Loan Calculation
You are considering taking out an $800,000 30year loan with equal monthly payments with a bank, which quotes annual rates on its deposits and loans of 1.2% and 3.6%, respectively.
 Without constructing a loan amortizationschedule,
 calculate the amount of interest that will be paid in the first month of the 25th year into the
 calculate the total amount of interest that will be paid over the life of the
 Interpret your answer for (a)(ii) and discuss the limitation(s), if any, of such an interpretation.
 Calculate the present value of the loan payments using a discount rate of2%.
 Interpret your answer for (c) as well as the difference between that answer and the actual loan principal. What can explain thisdifference?
 Holdings, an AsiaPacific telecommunications company, has excess capital and is looking to make a regional telecommunications investment. S. Corp won the contract to advise T. Holdings on the potential of the investment, and allows T. Holdings to pay for its charges in annual installments, starting at $2 million for the next year, and increasing at 10% annually until the final installment in the fifth year.
The project under consideration entails an initial infrastructural investment of $600 million, and subsequent investments of the same amount every five years. These assets will be depreciated on a straightline basis to a book value of zero five years from the purchase, but can be salvaged for approximately half the original investment amount. Revenue for the next year is projected to be $800 million, and is expected to grow at an annual rate of 20% for four years (i.e., years 2 through 5), after which revenues are expected to remain at that level indefinitely. Annual variable costs and yearend net working capital associated with the project are estimated to be 30% and 10% of annual revenue respectively, and fixed costs are estimated to be $80 million per year.
Neither the debt nor equity of T. Holdings is traded, but S. Corp reckons they are worth $3 billion and $6 billion respectively. In the immediate future, T. Holdings intends to recapitalize by issuing equity to repay all of their outstanding debt. In addition, S. Corp looked into Good Inc. and Bad Inc.—the former is a conglomerate with businesses such as global telecommunications, food and beverage, and financial services, whereas the latter is a pureplay which focuses on developing their telecommunications business in the Asia Pacific. Also, S. Corp provides the following information on these entities:
Good Inc. 
Bad Inc. 

