067 1000 600 168 1508 1145 060 040 150 1200 720 228 1868 1179 080 020 400 1500 900 408 2948 1310 Wita Claudia Aurina The firm s optimal capital structure can be determined by minimizing WACC As shown in the table WACC is minimised at a capital structure consisting of 40 debt and 60 eguity WACC value at this capital structure is 1145 Wita Claudia Aurina b If Eden s managers anticipate that the company s business risk will increase in the future what effect would this increase likely have on its target capital structure Wita Claudia Aurina Business Risk The riskiness of the firm s operations even if it uses no debt When business risk increases the probability of financial distress will be higher at any debt level An increase in business risk will decrease financial risk The target capital structure will have less debt Wita Claudia Aurina 1 Plot a graph of the aftertax cost of debt the cost of equity and the WACC versus 1 the debt capital ratio and 2 the debt equity ratio Wita Claudia Aurina 3500 13000 2500 2000 1500 1000 500 000 Graph of AfterTax Cost of Debt Cost of Equity and WACC Againts DebtCapital Ratio 1868 AfterTax Cost of Debt rd 1 1T IC39ost of Equity rs 1220 I 1310 r WACC 1153 11 45 1179 900 gm 720 420 480 0 02 04 00 03 DebtCapita Ratio Wa Wita Claudia Aurina Graph of AfterTax Cost of Debt Cost of Equity and WACC Against Debt Equity Ratio 3500 3000 2500 2000 O AfterTax Cost Of Debt 1500 Cost of Equity rs a f 1000 4 WACC 500 000 000 100 200 300 400 500 DebtEquity Ratio DE Wita Claudia Aurina v s 4 V v t 39 I l r a y m e p o l r I o 39 r 7 0 39 p a c a 1 01 1 Presented by Jin Wei a1 11 dends and Share Repurchase Marcus Sia Wenhui Tan TeCk Long Chen Qinghao William o I p l o I 4 o 0 P n u n r J v 0 II p 1 new 0 I o o attufa C a 9 avv r o z vaProJ l q 9 zfnp v t 3 v 0 Pantai Medical s stock trades at 90 a ua t wl owfwh iii In 1 HoraUrn 39b 334 tto39uu 00 351 390 D o39 uOo share The company is contemplating a 3 for2 stock spli Assuming that the stock a m w m t m a e S m b e h e I I h H g t W m n W O mu m h I d W m e VHm H r n w e O t w m s h s z m d W rm 3 W 9 09 H U m H nla O 0 w v c s a Jhoit rO vv 10 0o 60 1 n ool r v 1 z 0 5 3 ev lta p t a If fnJr39vv39u pr fr 0 3 2 split means that owner gets 3 new shares for every 2 old shares shares that used to exist Equot 395 a 0 Wealth after split Wealth before split 1 3 x stook price after split 2 x 90 39 0 Stock price after stock split Ifit39jviiff 2 X 3quot 55 531551 3 Z 5quot 15 5 39739 r 60 The stock is priced lower and is more affordable again P16 4 Stock Split 0 After a 5for1 stock split Iskandar Company paid a dividend of 075 per new share The presplit equivalent of this 075 DPS represents a 9 increase e over last year s presplit dividend What 5 Y was last year s dividend per share 39 0 Assume 394 no of shares before stock split a no of shares after stock split 5a A pre split dividend per share last year b E v 0 Presplit dividend current year 395 109 preSplit dividend last year 0 075 x 5a Pre split dividend current year 1090o X a 9A V O O 39 I n y 37rAJk 5 39 l 39 O C 11 r O I o 074A P16 7 Dividends 0 Berjaya Sporting Company is prepared to Income following 2012 statement shown in thousands of dollars the report 5 5 a rQVIr laroovlaor rfh ouv 39 v I nlm39 v iono39 Y r w Pw vor xv of o39 cap 0 ono Danton o i 0 Va9o o 9 In 1 7 39a v 0 v n v0 f 1 v u a a I l 391 fv 0 15200 11900 S b a S Operating costs including depreciation EBIT 3300 300 3000 1200 1800 Interest EBT a o I a u 39 O I A U l I t r no 739 I r 9 a u Taxes 40 Net Income 0 Prior to reporting this income statement Its The company has the company wants to determine 39dend V d annual 500000 shares of stock outstanding and its stock trades at 48 per share a The company had a 40 dividend payout ratio in 2011 If Berjaya wants to maintain this payout ratio in 2012 what will be its pershare dividend in 2012 Dividend Net Income 0 Dividend payout ratio 0 Dividend payout ratio 40 0 Net income 1800000 I w o r 339 a T 39I l r 1 39 I 14 39 3 39 1quot r v an r 4 39Ir39 3 ca 0 O 30 3 0 Number of shares 500000 Jet gt i v quot t u39 a G U I r z 1 i quot 391 quot Wt A I39 r t 39 v y gov a 7 I an O39lv no f J I J 399 o a In o o y a 391 I r a n 39 v c 7 rs o 4 c