Reference no: EM132792112

FIN516 Corporate Finance

Assignment 1

Question 1

You are considering investing in Facial Laboratories. Suppose Facial is currently undergoing expansion and is not expected to change its cash dividend while expanding for the next 4 years. This means that its current annual $3.00 dividend will remain for the next 4 years. After the expansion is completed, higher earnings are expected to result causing a 30% increase in dividends each year for 3 years. After these three years of 30% growth, the dividend growth rate is expected to be 2% per year forever. If the required return for Facial's common stock is 11%, what is a share worth today?

Question 2
Below are the financial statements for Diamond Drillers, Inc.

Diamond Drillers, Inc.
Income Statement for the year ended 2004

Net sales (75% are credit sales)	60.0
Less: Cost of goods sold	45.0
Gross profit	15.0
Less: Operating expenses	6.0
Earnings before interest and tax	9.0
Less: interest	2.0
Net profit	7.0
Less: tax (30%)	2.1
Net profit after tax	4.9

Diamond Drillers, Inc,

Balance sheet as at 31st December 2004

Assets	$m	Liabilities	$m
Current assets		Current liabilities
Cash	1.0	Bank overdraft	1.5
Marketable securities	8.0	Notes payable	7.0
Accounts receivable	14.0	Accounts payable	12.0
Inventories		Total current liabilities	20.5
	18.0
Total current assets	41.0	Long term debt	26.0

Fixed assets

Land & building               27.0             Shareholders' funds

Machinery & equipment

Furniture & fixtures

40.0                Ordinary shares ($1 par)                  22.0

Share premium reserve                    19.5

8.0

Total fixed assets                                     Retained earnings                          29.0

(net of accumulated depn)

Other assets

75.0                Total shareholders' funds                70.5

1.0

Total assets                        117.0             Total liabilities & shareholders'

funds

(Assume the closing balances are representative of average balances)

Calculate the following ratios for Diamond Drillers, Inc, and evaluate its position relative to industry averages.

	Industry Averages
Debt-to-equity ratio	1.07
Interest coverage ratio	7.30
Current ratio	2.85
Inventory turnover	2.45
Accounts receivable turnover	4.69

Question 3
a. i. Consider a series of 10 annual cash flows of $100 each. Given an effective interest rate of 6%, compute the present value of this series if the first cash flow occurs:

- today
- one year from today
- four years from today

ii. Consider a series of 10 annual cash flows of $100 each. Given an effective interest rate of 6%, compute the value of this series 15 years from today, if the first cash flow occurs:

- one year from today
- five years from today
- six years from today
b. You wish to set up a foundation to give an annual donation in perpetuity to your favourite charity, so you deposit $15,000 today in a trust account that earns 7%pa.

i . How much will your annual donation be if the first one is in one year's time?

ii. How much will your annual donation be if the first one is in four year's time?

Assignment 2

Question 1

Consider the dividend valuation model with constant growth. What happens if g equals r, or if g is greater than r?

Question 2

You are considering five projects. The initial investments followed by the NPVs for each project are: Project 1: $100,000 and $30,000; Project 2: $80,000 and $25,000; Project 3: $60,000 and $15,000; Project 4: $40,000 and $17,000; and, Project 5: $105,000 and $40,000. Answer the below questions.

(a) Using the profitability index, which one of the above projects would you choose first if you have limited funds?

(b) Suppose you have $110,000 for projects. Which projects would you choose?

(c) Will there be money left over? Is this good or bad?

Question 3
A new product is being considered by Brooks' Books, Inc. The after-tax cash flows at time zero include an outlay for depreciable equipment (I0) of $16M (M = million) and $2.2M for additional net working capital (ΔW). The project is expected to have an 8-year life (n=8), and the equipment will be depreciated on a straight-line basis to a zero book value (B=0) over 8 years. When the project terminates in eight years, it is anticipated that the market or salvage value (S) will be $2M and the net working capital will be released. The cash flows before tax (CFBTt) for the project are expected to be $5M per year. The cost of capital (r) is 16%, and the relevant tax rate (T) is 35%. Answer the below questions.

(a) What are the initial costs (CF0)?
(b) What is the after-tax value of the revenues minus expenses for each year (CFBTt)?
(c) What is the depreciation tax shield per year (DTSt)?
(d) What at the cash flows after tax for each year (CFATt)?
(e) What is the net salvage value (NSV)?
(f) What is the terminal value (TVn)?
(g) What is the NPV?
(h) Do we accept the project? (i). Why

Question 4

Converse is considering a capital budgeting project with a cost of capital of 10% and the following expected cash flow pattern:

Time	0	1	2	3	4	5
Cash flow	-100	25	50	50	25	10

(a) Calculate the NPV. Should the firm accept the project?

(b) Calculate the IRR. According to this criterion, should the firm accept the project?

(c) Calculate the payback (ignore discounting).

(d) What does payback tell you about the project's acceptability? Under what external circumstance might you be forced to look at it?

(e) How would your answers to parts (1) and (2) change if you were told that the project is one of two mutually exclusive projects the firm has under consideration?