Beta 
1.80 
1.20 
Market value of equity 
$10 billion 
$4 billion 
Market value of debt 
$20 billion 
$2 billion 
Face value of debt 
$22 billion 
$2.2 billion 
Years to debt maturity 
15 
5 
Annual coupon rate 
10% 
8% 
The prevailing corporate marginal tax rate is 20%, the expected return on the market portfolio is 15%, and the riskfree rate is 5%. Assume the firm’s cost of debt does not vary with capital structure and financial distress is costless.
 (i) Calculate and justify a suitable weighted average cost of capital based on T. Holdings’ existing capital
 Justify and calculate a suitable discount rate for the telecommunications project.
 (i) Compute operating cash flows for the first five
 Compute changes in net working capital for the first five
 Compute NPV based on cash flow from assets for the first five
 Should T. Holdings accept the telecommunicationsproject?
Debtfree, Inc., an unlevered firm, is planning to use debt in its capital structure. The firm currently has 5,000 shares outstanding trading at $60 per share. The firm plans to sell 150 6% annualcoupon, 10year bonds at their face values of $1,000 each and use the proceeds to repurchase some of its shares. When the bonds mature, Debtfree, Inc. plans to reissue new bonds to pay off the principal and to “roll over” its debt this way indefinitely. Assume the firm’s cost of debt does not change and there are no costs of financial distress. Earnings before interest and tax are expected to remain at $28,000 per year forever and the firm has a dividend policy of paying out all of its earnings. Maureen currently owns 100 shares of Debt free, Inc.
 (i) Calculate the total dollar annual dividend Maureen receives under the firm’s existing capital
 If the market learns of the capital restructuring before the exercise is completed, how many shares are repurchased under the planned capital restructuring?
 Calculate total dollar annual dividend Maureen receives under the firm’s planned capital
 Debtfree, Inc. completes its planned capital restructuring but Maureen prefers the annual dividend payout of the unlevered firm. What is Maureen’s cash flow from homemade leverage by referencing the levered firm’s capital structure and assuming that she can borrow and lend at the same rate as the firm?
 Is capital structure irrelevant?
 Redo part (a) assuming a onetier corporate tax rate of 20% applies. Ignore personal income
Loan Calculation
Part A (i)
The interest that will be paid in first month of 25^{th} year of loan is $ 705.6246.
The formula for computation of interest is IPMT(Rate, Per, Nper, PV, FV)
Accordingly, the formula put in was IPMT(0.036/12,289,360,800000)
The solution that was arrived stands at $ 705.62
Part A (ii)
The total amount of interest that will be paid over the life of the loan is $509378.61.
Sl No 
Particulars 
Amount ($) 
1 
Loan amount 
800000 
2 
Tenure 
30 years 
3 
Saving Interest Rate 
1.20% 
4 
Loan Interest rate 
3.60% 
5 
Monthly EMI 
3637.16 
6 
Total Amount of Emi 
1309378.61 
7 
Interest 
509378.61 
The computation of Monthly EMI has been done by using the formula PMT(rate, nper,pv,fv)
Accordingly, the values have been put in PMT(0.036/12,360(12*30),800000,0)
The value derived was $ 3637.16 per month EMI.
Further to compute the entire amount of EMI that has been paid, EMI has been multiplied by 360= 3637.16 *360=$1309378.61 and the interest amount that has been paid on principal has been derived by reducing the loan amount from the total EMI=
Total EmiPrincipal Loan
1309378.61800000= $5,09,378.61
Part B
The Principal amount of loan under the said programme is AUD 800,000 and interest on the same over the tenure of the loan i.e. 360 months is $5,09,378 roughly 63% of principal. Further, in case of repayment of loan initially the interest is set off and then principal leading to such huge interest on the loan over the tenure. It shall also be worthwhile to note that the amount of interest decreases over the tenure of the loan.
The above computation is based on the understanding that there are no prepayment of intention to set off the loan earlier. Further, the interest rate on such loan does not fluctuate over the period and borrower does not default the loan.
Part C
For computation of present value of the loan EMI paid over the period of 360 months have been discounted using the rate of 1.2% p.a. compounded monthly. Accordingly the formula used has been stated hereinbelow:
T( Sigma)t=0= Cash flow/(1+r)^{t}
Accordingly the present value of 1^{st }EMI has been calculated as =3637.16/(1+.012/12)^1
Last EMI = 3637.16/(1+.012/12)^360
The resulting value has been added to arrive at the value $ 1,09,9143.923. (Refer Excel for detailed computation)
Part D
The present value has been computed on the basis of time value of money and the rate used for discounting is rate for deposit which can be considered equivalent to risk free interest rate. Further, it shall be noted that loan repayment is inclusive of interest and principal.
The difference between the actual amount of loan granted and the present value of such loan is $ 2,99,143.9229 which represent that I am paying extra by taking the loan as the person who lent me the money has earned extra after considering the risk free rate of interest. The extra amount represent payment for undertaking risk.
WACC Calculation
The rational for such difference is use of lower discount rate i.e 1.2% instead of 3.6%. Thus, the difference is mainly on account of risk undertaken by the person lending the money.
Part A (i)
The computation of WACC is presented hereinbelow:
 Cost of Debt of the company before tax is 8%
 Cost of the debt net of tax = 8%*(1tax rate)=8%(120%)=6.4%
 Risk Free Rate is 5%
 Market Return is 15%
 Risk Premium= Market Return Risk Free Rate=15%5%=10%
 Beta of Bad Inc= 1.2
Since Beta Inc is similar to the tested company, Beta of asset of the same needs to be computed to derive the beta of the tested company:
Beta Asset= Beta Equity/(1+ (1tax)*Debt/Equity)
=1.2(1+(1+(10.2)*2/4)
=0.857
Beta of the tested company =
Beta of Equity = Beta of Asset *(1+ (1tax)*Debt/Equity)
=0.857*(1+(10.2)*3/6)
=1.2
 Cost of Equity = Risk Free Rate + Risk Premium* Beta of Equity
=5%+ 10% *1.2
=17%
 Weighted Average Cost of Capital of Company = (Cost of debt* weight of debt + Cost of equity* Weight of Equity)/ total weight
=(6.4%*3+ 17%*6)/9
=13.47%
Weighted Average Cost of capital 

Sl NO 
Particular 
Cost 
1 
Cost of Debt 
8% 
2 
Cost of Debt post tax 
6.4% 
3 
Risk Free rate 
5% 
4 
Market return 
15% 
5 
Risk Premium 
10% 
6 
Beta 
1.20 
7 
Cost of Equity 
17.00% 
8 
Weight of Debt 
3.00 
9 
Weight of Equity 
6 
10 
Weight of Debt 
3 
11 
WACC 
13.47% 
Computation of beta 

