Semester One 2020

Exam - Alternative Assessment Task

STUDENT ID: 30685958

SURNAME: Chan
GIVEN NAME: Ken Loong

UNIT CODE: BFW2140

UNIT TITLE: CORPORATE FINANCE 1

ASSESSMENT DURATION: 3 hours and 30 minutes (includes reading,

downloading, and uploading time)

 This is an individual assessment task.

 All responses must be included within this document and under

individual questions.

 Students are required to answer ALL questions.

 This assessment accounts for 50% of the total in the unit and has a hurdle
requirement of 45% to pass the unit.

 Upon completion of this assessment task, please upload this document to

Moodle using the assignment submission link.

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Statement before commencing the assessment task.

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Question MCQ 1 2 3 4 5 TOTAL

Allocated
50
Marks
Mark received
Second
marking

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Question NO. 1 (4+4+3=11)
a. Mr. James has two coupon bonds with different maturities. Bond A has 10 years
of maturity, while bond B has 30 years of maturity. Both the bonds have 10%
coupon rates paid annually and a par value of $100. If the yield to maturity
changes from 5% to 6%, what is the percentage change in the price of each
bond?
(4 Marks)

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b. Nimkin Inc. has recently developed a bakery product. Due to the positive
response from the customers, the company is planning to expand by investing all
its earnings. This year, the firm had $2 per share as the earnings. The growth
rate in these earnings is expected to be 20 percent annually until the end of year
4. Investors think that at the end of year 4, the company will pay 60 percent of its
earnings as dividends. The growth rate will reduce to 4 percent. What is the
value of the firm’s share today If the cost of equity capital is 8 percent?

(4 Marks)

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c. GIMINI Inc. has 217 million outstanding shares and expects $860 million
earnings at the end of this year. The company plans to payout 50% of its
earnings in total (paying 30% as a dividend and using 20% to repurchase
shares). If the firm’s earnings are expected to grow by 7.5% per year, and these
payout rates remain constant, determine GIMINI’s stock price. Assume that cost
of equity capital is 10%.
d. (3 Marks)

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Question No. 2 (4+4=8)
a. Mr. James has a commercial land near Monash University. He is planning to
consider the different uses of this land. Recently, he has been approached with
an offer to buy it for $220,000. Moreover, he is also considering three alternative
business projects: X, Y, and Z. He is thinking of operating his business choice
indefinitely. He has collected the following information about the uses.
Alternatives Initial Cash flow in Growth rate Cost of
Investment the First Year (r) capital (r)
(CF1)
X $400,000 $60,000 3.5% 12%
Y $200,000 $40,000 3% 10%
Z $500,000 $75,000 3% 13%

What is his ranking of these projects based on NPV? Where should we rank the
first choice (selling the land) if we take it as NPV? (4 Marks)

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b. Seashore Inc., is assessing the purchase of a new ship. The ship will cost $497
million and will operate for 20 years. The company estimates annual cash flows
from operating the ship to be $71.1 million, and its cost of capital is 12.5%.
a) Calculate the NPV and IRR of the purchase.
b) Prepare an NPV profile of the purchase and highlight the IRR.
c) Should the company proceed with the purchase?
d) How far off could the firm’s cost of capital estimate be before your
purchase decision would change? (4 Marks)

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Question NO. 3 (5+5+6=16)
a. Mr. Jerry is working on the evaluation of a new project for his company. In year 3
of his evaluation, he estimates that sales and cost of sold would be $5.8 million
and $3.48 million, respectively. The cost of the machine is $1 million, and it would
depreciate using the straight line method for a useful life of 5 years. The
corporate tax rate is 35 percent. Moreover, he expects an increase in working
capital from $210,000 in year 2 to $305,000 in year 3. What are the pro forma
earnings and cash flows for year 3?

(5 Marks)
b. Mr. Neale is planning to upgrade to better production equipment for his firm. This
will help him to make more of his product in the same amount of time. Thus, he
forecasts that total sales will increase next year by 18% over the current amount
of 110,000 units. If the selling price is $21 per unit, what are the incremental
revenues next year from this upgrade?
(5 Marks)
c. Suppose Intel stock has a beta of 1.6, whereas Boeing stock has a beta of 1. If
the risk-free interest rate is 4% and the expected return of the market portfolio is
10%, according to the CAPM,
a) What is the expected return of Intel stock?
b) What is the expected return of Boeing stock?
c) What is the beta of a portfolio that consists of 60% Intel stock and
40% Boeing stock?
d) What is the expected return of a portfolio that consists of 60% Intel
stock and 40% Boeing stock? (Show both ways to solve this.)
(6 Marks)

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Question NO. 4 (10+5=15)
a. Currently, the XYZ firm has a share price of $20. Next year, the firm is expected
to pay a $1 dividend per share. After that, the dividends will grow at 4 percent
per year.

a) What is an estimate of the firm’s cost of equity?

b) The firm also has preferred stock outstanding that pays a $2 per share
fixed dividend. If this stock is currently priced at $28, what is firm’s cost
of preferred stock?
c) The company has an existing debt issued three years ago with a
coupon rate of 6%. The firm just issued new debt at par with a coupon
rate of 6.5%. What is the pretax cost of debt of the company?
d) The company has 5 million common shares outstanding and 1 million
preferred shares outstanding, and its equity has a total book value of
$50 million. Its liabilities have a market value of $20 million. If firm’s
common and preferred shares are priced as in parts (a) and (b), what
is the market value of the firm’s assets?
e) The company faces a 35% tax rate. Given the information in parts (a)
through (d), and your answers to those problems, what is XYZ’s
WACC?
f)
(10 Marks)

