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Cost of Capital

Question 1 Depicting project NPV:

Cost of Capital

 8%

Year

Revenue

Cost

Cash flow

Discount rate

Discounted cash flow

0

(7,000,000)

 (7,000,000)

 1

 (7,000,000)

1

(2,000,000)

 (2,000,000)

0.93

 (1,851,852)

2

 12,000,000

(2,000,000)

 10,000,000

0.86

8,573,388

 Net present value (NPV)

 (278,464)

The overall reason behind choosing the NPV is mainly to detect time factor of the overall future cash flows conducted by the organisation. In addition, use of net present value mainly allows organisations to detect the overall viability of the investments and how much it could add value to the firm. However, the calculation of the NPV mainly depicts a negative value of (278,464), which makes the company reject the overall project. In this context, Brigham & Ehrhardt (2013) stated that companies with the help on NPV valuation are mainly able to discount the future cash flows and detect actual viability of the organisation.

NPV Calculation:

Cost of capital

 10%

Business A

Business B

Year

Cash flow

Discount rate

Discounted cash flow

Cash flow

Discount rate

Discounted cash flow

0

 $                                                           (60,000)

1

                            (60,000)

 $                         (60,000)

1

                            (60,000)

1

 $                                                              50,000

0.909090909

                               45,455

 $                            10,000

0.909090909

                                 9,091

2

 $                                                              30,000

0.826446281

                               24,793

 $                            20,000

0.826446281

                               16,529

3

 $                                                              20,000

0.751314801

                               15,026

 $                            80,000

0.751314801

                               60,105

Net present value

25,274

 Net present value

25,725

Cost of Capital

10% 

Business A

Business B

Year

Cash flow

Cash flow

0

 $ (60,000)

 $    (60,000)

1

 $ 50,000

 $    10,000

2

 $    30,000

 $    20,000

3

 $  20,000

 $     80,000

IRR

37%

26%

The overall IRR and NPV of Business A is mainly adequate than Business B, which could increase profitability of the organisation. Furthermore, IRR of Business A is mainly higher, which depicts its return generation capacity that is higher than Business B. Burger, Kaufman, & Atkinson (2015) mentioned that when NPV of the business options is relatively same then IRR is mainly evaluated, as it helps in depicting the actual return generation capacity of the investment. Therefore, seeing the IRR and NPV Grey and John is mainly advised to select Business A for the investment purpose.

The evaluation of both the business portrays a viable income and an increment in the availability of funds could mainly help in adoption both businesses. The NPV and IRR of both businesses are relatively adequate for investment purposes and investment in both the project simultaneously could allow the company attain higher return from investment (Dudin et al., 2014).

Calculation of the Payback period:

Year

Project A

Project B

Cash Flow

Cumulative cash flow

Cash flow

Cumulative cash flow

0

 $                                                         (200,000)

 $                       (200,000)

 $                       (180,000)

 $                       (180,000)

1

 $                                                              76,000

 $                       (124,000)

 $                           60,000

 $                       (120,000)

2

 $                                                              76,000

 $                         (48,000)

 $                           64,000

 $                         (56,000)

3

 $                                                              76,000

 $                            28,000

 $                           72,000

 $                            16,000

4

 $                                                              76,000

 $                         104,000

 $                           80,000

 $                            96,000

5

 $                                                              76,000

 $                         180,000

 $                           90,000

 $                         186,000

Payback period

                                                                      2.63 years

                                   2.78 years

Stating whether project’s payback period meet company’s laid down criteria:

The payback period of both the project is relatively at 2.63 and 2.78 years, which is relatively lower than the specified 3 year payback period of the company.

Option 1

Project

Investment

NPV

PI

Buy a Duplex apartment near campus

 $50,000

 $22,500

1.45

Option 2

Project

Investment

NPV

PI

Buy a collection of old comics books

 $ 5,000

 $ 1,000

1.2

Start a small moving business

 $ 25,000

 $ 10,000

1.4

Buy a new car for your business

 $ 20,000

 $ 10,000

1.5

Total Investment

 $ 50,000

 $ 21,000

1.42

From the evaluation of above two tables, Option 1 is mainly chosen, as the most viable investment option. This option mainly allows the organisation to increase their probability and generate higher revenue from investment. Both NPV and PI of option 1 are relatively higher than option 2, which could be used by the company to increase its return from investment. Therefore, investment in Duplex apartment is the most viable option that is been presented (Finkler, Smith, Calabrese & Purtell, 2016).