Sl NO 
Particular 
Cost 
1 
Beta Levered 
1.2 
2 
Beta Unlevered 
0.857142857 
3 
Beta of Proposed project 
1.2 
For computation of cost of equity, only Bad Inc. has been considered as Bad Inc. business is similar to that of the company being analysed. Thus, on the basis of same WACC has been estimated @13.47%.
Part A (ii)
The suitable discount rate is Weighted Average Cost of capital of the project i.e. 13.47% as the same justifies the require rate of return desired by the people who are financing the project. Thus, WACC shall serve the purpose of suitable discount rate below which the project shall not be accepted. (CFI Education Inc., 2018)
In addition, the above represents the hurdle rate and the minimum rate of return that shall be given to investor for the project to survive and continue. Thus, it shall be prudent to use this rate as the same represent reward for the risk undertaken by the investor,
Part B (i)
The operating cash flows of the project for the first five years have been detailed hereinbelow:
Sl No 
Particular 
year 0 
year 1 
year 2 
year 3 
year 4 
year 5 
Terminal Value 
1 
Revenue 
800 
960 
1152 
1382.4 
1658.88 

2 
Annual Working Cost (Variable) 
240 
288 
345.6 
414.72 
497.664 

3 
Fixed Cost 
80 
80 
80 
80 
80 

4 
Depreciation 
120 
120 
120 
120 
120 

5 
EBIT (1234) 
360 
472 
606.4 
767.68 
961.216 

6 
Tax (5*20%) 
72 
94.4 
121.28 
153.536 
192.2432 

7 
EBI (56) 
288 
377.6 
485.12 
614.144 
768.9728 

8 
Depreciation 
120 
120 
120 
120 
120 

9 
OCF 
408 
497.6 
605.12 
734.144 
888.9728 
 Revenue for year 1 has been provided and from year 2 the same has been computed like
Year 1*1.2=800*1.2=960
Year 2*1.2=960*1,2=1152
…….
Year 4*1.2=1382.4*1.2=1658.88
 Annual Working Cost or Variable cost has been computed in the following manner
Year 1= Revenue Year 1*30%=800*30%=240
Year 2= Revenue Year 2*30%=960*30%=288
Year 5= Revenue Year 5*30%=1658.88*30%=497.664
 Fixed cost has been provided at $80.
 Depreciation has been computed by allocating the plant cost over a period of 5 year i,e
600/5=120 every year
 Earnings Before Interest and Tax has been computed by = Revenuevariable costfixed costdepreciation
For year 1
= 80024080120=$360
For other year similar calculation has been done.
 Tax has been computed = EBIT*30%
For year 1
= $360*20%= $72
For other years similar computation has been done.
 Operating Cash Flow = EBITTax + Depreciation
For year 1
= $360$72+$120=$408
For year 5
=961.216192.2432+120=$888.9728
Part B(ii)
The change is working capital over next five years has been presented herein below:
Sl No 
Particular 
year 0 
year 1 
year 2 
year 3 
year 4 
year 5 
Terminal Value 
1 
Net Working Capital Level 
80 
96 
115.2 
138.24 
165.888 

2 
Change in Net Working Capital 
80 
16 
19.2 
23.04 
27.648 

3 
Net Cash flow from sale of Asset 
240 

4 
Realisation of Net working capital at end 
165.888 
The said computation has been derived in the following manner:
 Net Working Capital Level
For year 1 = Revenue for year 1*10%=800*10%=$80
For Year 5= Revenue for year 5*10%=1658.88*10%=$165.89
 Change in Working Capital level
For year 1 = Working Capital Level in Year 1 Working Capital level in Year 0=800=$80
For year 2 = Working Capital Level in Year 2 Working Capital level in Year 1=9080=$16
For year 5 = Working Capital Level in Year 5 Working Capital level in Year 4=165.88138.24=$27.648
 Net Cash flow from sale of Asset : Sale Value *(1Tax Rate )
Projected Cash Flows and Financial Analysis for Project
=300*(120%) =$240
 Realisation of Working Capital at the end of the project = Net Working Capital level at year 5 = $165.89
Part B(iii)
Sl No 
Particular 
year 0 
year 1 
year 2 
year 3 
year 4 
year 5 
Terminal Value 
1 
Infrastructural Investment 
600 