I 0 r Y o a r I a u I 39 o I o v r o F 1 I p a 9 pr Ruhr lkl gthr Hhut rw w 4 P 14 4 Wu 4 Vr n v I mg dend M D No of shares outstand 720000 500000 144 40 1800000 720000 39dend V 4 o to 7 A 39 394 I lt o of IV A 7 39 Q 0 Dividend 2012 40 x Net Income 2012 0 Pershare d Ircox 391 v Iva Uni 4 IA 0 a w A 39 F V It av I r v u o n I 039 v o f v I 1 or o gt 7 v o o o I 391 o b If the company maintains this 40 payout ratio what will be the current dividend yield on the company s stock Dividend per share 0 0 DIVIdend yield Current Stock price X 100 0 144 4800 X 1 0000 1 4 I 744W v 39r l i 390 U u p 39o39aiv vr0aquot J V 0 X o o w L 439 f r 039 voo r39quotru r 100 o 39I o39 O l39 v Ir l ovo IP I a o w OH39 1 u up I n or 2 0 r n a mo v7 r s o J T 4 r r a 1 39 u l Ia gr ro vprtf v I carp 1 17 f 9 V1939 99 v rfoPOoJ has What was the number of shares outstanding company s pershare dividend in 2011 C remaIne d constant Ividend Net Income D 60000 39dend NI 0 Number of shares 500000 0 Dividend payout ratio 40 0 Net income 1500000 0 Dividend payout ratio 0 D gov a 7 I an quotlv 0 no f J I J 399 o a In o o y a 391 I r a n 39 v c 7 rs o 4 c I 0 r Y o a r I a u I 39 o I o v r o F 1 I p a 9 pr Ruhr lkl 50hr Hhut rw w 4 P 14 4 Wu 4 Vr v I mg dend M D No of shares outstand 600000 500000 120 40 1500000 600000 39dend V 4 0 up 39 394 I I O 9 IV p 7 v Q 0 Dividend 2011 40 x Net Income 2011 0 Pershare 0 Ircox lw lq 391 v Iva Uni n 0 u w A I r 1 4v I r u u o n I a v o T v I 1 or o gt f v o o o I v As an alternative to maintaining the same dividend payout ratio Berjaya is considering maintaining the same per share dividend in 2012 that it paid in 2011 If it chooses this policy what will be the company s dividend payout ratio in 2012 1 quot45 0 Pershare dividend 2011 120 0 Maintaining the same pershare dividend in 2012 Dividends Pershare dividend x No of shares outstanding 120 x 500000 600000 Dividend 0 DIVIdend payout ratio N et Income 600000 55 1800000 33 3333 Therefore maintaining the same pershare dividend does not maintain the same dividend payout ratio e Assume that the company is interested in dramatically expanding its operations and that this expansion will require significant amounts of capital The f company would like to avoid transactions costs involved in issuing g new equity Given this scenario would it make more sense for the company to maintain a constant dividend payout ratio or to maintain the same pershare dividend Explain Since the company would like to avoid transaction rquot costs involved in issuing new equity it would be best for the firm to maintain the same preshare dividend This will provide a stable dividend to if q j investors yet allow the firm to expand operations without significantly affecting the dividend A constant dividend payout ratio would cause serious fluctuations to dividend depending on the level of earnings If earnings are high then 3939iquotfl dividends would be high However if earnings are i quot t 15759quot5 515 2 low then dIVIdends would be low ThIs would cause great uncertainty for investors regarding I if I dIVIdends and would cause the firm 5 stocks to 2 quot decline because investors prefer a more stable quot quot dividend policy a r f quot1 n v u o 9 My a 4 A 3 39 39 139 0 A47 L J 7 i AA AAi A i AA 7 7 7 i P16 8 Alternative Dividend Policies 0 Royal Selangor Couture is expecting to pay an annual dividend per share of 075 out of annual earnings per share of 225 Currently Royal Selangor s stock is selling for 1250 per share Adhering to the company s target capital structure the firm has 10million in assets of which 40 is funded by debt Assume that the firm s book value of equity equals its market value In past years the firm has earned a return on equity ROE of 18 which is expected to continue this year and into the foreseeable future 0 Book Value of Equity Market Value 0 ROE 18 0 Assets Debt 40 0 Total assets 10mi lOn 0 Stock Price 1250 0 EP8 225 439 f f 39r I I v 0 DPS 075 Information Extracted a Based on that information what longrun growth rate can the firm be expected to maintain Hint g Retention rate x ROE Net Income No of shares Dividend Paid No of shares Dividend Paid No of shares Net Income No of shares DPS 39EPS 075 39 225 033 