Evaluation of Business A and Business B

Option 1

Option 2

Year

Revenue

Cost

Cash inflow

Revenue

Cost

Cash inflow

1

5000

0

5000

0

-20000

2

5000

0

5000

1

10000

3

10000

-20000

-10000

2

10000

4

10000

0

10000

3

10000

5

10000

0

10000

4

10000

NPV

$12,242.68

5

10000

NPV

$13,521.55

From the evaluation of above NPV valuation, replacement of old machine from new machine could be more viable, as its NPV is relatively higher. Therefore, it could be beneficial for the company to replace the current machine with the new machine to attain a higher return from investment and increase its firm value.

a) Depicting the expected return for two shares:

Share X

Share Y

Probability

Er

returns

Probability

Er

returns

0.2

0.02

10%

0.1

0.008

8%

0.4

0.06

15%

0.3

0.036

12%

0.3

0.054

18%

0.5

0.075

15%

0.1

0.02

20%

0.1

0.019

19%

Expected return

15.40%

 Expected return

13.80%

b) Providing relative recommendation to Antec Corporation:

From the evaluation of above table, expected return of Share X is relatively identified at 15.40%, which is higher than 13.80% that is provide by Share Y. Therefore, Antec Corporation could invest in Share X, as it might increase the overall return from investment.

i) Providing recommendations:       

As per theoretically knowledge Standard Deviation is denoted by the risk involved in investment and therefore it is advisable to select projects, which has the least standard deviation. Therefore, Project X will mainly be chosen, as it has the least standard deviation from investment.

ii) Depicting whether opinions changes if coefficient is used:

Project

Coefficient

NPV

Standard deviation

 X

0.74

122,000

90,000

 Y

0.53

225,000

120,000

The incorporation of coefficient measure mainly depicted the investment, which has the least risk from investment. According to coefficient Project Y is mainly chosen, as it has the least risk.

iii) Mentioning about the measure that could help in understanding the situation:

Use of Coefficient might help in depicting the overall viable option, which could help in depicting adequate investment opportunity with least risk.

Question 7:

Risk free return

4%

Beta

0.8

Market return

14%

Er

Rf + Beta * (Rm- Rf)

Er

4% + 0.8 * (14% - 4%)

Er

12%

Expected return

11%

The expected return is relatively lower than Er, which indicates that investment in mutual fund is relatively viable.

Stating source of financing cost:

Cost of  Debt

= (1+(1000-N)/n) / ((N+1000) / 2)

= (1+(1000-950)/10) / ((95+1000) / 2)

= (1+(1000-950)/10) / ((95+1000) / 2)

= 105 / 975

= 10.8%

Cost of Debt After tax

= 10.8 * (1-0.6)

= 10.8 * 0.4

= 6.4

Cost of Preferred stock

=  Dp / Np

=  11 / (100-4)

=  11 / 96

=  11.5%

Cost of common stock

= (D1 / P0)

= (6 / 80) + 6%

= 0.075 + 6%

= 13.5%

New Cost of common stock

= (D1 / P0)

= (6 / (80-4-4)) + 6%

= 0.0833 + 6%

= 14.3%

Evaluating weighted average cost of the firm:

Capital

Weight

Cost of capital

WACC

Long term debt

40%

6.4%

2.6%

Common Equity

45%

13.5%

6.1%

Preferred  stock

15%

11.4%

1.7%

 Total

10.3%

Mentioning about viability of the investment opportunity:

Option D will mainly be chosen for the investment, as it has the highest return from investment and increase the overall profitability of the company. Thus, the investment of 600,000 mainly needs capital of 375,000, as 225,000 are obtained from retained earnings.

Mentioning about the influential factors that affect capital structure of the company, while depicting the financial and non-financial factors:

Some factors have relative influence on the capital structure of companies, which are depicted as follows.