2 
Depreciation 
120 
120 
120 
120 
120 

3 
Salvage Value 
240 

4 
Revenue 
800 
960 
1152 
1382.4 
1658.88 

5 
Annual Working Cost 
240 
288 
345.6 
414.72 
497.664 

6 
Working Capital 
80 
16 
19.2 
23.04 
27.64 
165.88 

7 
Fixed Cost 
80 
80 
80 
80 
80 

8 
Net Cash Flow 
280 
456 
587.2 
744.64 
933.576 
405.88 

9 
Tax 
72 
94.4 
121.28 
153.536 
192.2432 

10 
Cash Flow after Tax 
208 
361.6 
465.92 
591.104 
741.3328 
405.88 

11 
Depreciation 
120 
120 
120 
120 
120 

12 
Cash Flow after Tax & Depreciation 
328 
481.6 
585.92 
711.104 
861.3328 
405.88 

13 
Discounting factor 
1 
0.881316 
0.776718 
0.684534 
0.603291 
0.53169003 
0.53169003 
14 
Present Value of Cash flows 
600 
289.0717 
374.0674 
401.0822 
429.0026 
457.9620621 
215.8023493 
15 
Net Present Value 
1566.988 
Uptill cash flow after tax and depreciation computation has been detailed above
Post that the computation of present value has been provided hereinunder:
Cash Flow at year 1 *(1/1+ WACC)=328*.881316=289.717
Cash Flow at year 2 *(1/(1+ WACC)^2)=328*.776718=374.067
Cash Flow at year 5 *(1/(1+ WACC)^5)=861.322*.53169=457.962
Further Net Present Value has been computed by using the formula=
Summation of Present value of csh flow form year 1 to terminal Value Year 0=2166.988600=$1566.88
Part B(iv)
Yes, the project shall be accepted based on quantitative analysis of the project as the Net Present value of project is $1567.651 at 13.47 % rate of discounting. Further, positive Net Present Value indicates that project is feasible.
PART A (i)
Sl No 
Particulars 
Quantity (a) 
Rate (b) 
Amount(C=a*b) 

1 
Share 
5000 
60 
300000 

2 
10 Year Bond 
150 
1000 
150000 

3 
Buy Back Shares 
2500 
60 
150000 

4 
Cost of Debt before Tax 
6% 

5 
Earnings Before Interest and Tax 
28000 

6 
Tax Rate 
NiL 

7 
Profit after Tax 
28000 

8 
Dividend Per Share 
5.6 

9 
Dividend received by Maureen 
100 
5.6 
560 
Answer (a(i)) 
The computation has been derived in the following manner
Earnings Before Interest and Tax = $28000
No of Shares=5000
Dividend per share=EBIT/No of shares=28000/5000= $5.6
No of Shares of Maureen=100
Dividend Received by Maureen= 100*$5.6= $560
Part A (ii)
Sl No 
Particulars 
Quantity (a) 
Rate (b) 
Amount(C=a*b) 

1 
Share 
5000 
60 
300000 

2 
10 Year Bond 
150 
1000 
150000 

3 
Buy Back Shares 
2500 
60 
150000 

4 
Cost of Debt before Tax 
6% 

5 
Earnings Before Interest and Tax 
28000 

6 
Tax Rate 
NiL 

7 
Profit after Tax 
28000 

8 
Dividend Per Share 
5.6 

9 
Dividend received by Maureen 
100 
5.6 
560 

10 
Buy Back Shares 
2500 
60 
150000 
Answer (a(ii)) 
The detail of computation has been provided hereinbelow:
Amount of debt issued= 150*1000=$150000
Share price=$60
No of share to be bought back=Debt/Share price=150000/60=2500
PART A (iii)
Sl No 
Particulars 
Quantity (a) 
Rate (b) 
Amount(C=a*b) 