0 DPS EPS Dividend Net Income o 7 n a f u I I r n 7 DD a I r o 39 I7 I r O 0 r 7 7 on p a I O aquot o7 39 a I at 7 o I I 7 F 3 u v C o39 0 Y Qa39u 7 gt T r r 7 c r 9 r y o r 0 7 a p o a 7 I v 0 I7 l O a o n n r p a 39 p I 397 1 p a r7 r 2 I l l7 7 7 r 7 4A p 1 r 7 o fp r V 1 O 7 I I I I t r I If a 9 4 out 4 0 39 POO a o p a 7 I 7 n F r 7 D I I o39 YAvt y a39v 7 c a 392 392 9 3 n C vln 7 0 1a 9 f r v a o a r I n 7 a 739 7 u39 0 39o 7 I 3 39 Net Income Net Income Dividend 0 Retention rate Ividend Net Income D 1 0667 Retention Rate x ROE 0667 x 18 0 2 0 0w rl r 9 IIquot v v ol 390 o v r o o 0 I o 0 Al u a v pr r39 a 1 39039 7 o 40 I v I v I I I 39 v 391 39 I r a 1 Out t i blPL iiuiUil yttrir whit intPip Irlr f 1 it 7 7 5 0 7 Jr a 7 7 l O o I v a n I A 4 7 4 o 7 r 7 to f o39 C 7 7 y o C 0 7 u o f o 7 a t Model dend Discoun T39s Ni 0 D next year s dividend 0 g growth rate of dividend assumed to be constant 0 P0 current stock price D 1J4 liai tn ado dial cltalllha nlffr t r u o 9 05 1 I p 39 I 3909 If 7 u l v o 1 a 139 o I 7 0 no I39t a u O g c o 39u I o o39oo 39 0 c o n 9 p r39 9101 p c u 0 o o 0 OM n 1 0 w a v I p f y a 039 lwr p I I o 39939 t ol 3 o o I r 1 lr39r 1 s I v I v a o u I w o o t 1 E e It I oo al o g I 1 I o 1 a car A I 39 M yo 3 i g 0 I 39139 139 y i op 397 5 I 1 v V T E 4 1 I I 9 I L o o H o 1 39 l 1 I I a DUI 1 397 39 p g I 39 v I A e v I r 9 I p c 139 r J r C r v r v r R 7 n r v n a 39 o I I39 A 7 n r p v I f quot a f p a39 c zaaA r C Io c 1 t A 0D p39A a F l 39 t 397 What is the stock s required return 3quot c If the firm increased their annual dividend to 3 150 per share analysts predict there will 7 no change in the firm s stock price or ROE Find the firm s new expected longrun growth rate and required return New expected longrun growth rate L f1 r r L V39 v 393 r r r aimdend pea ShEITE 0 Dividend p y ut r tm r F 39 Earningg per Sh TE39 a 39u 39 39 hi 39 39711quot I f i 54 l 31135 1quot 395 f f 55 fl fjggig39 0 g Retenti n rate 1 RISE 153253 r 3 ggg j i 1 w end pay ux r tm X REE jg lt 1 0666 X 16 6 i h a a o 5 7 up 9 P39r 39 I v 9 u w p u o Io a 7 0 l 7 o o I D co 7 39 u 3 oo f o r39 op 397 0 1 o l v u D 397 I 1 a I at 3990 o o 7 1 1 v7 I 39 7 o v I j I 01 V 7 t I a a v r R 39 r r n v n a y I39 7 u n 7 a I n 7 I p v I 7 t 13 nf p a39 c In A a f O Io c7 39 a 390 Plv A 0D p39A at F 39 I 9 f 3 o s 7 g o r 9 f s O a 7 o to 9 p o o 0 v r I New required return 0 1 P 0 TS 150 0 06 1250 39 012 006 018 gr 18 0 Suppose the firm sticks to their original plan of issuing annual dividend of 075 per share 0 But the firm decides to issue stock dividend instead of cash dividend j 0 Implies that given a share price of 1250 shareholders g will receive 1 share of stock for every 1250 in dividend due 39 3953955e39fif 0 How many new shares of stock will be issued quot How much will the company s earnings per share ice dldted kquot rquot v 39 g m 7 39 39 w o zywv gvt s 0 How many new shares of stock will be issued 39 I39 0 Find the initial shares outstanding 0 Tiami Equity Tami ISSEIJS X Equity r tm 10m X 16 6m it i 0 Net tumma Tami Equity X REE 4 i z 3 6111 x 013 13903 I 6395quot NEE tummi x EPS Sharing utgtm tding 1 03m Sh TES ut t di g Shareg utgt nding iii 0 Tami iii Fl d d 360000 035 X 30000 DPS 2x Sham93 umt nd 0 N f divid ndgh rm ESSHE d 1250 23300 Sh 360000 IFE FTI HE mg Tum divid nd 4 N I 4 Jmlluluu ltj xlilj nw4i1tl1 n a a 4 m l xv vu I V V r o 39 o o v 1 u I p o u r 39 p 7 a I 3907 O 39 lt397 O I o 37 o re 7 Q T O r o r 7 1 DD i o r v r I I ll 0 I r r A o p a I O 17 7 O a 7 o QYV I 7 F0 3 u C n c39 4rv 739 I a 397 c to o r o r o 7 D o o a 7 l I7 l o 1 f I p 397 1 c a a 7 r x 397 I o o 7 7 I 7 A I r 7 v r f V 1 o O I I I t r I f 9 A cut 0 v Q POI ap 7 o p a 7 4 7 3 r r o A 0 9 A 39v 7 I a 2 T 9 n It 7 v 1 o r r v a O p u 39 r of n 7 r a 7 v 0 o 7 39 v v a 9 v ngs per share be dluted S earn 0 How much will the company I u u Libr lluuiflrwhhltx 0 New EPS NEE in ame 02721132122232 81222222218289 New Sh TES 23212322 1080000 480000 28800 21226 I I 5 9 39 o n O in A o r 39 r r 9 o a rd 0 0 391 f 39 I o lo y A 39 r u 7 9 1 1r 0 081222022 22f EPS 2 Rd EPS NEW EPS Iu rl I gt r Fl n intol l1 wquoto II39quot M c r vs o a v y 39739 7 0 p vof ll39l q C 39 I39 o 0 