Assignment 3

Question 1

Your spouse has several investments. One of them is 500 shares of Royal Oil. Royal is expected to pay a dividend next year of $2.38. The expected dividend growth rate is 6% per year forever. Another of your spouse's investments is 600 shares of Light House. It has an expected growth rate in dividends of 4% per year forever. It sells for $51.875. It is expected to pay a dividend of
$3.35 per share next year. Answer the below questions.

(a) If Royal is selling for $29.45 per share, what is your spouse's expected return on Royal Oil?

(b) What is your spouse's expected return on Light House?

(c) Does it appear if one of the investments is superior to the other? Explain.

Question 2

The Rookie Group, Inc., has identified the following two mutually exclusive projects. The cash
flows for project "Stevie" for years 0 through 4 are respectively: -$12,500, $4,000, $5,000,
$6,000 and $1,000. For project "Morrie", the cash flows for years 0 through 4 are respectively: -
$12,500, $1,000, $6,000, $5,000 and $4,000. Answer the questions below.

(a) What is the IRR for each of these projects? If you apply the IRR decision rule, which project should the company accept? Is this decision necessarily correct?

(b) If the required return is 11 percent, what is the NPV for each of these projects? Which project will you choose if you apply the NPV decision rule?

(c) Will your IRR decision always agree with your NPV decision for this situation of mutually exclusive projects?

Question 3

The cost of capital for a firm can differ from the cost of capital for each of its businesses. When a firm has multiple businesses, it is important to use the cost of capital appropriate to the particular project under consideration, rather than the firm's overall cost of capital, when evaluating a proposed project. Renowned Cola, Inc.'s 2005 annual report explains that Renowned Cola's investments are expected to generate cash returns that exceed its "long-term cost of capital," which Renowned Cola estimated to be approximately 10% at year-end 2005. Renowned Cola has three main lines of business, soft drinks, notably Dr. Cola; snack foods, such as Fritos; and restaurants. Restaurant investments include NPC, which has a beta of 0.80 and a debt-to-firm value ratio is 0.31. Renowned Cola did not report costs of capital separately for these three businesses. Below, we have available year-end data for 2005 provided by Renowned Cola.

Renowned Cola's Items                    Values

Cash and marketable securities                       $1,498M (market value assumed) Short-term debt                                                                        $706M

Long-term debt                                               $8,509M ($8,747M market value)

Common shares outstanding	788M
Year-end share price	$55.875
Income tax rate	34%
Renowned Cola's beta	1.0
Long-term borrowing rate	6.75%
Short-term riskless rate	5.13%
Intermediate-term riskless rate	5.50%
Long-term riskless rate	6.00%
Short-term market risk premium	8.40%

Intermediate-term market risk premium         7.40%

Long-term market risk premium                                       7.00%

Given the above information, answer the below questions.

(a) Calculate the market value of Renowned Cola's debt at year-end 2005. What is the book value of debt? Why do usually use market or book values for debt? Explain.

(b) To the nearest million, calculate the market value of Renowned Cola's stockholders' equity at year-end 2005.

(c) Renowned Cola subtracts the value of its short-term debt from its total debt when calculating its "net debt ratio." Renowned Cola believes that the market values for its traded debt are not accurate because the bonds trade infrequently. Given this belief and their treatment of short-term debt, compute Renowned Cola's net debt ratio using book values for debt.

(d) Compute L. Using the CAPM compute re for short-term, medium-term, and long-term investments. Compute WACC for short-term, medium-term, and long-term investments. Suppose you were considering a long-term capital investment project, which WACC would you use and why? You can assume that the asset's risk profile for the project mirrors Renowned Cola's overall risk profile.

(e) Should Renowned Cola use its overall cost of capital to evaluate its restaurant capital investments? Under what circumstances would it be correct to do so?

Question 4
You have been offered a contract for six years to set up an overseas manufacturing plant to make and distribute Australian T-shirts. If you accept the offer, the following conditions will apply:

i. You will receive a once-off payment of $5,000 on the signing of the contract

ii. You will receive a annual salary of $120,000 for the first two years;
$150,000 for the next two years; and $180,000 for the remaining two years. This salary will be paid quarterly in equal amounts, the first being paid three months after the signing of the contract.

iii. If you generate sales in excess of $1,000,000 in any one year, you will receive a bonus of $10,000 at the end of that year (31st December). You consider there is a 25% probability that you will achieve the bonus in any one year.

If you sign the contract, you will do so today, 1st January 2009. You can ignore all taxes.
a. Draw a timeline of these cash flows.

b. What is the value of the contract to you today if the effective interest rate is 12%pa? (Remember to adjust the interest to an effective quarterly rate, where applicable.)

c. You decide to save 30% of all payments you receive during the six years and at the end of the six years you place these savings into a savings account at 6% pa. You will use these savings to help pay for your parents retirement home. You expect them to be in the home for 20 years and you will make 20 equal annual withdrawals to pay the home.

What will be the size of the annual withdrawals (the first being on the first day after the end of the contract) if you wish to have $100,000 left in the account after 20 years?

Attachment:- Corporate Finance.rar