1 
Share 
5000 
60 
300000 

2 
10 Year Bond 
150 
1000 
150000 

3 
Buy Back Shares 
2500 
60 
150000 

4 
Cost of Debt before Tax 
6% 

5 
Earnings Before Interest and Tax 
28000 

6 
Tax Rate 
NiL 

7 
Profit after Tax 
28000 

8 
Dividend Per Share 
5.6 

9 
Dividend received by Maureen 
100 
5.6 
560 

10 
Buy Back Shares 
2500 
60 
150000 

11 
Earnings Before Interest and Tax 
28000 

12 
Interest (2*4) 
9000 

13 
Profit after Tax (1112) 
19000 

14 
Dividend per share (13/3) 
7.6 

15 
Dividend received by Maureen 
100 
7.6 
760 
Answer (a(iii)) 
The computation has been derived in the following manner
Earnings Before Interest and Tax = $28000
Interest= Debt Amount* 6%=150000*60%= $9000
Earning before Tax= EBITInterest=280009000=$19000
Dividend per share=EBIT/No of shares=19000/2500= $7.6
No of Shares of Maureen=100
Dividend Received by Maureen= 100*$7.6= $760
PART A (iv)
Sl No 
Particulars 
Amount 
1 
No of shares under existing Capital Structure 
100 
2 
Proportion of debt in the capital structure of the company 
50% 
3 
Total Capital of Maureen 
6000 
4 
Total value of shares to be sold 
3000 
5 
Total debt to be let out (34) 
3000 
6 
Receipt of dividend (50*7.6) 
380 
7 
Interest (3000*6%) 
180 
8 
Total Receipt (6+7) 
560 
The computation has been derived in the following manner
The proportion of debt in the capital of the company=Debt/ Total capital=1500000/300000=50%
Total Capital of Maureen = Number of Shares* Rate per share=100*60=$6000
Value of share to be sold to incorporate debt= Capital*50%=6000*50%=$3000
Interest on Debt =Debt Amount * Rate of Coupon=3000*6%=$180
Dividend Receipt= No of Shares* Dividend per share=50*7.6=$380
Total Receipt=Interest + dividend= $180+$380=$560
Part (v)
In terms of Modigliani Miller theory, capital structure is irrelevant and the value of the company is dependent on the net operating cash flow of the company. However, under such thesis there is no transaction cost and taxes. Further, if the environment compasses tax then the above proposition does not hold true as the value of the company is increased by the present value of tax benefit. Further, cost of equity of the company shall rise on account of debt in the capital structure in terms of MM Theory leasing to same WACC.
Part B (i,ii &iii)
Sl No 
Particulars 
Quantity (a) 
Rate (b) 
Amount(C=a*b) 
1 
Share 
5000 
60 
300000 
2 
10 Year Bond 
150 
1000 
150000 
3 
Buy Back Shares 
2500 
60 
150000 
4 
Cost of Debt before Tax 
6% 

5 
Earnings Before Interest and Tax 
28000 

6 
Tax Rate 
20% 

7 
Profit after Tax 
22400 

8 
Dividend Per Share 
4.48 

9 
Dividend received by Maureen 
100 
4.48 
448 
10 
Buy Back Shares 
2500 
60 
150000 
11 
Earnings Before Interest and Tax 
28000 

12 
Interest (2*4) 
9000 

13 
Profit after Tax (1112)*80% 
15200 

14 
Dividend per share (13/3) 
6.08 

15 
Dividend received by Maureen 
100 
6.08 
608 
The computation has been provided hereinbelow:
Earnings Before Interest and Tax = $28000
Earning After Tax =EBIT*(1Tax rate)=28000*(120%)= $22400
No of Shares=5000
Dividend per share=EBIT/No of shares=22400/5000= $4.48
No of Shares of Maureen=100
Dividend Received by Maureen= 100*$4.48= $448 (Answer)
Amount of debt issued=$150000
Share price=$60
No of share to be bought back=Debt/Share price=150000/60=2500 (Answer)
Interest= Debt Amount* 6%=150000*60%= $9000
Earning before Tax= EBITInterest=280009000=$19000
Earning After Tax= EBT*(1Tax rate)=19000*(120%)= $15200
Dividend per share=EBIT/No of shares=15200/2500= $6.08
No of Shares of Maureen=100
Dividend Received by Maureen= 100*$6.08= $608(Answer)
PART B (iv)
Sl No 
Particulars 
Amount 
1 
No of shares under existing Capital Structure 
100 
2 
Proportion of debt in the capital structure of the company 
50% 
3 
Total Capital of Maureen 
6000 
4 
Total value of shares to be sold 
3000 
5 
Total debt to be let out 
3000 
6 
Receipt of dividend (50*6.08) 
304 
7 
Interest (3000*6%) 
180 
8 
Total Receipt (6+7) 
484 
The computation has been provided hereinbelow:
The proportion of debt in the capital of the company=Debt/ Total capital=1500000/300000=50%
Total Capital of Maureen = Number of Shares* Rate per share=100*60=$6000
Value of share to be sold to incorporate debt= Capital*50%=6000*50%=$3000
Interest on Debt =Debt Amount * Rate of Coupon=3000*6%=$180
Dividend Receipt= No of Shares* Dividend per share=50*6.06=$304
Total Receipt=Interest + dividend= $180+$304=$484
PART B (v)
In terms of Modigliani Miller theory, capital structure is irrelevant and the value of the company is dependent on the net operating cash flow of the company. However, under such thesis there is no transaction cost and taxes. Further, if the environment compasses tax then the above proposition does not hold true as the value of the company is increased by the present value of tax benefit. Further, cost of equity of the company shall rise on account of debt in the capital structure in terms of MM Theory leasing to same WACC. (Study.com, 2018)
References:
CFI Education Inc. (2018). WACC. Retrieved October 3, 2018, from corporatefinanceinstitute.com: https://corporatefinanceinstitute.com/resources/knowledge/finance/whatiswaccformula/
Study.com. (2018). The ModiglianiMiller Theorem: Definition, Formula & Examples. Retrieved October 3, 2018, from Study.com: https://study.com/academy/lesson/themodiglianimillertheoremdefinitionformulaexamples.html
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