C39 n 79 5 arr C o 9 r r 399 347 f 2 a A t0 b o I usurp 225 21226 2 013 22222 Share n m t n e t t a r U 0 V r O f U 0 V k n a In I Tutorial 8 Basics of Capital Budgeting Unequal Lives Project Marianne Wethe Koch Solveig Wanvik Skogan LiIn Ming Chong Vartika Sarna Lene Erdal P12 14 Choosing mandatory projects on the basis of least cost Presented by Marianne Wethe Koch P12 14 Kim Inc must install a new air conditioning unit in its main plant Kim absolutely must install one or the other otherwise the highly profitable plant would have to shut down Two units are available HCC and LCC for high and low costs respectively HCC has a high capital cost but relatively low operating costs while LCC has a low capital cost but higher operating costs because it uses more electricity The units costs are shown below Kim s WACC is 7 percent P12 14 Expected Net Cash Flows YEAR HCC LCC O 1 2 600000 100000 50000 175000 50000 175000 50000 175000 50000 175000 50000 175000 P12 14a Which unit would you recommend Explain NPV i CE r0 17 t CF1 CF2 CFN 1 2 N 1r 1r 1r 0 Net PresentValue NPV is the sum of the discounted cash flows Where the discount rate is r CF0 0 The greater the NPV is the more value the project adds 0 CFt is the expected net cash flow at time t P12 14a HCC 0 1 2 3 4 5 i l i l i l gt 600000 50000 50000 50000 50000 50000 NPVHCC 600000 50000 50000 50000 50000 50000 1 0071 1 0072 1 0073 1 0074 1 0075 80500980 P12 14a LCC I I I I gt 0 1 2 3 4 5 I I I I I I 475000 475000 475000 475000 I I 400000 475000 175000 175000 175000 175000 175000 10071 10072 10073 10074 10075 81753455 NPVLCC 100000 9 Since NPVHCCgtNPVLCC Kim Inc should Choose HCC to minimise their losses K P12 14b If Kim s controller wanted to know the IRRs of the two projects what would you tell him 0 To calculate the Internal Rate of Return IRR you need to solve the equation NPVZO with respect to r N CE i0 1IRRt 0 IRR is the discount rate when NPVZO 0 In our case there is no IRR because all the cash flows are negative 9 No IRR can force the PV of the inflows to equal the cost when there are no inflows NPV P12 14C If the WACC rose to 15percent would this affect your recommendation Explain your answer and reasons Why this result occurred NPVHCC 6009000 500001 500002 500003 500004 500005 1015 1015 1015 1015 1015 76760775 1 NPVLCC 100000 175000 175000 175000 175000 75000 1015 1015 1015 1015 1015 686627 14 P12 14C 0 Since NPVLCCgtNPVHCC Kim Inc should choose LCC to minimise their losses Why this result occurred 0 The WACC does not affect the first cash flow when tZO and the first cash flow of LCC is lower than of HCC 0 With an increasing WACC the cash outflows are discounted at a higher rate 9Since LCC has greater cash outflows then HCC the cost of LCC decreases more then the cost for HCC LCC is therefore recommended P12 17 Capital budgeting criteria Presented by Solveig Wanvik Skogan P12 17 A company has 12percentWACC and is considering an investment that cannot be repeated with the following net cash ow Expected Net Cash Flows 0 300 1 387 193 100 600 600 850 ImU lPUJN 180 P12 17 Filming lle W fur pm erc it W 11 I I 3 11 5 E T i i i i I I I I I I I 39 l PrndE I t 3IIIIII 3 E1II 191II 139IIIIII 1 l i m i 5 39 39 l t 34554 15135 11s 314 iii l an T51 4 II 34129 Present Ii fzalue If masts 951111 Terminal Value W 2541 C tu a r N 3 4352 II W PRESS III grail 151 EEEEII Ri e f E I ill E 39m39EllzJ3g i ML 115 1511193 Excel W func iuan W C5 1 lil lr39 K P12 17 N Z CIE 1 r N CUE i0 Emmi 1MIRRN TV 1MIRRN 1 MIRR TV N 1 PV costs PV costs 2 P1217 0 By substituting the values 3 2 1 MIRR 600gtlt1012 600gtlt1O12 850gtlt1O12 7 1 387 193 100 180 00 2 3 7 1012 1012 1012 1012 1 MIRR 25475968 7 1 9519950162 MIRR 015098817 z 1510 0 The MIRR of ProjectA was found to be 15 10 NPV and IRR Presented by Lim Ming Chong P12 18 A store has 5 years remaining on its lease in a mall Rent is 2000 per month 60 payments remain and the next payment is due in 1 month The mall s owner plans to sell the property in a year and wants rent at that time to be high so the property will appear more valuable Therefore the store has been offered a great deal owner s words on a new 5 year lease The new lease calls for no rent for 9 months then payments of 2600 per