Financial Factors:

The use of cash flow and equity financing could be used to depict adequate capital structure of an organisation. The overall financial factors depict an effective design that increases the overall operational capability of an organisation (Hill et al., 2013).

Investment Options

Non-Financial factors:

Emergency preparation and economic conditions are mainly identified as the overall non-financial factors, which allow organisation to evaluate its capital structure. Therefore, using the factors companies are mainly able to increase their performance and generate revenue from investment (Jiraporn, Jiraporn, Boeprasert & Chang, 2014).

Sales

Probability

Fixed cost

Variable cost

PBT

 $250,000

0.1

125000

100000

 $25,000

 $375,000

0.6

125000

150000

 $100,000

 $500,000

0.3

125000

200000

 $175,000

Number of shares

Per share value

Capital ordinary shares

30,000

 $10

 $300,000

Equity ratio

Debt ratio

Interest

Interest payments

Number of shares

80%

20%

10%

6000

24,000

60%

40%

11%

13200

18,000

40%

60%

12%

21600

12,000

Particulars

Amount

Sales

 $             375,000

Fixed cost

 $             125,000

Variable cost

 $             150,000

Interest cost (Debt 20%)

 $                 6,000

PBT

 $               94,000

Tax (40%)

 $               37,600

PAT

 $               56,400

EPS

2.35

Particulars

Amount

Sales

 $                  375,000

Fixed cost

 $                  125,000

Variable cost

 $                  150,000

Interest cost (Debt 40%)

 $                    13,200

PBT

 $                    86,800

Tax (40%)

 $                    34,720

PAT

 $                    52,080

EPS

2.89

Particulars

Amount

Sales

 $          375,000

Fixed cost

 $          125,000

Variable cost

 $          150,000

Interest cost (Debt 60%)

 $            21,600

PBT

 $            78,400

Tax (40%)

 $            31,360

PAT

 $            47,040

EPS

3.92

b) Mentioning optimal capital structure of maximum EPS:

Equity ratio

Debt ratio

EPS

40%

60%

3.92

The overall debt to equity ratio is relatively at 60:40, which makes the EPS at 3.92. Therefore, the use of above depicted capital structure could eventually allow the organisation to attain higher income from their investment.

Question 11:

a) Loan proposal dollar cost:

ASB Bank

Westpac Bank

b) Depicting adequate recommendation plan:

The loan provided from Westpac Bank could be used as the loan options, where it provides a dollar cost of 100,000 that is relatively lower than ASB Bank.

Option 1

 Value

Credit sales

         2,550,000

Interest cost

         34,931.51

account receivables

40

Credit sales per day

           8,732.88

Overdraft rate

10%

Credit sales Next year

         3,187,500

Estimated borrowing amount

                3,187,500 

Accounts receivables

349,315

Annual cost

47000

Total cost

         365,750

Option 2

 Values

Credit sales

         2,550,000

account receivables

35

Interest

12%

Accounts Receivable

305,651

Credit sales per day

           8,732.88

Credit sales Next year

         3,187,500

Interest cost

       306,000.00

Administration fees

           41,437.5

Estimated borrowing amount

         2,550,000

Total cost

       347,437.50

The overall evaluation of the above options could mainly help in identifying the adequate measure, which could help in reducing total costs incurred by Waste Co. The option 2 is mainly identified, as the overall viable approach, which allows the company to attain less cost from operations. The use of options 2, could mainly helps in reducing cash outflow, which might help in improving its financial position (Jiraporn, Jiraporn, Boeprasert, & Chang, 2014).

i) Depicting whether car buying or leasing can be done:

The NPV related to leasing the car is relatively higher than the NPV for purchasing the car. Therefore, the courier firm could use lease option to improve its overall profitability and attain higher revenue from investment.

ii) Depicting the common motivation for leasing:

Companies with the help of leasing are mainly able to reduce capital blockage and increase its ability to attain higher profitability. Moreover, leasing measure allow organisation to acquire different assets without adequate investment and capital blockage (Petty et al., 2015).

iii) Conflicts arise with leases and why:

The main problems or conflict that could be identified from lease is the trust that needs to be conducted to the lessee. The risk of fraud and over usage conducted by the lessee is the major conflict or problems, which might arise between the lessee and lesser. The overall usage of the equipments could mainly accelerate problems in the machine, which mainly shortens its life span (Renz, 2016).

a) Mentioning the reason why underwriters want securities under priced before new security offering:

Machine Replacement

The main reason that could be identified why underwriters wants securities under priced is because of the demand increment, which could be conducted before the IPO initiation. The underwriters mainly aim to attain maximum of the investors, which needs attractive pricing that needs to be conducted to increase the turn up in the auction day. Furthermore, the financial institutions mainly need IPO at discounted prices for increasing the overall return from investment. Therefore, the underwriters with the help of reduced prices are mainly able to attract the requited investors, which could make the IPO auction a success (Sheffet et al., 2014).

b) Depicting factors encircling total costs of an IPO:

The type of costs, which could be included in the IPO are mentioned as follows.

  • Underwriters spread
  • Cost of under pricing
  • Expenses such as SEC filing fees, legal fees, and other expenses

a) Mentioning the process, where capital can be raised from financial market and financial institutions:

Being the chief financial controller of Gaga Enterprise raising the money from financial market is identified to be more suitable than raising capital from financial institutions. The overall funds could be raised from preferred or common stock and bonds, which might be conducted from both financial market and financial institutions. However, the capital raised from the financial market could only allow the company to attain its actual market value and increase the raised capital. The collection of funds from the financial institution company’s ability to detect its actual value could be reduced, as the financial institutions will buy shares or bonds at the rate, which deemed them fit and adequate. Furthermore, the company could only chose the option, which reflects the least interest, as it reduces the overall cash outflow of the company (Swanson, Territo & Taylor, 2016).

b) Mentioning the options that might help in attain higher income after tax income for the first year:

Promissory note could mainly allows Reston Inc to reduce the overall cash outflow and taxable income. The promissory note is mainly identified, as the interest payment capital, which could be tax deductable and might allow the company to attain higher retained income. Whereas, the use of dividends could not allow Reston Inc to attain additional benefits, as not tax benefits are provided from dividends payments. Therefore, it could be understood that use of promissory note by the company could mainly help in increasing retained earnings after tax.

Reference:

Brigham, E. F., & Ehrhardt, M. C. (2013). Financial management: Theory & practice. Cengage Learning.

Burger, R. H., Kaufman, P. T., & Atkinson, A. L. (2015). Disturbingly weak: The current state of financial management education in library and information science curricula. Journal of Education for Library and Information Science, 56(3), 190.

Dudin, M. N., Lyasnikov, N. V., Yahyaev, M. A., & Kuznecov, A. V. E. (2014). The organization approaches peculiarities of an industrial enterprises financial management.

Finkler, S. A., Smith, D. L., Calabrese, T. D., & Purtell, R. M. (2016). Financial management for public, health, and not-for-profit organizations. CQ Press.

Hill, M. D., Kelly, G. W., Lockhart, G. B., & Ness, R. A. (2013). Determinants and effects of corporate lobbying. Financial Management, 42(4), 931-957.

Jiraporn, P., Jiraporn, N., Boeprasert, A., & Chang, K. (2014). Does corporate social responsibility (CSR) improve credit ratings? Evidence from geographic identification. Financial Management, 43(3), 505-531.

McKinney, J. B. (2015). Effective financial management in public and nonprofit agencies. ABC-CLIO.

Petty, J. W., Titman, S., Keown, A. J., Martin, P., Martin, J. D., & Burrow, M. (2015). Financial management: Principles and applications. Pearson Higher Education AU.

Renz, D. O. (2016). The Jossey-Bass handbook of nonprofit leadership and management. John Wiley & Sons.

Sheffet, A. J., Flaxman, L., Tom, M., Hughes, S. E., Longbottom, M. E., Howard, V. J., ... & Brott, T. G. (2014). Financial management of a large multisite randomized clinical trial. International Journal of Stroke, 9(6), 811-813.

Swanson, C. R., Territo, L., & Taylor, R. W. (2016). Police administration: Structures, processes, and behavior. Prentice Hall.

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