month for the next 51 months The lease cannot be broken and the store s WACC is 12percent or 1 percent per month P12 18a Should the new lease be accepted 0 New lease should be accepted if NPV for new lease is greater than NPV for old lease P12 18a Old Lease O 1 2 9 10 59 60 I I I I I I I gt I I I I I I I 0 2000 2000 2000 2000 2000 2000 New Lease O 1 2 9 10 59 60 I I I I I I I gt I I I I I I I O O O 0 2600 2600 2600 N NPVZlt1 mt t0 I I CFZ I 0 39 1r1 39 1r2 39 CFN 1 rN P1218a For old lease 0 CF1 to CF6O 2000 0 r I 001 Therefore 2000 2000 NPVOld O 1 0011 1 0012 2 8991008 2000 10016O P12 18a For new lease 0 CF1 to CF9 Z O CF10 to CF6O I 2600 0 r I 001 Therefore 0 O 2600 2600 NPVW 20 1 9 10 60 1001 1001 1001 1001 2 9461145 9 Since NPVO1 d is greater than NPVnew the neW lease should not be accepted P12 18b If the storeowner decided to bargain with the mall s owner over the new lease payment what new lease payment would make the storeowner indifferent between the new and the old leases 0 The storeowner will be indifferent when PV of old lease equals PV of new lease P 12 18 b PVOZd PVnew 60 PMT PMT PMT pMT 8991008 2 2 1 001t 1 00110 1 00111 1 001 1 PMT PMT PMT gt Z 1 0019 1 0011 1 0012 100151 1 51 PMT 9 Z 1 1 001 i1 1 001 89910O91019 9833334 i PMT 21 1 001 P12 18b i PMT PMT 1 1 21 1001t 001 100151 9833334 M1 1 001 1 00151 9833334 N IYR PV PMT FV Output 24 7080 9 Therefore the payment of the new lease should be 247080 P12 18C The storeowner is not sure of the 12percentWACC it could be higher or lower At what nominal WACC would the storeowner be indifferent between the two leases P12 18C 0 Calculate the difference between the 2 payment streams new i0 1I t i0 1I t i PMTOM i PMT i PMTOM PMTW 0 i0 1 rY P12 18C 0 Find its Internal Rate of Return IRR i PMTold PMTW 0 i0 1 rY 39 Comparing with i 02 o i0 1IRRt P1218C Periodm t O O O O 1 1 9 2000 O 2000 9 10 60 2000 2600 600 51 Using the Financial Calculator IRR 191 0 WACC Z IRR X 12 I 2294 9Therefore the nominal WACC should be 22 94 Capital budgeting criteria Presented by Vartika Sarna P12 23 Your division is considering two projects Its WACC is lOpercent and the project s after tax cash flows in millions of dollars would be 0 30 30 1 5 20 2 10 10 3 15 8 4 20 6 P12 23a Calculate the project s NPVS IRRS MIRRS regular paybacks and discounted paybacks P12 23a ProjectA O 1 2 3 4 i i l l i gt 30m 5111 10m 15m 20111 To nd NPVA N F NPVA C t t r0 1 7 5 10 15 20 1 2 3 4 1O10 1O10 1O10 1O10 7739908476 z 774milli0n P12 23a To find IRRA NPV i CE t 0 20 1IRRA 0 30000000 1 1 5000000 1 2 10000000 1 3 15000000 1 4 20000000 1 Using the Financial Calculator 0 IRRA19193955713 z 1919 i0 P12 23a To nd MIRRA N N CIF 1 4 DE t 1 1rt 1MIRRAN 3 5gtlt1O103 10gtlt10102 15gtlt1O1020 1 MIRRA4 MIRRA 1649642072 z 1650 P12 23a Cumulative 3 O ProjectA Cumulative 30 10 0 8 14 Project B Discounted 3O 454454 8264 4 63 11269722 13660269 Cash FlowA Discounted 3O 18181818 82644 63 6010518 409808O Cash Flow B Cumulative 3O 254 54 5 17 19008 592036 773991 Discounted ProjectA Cumulative 3O 1181818 3553719 24567679 655488 Discounted Project B P12 23a Hence we nd the regular and discounted paybacks of project A Number of ears y Unrecovered cost at start of year Payback prior to full recovery Cash ow during full recovery year O Payback A regular 2 3 2 0 3 years Payback A discounted 3 34334years z 3years and Smonths P12 23a 0 Answers for Project B 0 NPVB 6 5 Smillion 0 IRRBZZZ 16 MIRRB156 0 PaybackB regular2years 0 PaybackB discounted 2 5 9yearsz2years and 7months P12 23b If the two projects are independent which projects should be chosen AS the NPV gt O for both projects they should both be accepted P 12230 If the two projects are mutually exclusive and the WACC is lOpercent which projects should be chosen AS the NPV gives a direct measure of value added and we can see that the NPVA is greater than NPVB project A should be chosen P12 23d Plot NPV pro les for the two projects using WACC of 5 10 15 20 We and using the IRR of the 2 projects Identify the projects IRRs on the graph NPV m 5 Z IRRA 192 5 1 0 1 5 Cost of capital 20 2250 NPVA WACC 5 10 15 20 NPV B NPVA 13243813 7739908 3207071 05632716 NPVB 9964829 6554880 3643390 11342592 P12 23h Now look at the regular and discounted paybacks Which project looks better When udged by the paybacks P12 23h Payback 3 years 2 years Discounted 343 years 259 years Payback 0 Payback is lower for project B 0 Discounted payback is lower for project B 0 Cost recovery time is shorter for project B 0 Project B has lower risk 0 Project B has higher liquidity 0 Project B is better P12 19 Multiple IRRS and MIRR Presented by Lene Erdal P12 19 A mining company is deciding whether to open a strip mine which costs 2 million Cash in ows of 13 million would occur at the end onear 1The land must be returned to its natural state at a cost of 12 million payable at the end of Year 2 P12 19a Plot the project s NPV profile using WACC of O 10 50 80 100 200 300 400 410 420 430 and 450 We P12 19a O 1 2 I I I gt 2m 13m 12m N NPV 2 CE r0 1Vt NPV 2 2 13 12 l 1 2 1WACCl 1WACCl P1219a 0 10 50 80 100 200 300 400 410 420 430 450 1 009917 133333 151852 15 1 05 012 008766 005621 002563 003306 P12 19a NPV pro le P12 19b Should the project be accepted ifWACCZIO Vo If WACC20 Explain your reasoning I WAcc10 IfWACC20 ONPV OO99 million 0 NPVZO5million End of Presentation Thank you BU 8221 TUT9 Done by Astrid Wong Siew Me Question 13 1 Kelly Ann Rodrigues Question 13 2 Choo Meijing Question 13 1921 Eileen Tay Kai Ying Question 13 19C Priscilla Tay Shi Yun Question 13 13 Question 13 1 39 Operating cash ows rather than accounting pro ts are listed in Table 13 1 Why do we focus on cash ows as opposed to net income in capital budgeting Astrid Wong Siew Me Capital Budgeting 39 Capital budgeting is the analysis of potential projects eg investments in tangible xed assets and intangible assets 39 Cash ow represents a company s overall nancial health and indicates What the company can spend and reinvest Net income is the pro t that remains with a company after deducting all the expenses 39 Depreciation and Amortization is factored in under the expenses Astrid Wong Siew Me Capital Budgeting 39 Capital budgeting decisions should be based on cash ows since they re ect the actual cash a company has 39 Only actual cash can be spent and reinvested Thus this makes it relevant for capital budgeting 39 Recall that in the stock valuation chapter we focused on dividends which represent cash ows rather than on earnings per share Astrid Wong Siew Me QN 1313 2 Project Cash ows Eisenhower Communications is trying to estimate the rst year cash flowat Year 1 for a proposed project The nancial staff has collected the following information on the project Sales Revenue 10 million Operating Cost excluding depreciation 7 million Depreciation 2 million Interest Expense 2 million The company has a 40 percent taX rate and its WACC is 10 percent Kelly Ann Rodrigues I l l I a What is the project s Cash flow for the rst year t1 39 Operating Income Before Tax Sales revenue operating cost excluding depreciation depreciation 10 million 7 million 2 million I 1 million Operating Income After TaX I Operating Income Before TaX l T I 1 million 1 04 06 million Operating Cash Flow 2 Operating income After Tax Depreciation 206 million 2 million 26 million Kelly Ann Rodrigues Sales Revenue if Operating Costexcluding depreciation Depreciation Operating Income before Tax c F1 10 million 7 million 2 million 1 million TaX4OOo Operating Income after Tax Depreciation Operating Cash Flow U l l 04 million 06 million 2 million 26 million e l Kelly Ann Rodrigues 39 Therefore the project s cash flow for the rst year is 26 million Kelly Ann Rodrigues I l b If the project would cannialize other projects by 1 million of cash ow before taxes peryear how would this Change your answer to part a 39 De nition of Cannibalization 39 A type of negative externality where a new project reduces cash ows that a rm would have had otherwise Kelly Ann Rodrigues As it is before taxes Operating Cost excluding Depreciation I 7 million 1 million I 8 million Therefore Operating Cost Before Tax 2 10 million 8 million 2 million I 0 million Operating Cost After Tax 2 0 million 1 04 I 0 million Operating Cash Flow 2 0 million 2 million I 2 million Kelly Ann Rodrigues F1 Sales Revenue 10 million Operating Costexcluding 8 million depreciation Depreciation 2 million Operating Income before Tax 0 million TaX4OOo 04 million Operating Income after Tax 0 million Depreciaiton e 2 million Operating Cash Flow 2 million Kelly Ann Rodrigues 39 Due to cannibalization the new project s cash flow would be 2 million compared to the answer in part a which was 26 million Kelly Ann Rodrigues I l l l c Ignore part b If the tax rate dropped to 30 percent how would that change your answer to part a 39 Tax Rate has changed from 40 to 30 Therefore affecting the operating income After Tax 39 Operating Income After Tax I 1 million 1 03 I 07 million 39 Operating Cash Flow I 07 million 2 million I 27 million I l l l Kelly Ann Rodrigues l 1gt Sales Revenue 10 million quot Operating Costexcluding depreciation Depreciation 7 million 2 million Operating Income before Tax 1 million TaX3OOo Operating Income after Tax Depreciaiton Operating Cash Flow U d i i 07 million Zm hon e 27 million 03 million l Kelly Ann Rodrigues When the tax rate dropped to 30 percent The new project s cash ow is 27 million compared to the answer in part a which is 26 million Kelly Ann Rodrigues Question 13 19 a 39 Holmes Manufacturing is considering buying a new machine 39 Costs 250000 39 Decrease pre taX manufacturing costs by 90000 39 3 year MACRS method to depreciate the machine 33 45 15 7 Expected to have a value of 23000 at the end of the 5 year operating life NOWC increase by 25000 initially WACC 1000 Marginal TaX Rate 40 Choo Meijing Annual Depreciation Expense Depreciation Expense calculated using the MACRS I Cost of Asset Basis Percentage Rate Rate 1 2 3 4 033 045 015 007 Basis 250000 250000 250000 Depr 82 500 Observe that 112500 sum of depreciation 37 500 costs I Basis 17500 250000 1 1 Choo Meijing Year 0 Initial Cost Cost of New Machine I 250000 Increase in NOWC I 25000 Thus the total initial cost I 275000 Note that positive initial cost leads to initial cash ow being negative Hence Cash ow in Year 0 is 275000 Choo Meijing Interim Incremental OCF Add Net decrease in pre taX manufacturing costs Subtract Net increase in depreciation charge I Net Change in EBIT Subtract Net increase in taxes I Change in NOPAT Add back Net increase in depreciation charge I Incremental Operating Cash ow for the period l i I Choo Meijing Interim Incremental OCF Year 1 Add Net decrease in pre taX manufacturing costs Subtract Net increase in depreciation charge 2 Net Change in EBIT Subtract Net increase in taxes 40 2 Change in NOPAT Add back Net increase in depreciation charge I Incremental Operating Cash ow for the period 90000 82500 I7500 3000 I4500 82500 I87000 Choo Meijing Interim Incremental OCF Year 2 Add Net decrease in pre taX manufacturing costs Subtract Net increase in depreciation charge 2 Net Change in EBIT Subtract Net increase in taxes 40 2 Change in NOPAT Add back Net increase in depreciation charge I Incremental Operating Cash ow for the period 90000 112500 22500 s9000 I13500 112500 I99OOO Choo Meijing Interim Incremental OCF Year 3 Add Net decrease in pre taX manufacturing costs Subtract Net increase in depreciation charge 2 Net Change in EBIT Subtract Net increase in taxes 40 2 Change in NOPAT Add back Net increase in depreciation charge I Incremental Operating Cash ow for the period 90000 37500 I52500 21000 I31500 37500 I69000 Choo Meijing Interim Incremental OCF Year 4 Add Net decrease in pre taX manufacturing costs Subtract Net increase in depreciation charge 2 Net Change in EBIT Subtract Net increase in taxes 40 2 Change in NOPAT Add back Net increase in depreciation charge I Incremental Operating Cash ow for the period 90000 17500 I72500 29000 I43500 17500 I61000 Choo Meijing Terminal Year Net Cash Flow Add Net decrease in operating revenue Subtract Net change in taX 40 2 Net change in NOPAT I Incremental operating cash ow before project windup considerations Add nal salvage value of new asset Subtract taxes due to sale of asset Add back the NOWC recovered Terminal Year incremental net cash ow Since there is no depreciation charges in this period therefore 90000 36000 54000 54000 23000 9200 25000 92800 Incremental operating cash ow defore project Windu considerations I net change in NOPAT I 54000 I l l l Choo Me 11mg To get the project s NPV PV CF 1 1 An 0 1 2 3 4 275000 87000 99000 69000 61000 92800 275000 87000 11 9900011A2 6900011A3 6100011A4 928001125 7909091 8181818 5184072 4166382 5762150 Project s NPV 275000 7909091 8181818 5184072 4166382 5762150 3703513 Choo Meijing 0 cost of new asset 250000 Increase in NOWC 25000 Initial cost 275000 Decrease in pre taX manufacturing costs 90000 90000 Depreciation charges 112500 0 Net change in EBIT 22500 90000 TaX charges 9000 36000 After taX income 13500 54000 Add back the depr charge 112500 0 Operating Cash flow 99000 54000 Final salvage Value 23000 Tax due to disposal 9200 Increase in NOWC 25000 Terminal cash ow 92800 PV of cash ow 275000 7909091 8181818 5184072 4166382 3352975 NPV 275000 7909091 8181818 5184072 4166382 3352975 83703513 1 l l l Choo Meijing Question 13 19 C Suppose the CFO wants you to do a scenario analysis with different values 13 75 quot f 7quot 7 1 7 5quot s i f f t F 339 f quot7 i39r i i39 f oquot jngquot f f quot 7 f f 39 if i sin is L r 7quot LL 737 M ii L r t L t if 739 ii iii 39 L t ij 57517 739 739 7771 M105 Worst Case 035 72000 18000 30000 Base Case 035 90000 23000 25000 Best Case 108000 28000 20000 Eileen Tay You have calculated the Base Case in a Calculate the project s given that Best Case NPV is 8173379 and the Worst Case NPV is 766352 its and its 766352 3703513 8173379 ENPV I PWorst X NPVworst Pbase X NPVbase Pbest X NPVbest I 035 766352 035 3703513 030 8173379 Eileen Tay Standard deviationo PWorst NPVworst ENPV2 Pbase NPVbase ENPV2 Pbest NPVbest ENPV2 035 766352 3534300232 0353703513 34800212 O308173379 34800212 I 3596784 Coef cient of variation CV I oENPV I 3596784348002 I 103 Eileen Tay Should the project be accepted We recommend that the project be accepted because it has a CV of just slightly more than 1 which indicates that the project has a low stand alone risk Eileen Tay Question 13 1 3 Haley s Graphic Designs Inc is considering two mutually exclusive projects Both require an initial investment of 10000 and are typical average risk projects for the rm Project A has an expected life of 2 years with after tax cash in ows of 6000 and 8000 at the end of Years 1 and 2 respectively Project B has an expected life of 4 years with after tax cash in ows of 4000 at the end of each of the next 4 years The rm s WACC is 10 0o Priscilla Tay I l l I a If the projects cannot be repeated which project should be selected if Haley uses NPV in its criterion for project selection Project A 2 Where r I WACC Priscilla Tay NPVA 10000 600011 8000112 206612 Calculation Method CFO I 10000 C01 I 6000 C02 I 8000 F01 F02 1 lYRI10 CPT NPVA I 206612 Priscilla Tay Project B 0 1 3 4 i i 39 i i 10000 4000 4000 4000 4000 NPVB 10000 Mom11 Mom112 Mom113 Mow114 2 67946 iii Calculation Method CFO I 10000 C01 I 4000 F01 I 4 I YR I 10 CPT NPVB I 267946 Priscilla Tay Using NPV as its criterion when projects are mutually exclusive accept projects with the highest positive NPV NPVA 206612 lt NPVB 267946 Project B should be selected since its NPV is higher that project A Priscilla Tay I l l l b Assume the projects can be repeated and that there are no anticipated changes in the cash flows Use the replacement chain analysis to determine the NPV of the project selected Find a common life Project A 2 years Project B 4 years Common life I 4 years Project A O 10000 Priscilla Tay NPVA 10000 mom11 2000112 mow113 80001i4 377365 Calculator Method CFO I 10000 C01 I 6000 C02 I 2000 C03 I 6000 C04 I 8000 F01 F02 I F03 I F04 1 lYR 10 CPT NPVA I 377365 NPVA 377365 gt NPVB 267946 Project A should be selected since its NPV is higher that project B l l Priscilla Tay I l l I C Make the same assumptions in part b Using the equivalent annual annuity BAA method What is the EAA of the project selected When pro t is spread equally with equal time interval Annuity Priscilla Tay F PVA PMT 1 1 N I b 11N Project A 377364 I PMTO1 1 11IO14 Solving PMT I EAA I 119048 Calculation Method N I 4 UK I 10 PV I NPV I 377364 FV I O Solve for PMT I EAA I 199048 Priscilla Tay PVAN PMT1 1 J I b DH Project B 267946 PMTO1 1 11014 Solving PMT I EAA I 84529 Calculation Method N I 4 UK I 10 PV I NPV I 267946 FV I O Solve for PMT I EAA I 84529 Project A is better since the EAAA gt EAAB l l Priscilla Tay

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