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b. You are an entrepreneur starting a biotechnology firm. If your research is
successful, the technology can be sold for $21 million. If your research is
unsuccessful, it will be worth nothing. To fund your research, you need to raise
$4.8 million. Investors are willing to provide you with $4.8 million in initial capital
in exchange for 40% of the unlevered equity in the firm.
a) What is the total market value of the firm without leverage?
b) Suppose you borrow $0.4 million. According to MM, what fraction of the
firm’s equity must you sell to raise the additional $4.4 million you need?
c) What is the value of your share of the firm’s equity in cases (a) and (b)?
d)

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 (5 Marks)

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Formula Sheet

Week 2 – Corporate Financial Mathematics 1

 FV (Single CF)=C ( 1+r )n

C
 PV (Single CF)=
( 1+r )n

C1 C2 CN
 PV (mutiple CFs)=C0 + + +…+
( 1+r ) ( 1+r ) 2
( 1+r )N

C
 PV ( Ordinary Perpetuity )=
r
C
 PV ( Perpetuity Due )=C +
r

 PV (Ordinary Annuity )=
C
r
1−
( 1
( 1+r ) N )
 PV (Annuity Due)=
C
r (
1−
1
( 1+r )N
(1+ r )
)
C
 FV (Ordinary Annuity )= ( ( 1+ r )N −1 )
r
C
 FV ( Annuity Due )= ( ( 1+r ) N−1 ) (1+r )
r

Week 3 – Corporate Financial Mathematics 2

C
 PV ( Growing Ordinary Perpetuity )=
r−g

( ( ))
N
 C 1+ g
PV (Growing Ordinary Annuity)= 1−
r−g 1+ r

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 PV
C( Ordinary Annuity)=

( ( ))
❑
 1 1
1−
r (1+r )N

( )
m
 APR
1+ EAR= 1+ =(1+ EPR)m
m

APR
 EPR=
m
Nomin al Rate−Inflation Rate
 Real rate= ≈ Nominal−Inflation Rate
1+Inflation Rate

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Week 4: Bond and Stock Valuation
Coupon Rate × Face Value
 CPN =
Number of Coupon Payments per Year

( )
1/ n
 Face Value
1+YTM n =
Price

 P=CPN ×
1
y
1−
( 1
( 1+ y ) N
+
)FV
( 1+ y )N
¿1 + P1−P0 ¿1 P1−P0
 R E= = +
P0 P0 P0
¿1 ¿2 ¿N PN
 P 0= + 2
+ …+ N
+ N
1+r E ( 1+r E ) ( 1+r E ) ( 1+r E )
¿1
 P 0=
rE
¿1
 P 0=
r E−g
¿1 ¿2 ¿N 1 ¿
 P 0= + + …+ +( ) N +1
( 1+r E ) ( 1+ r E ) r E−g
2 N N
1+r E ( 1+r E )

Week 5 – Investment Decision Rules

 NPV =PV ( Projec t ' sfuture cash flows ) −PV (Projec t ' scosts)
C1 C2 CN
 NPV =C0 + + +… .+
(1+r ) (1+r )2
(1+r )
N

Terminal value inflows

 PV outflows = N
(1+ MIRR)
Remaining cost
 Payback period=Years before cost recovery +¿ recover ¿
Cashflow during the year

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 PV
EAA=

( ( ))
N
1 1
1−
r 1+r

ValueCreated NPV
 Profitability Index= =
Resource Consumed Resource Consumed

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Week 6 – Fundamentals of Capital Budgeting and Working Capital Management

Incremental Earnings= ( Incremental Revenues−Incremental Cost −Depreciation ) × (1−Tax Rate )


FreeCash Flow= ( Revenues−Costs−Depreciation ) × ( 1−Tax Rate ) + Depreciation−CapEx−Change∈ NWC
+ After tax CF ¿ asset sale(if any)−Oppotuinity Cost (if any )

 Net working capital=Cash+ Inventory + Receivables−Payables

 After −taxCash flow ¿ Asset Sale=Sale Price−( Tax Rate ×Capital Gain )

 Capital Gain=Sale Price−Book value

 Book value=Purchase Price−Accumulated Depreciation

Accounts payable
 Accounts payable days=
Average Daily Cost of Goods Sold(¿ purchases i f given)

Inventory
 Inventory Days=
Average Daily Cost of Goods Sold

Accounts Receivable
 Accounts Receivable Days=
Average Daily Sale s

 Operating cycle=Inventory days+ Accounts receivable days

 Cash conversion cycle=Operating cycle−Account payable days

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Week 8 – Risk and Return

¿t +1 +Pt +1−Pt ¿t +1 Pt +1−Pt

 Rt +1= = + =Dividend yield+ CapitalGain Yield
Pt Pt Pt

1
 Ŕ= ( R +R +…+RT )
T 1 2

 Var ( R )=
1
T −1
( [
R 1− Ŕ ) + ( R 2− Ŕ ) +…+ ( RT − Ŕ )
2 2 2
]
Pr ( Ri )
 [
[¿ ( R1 −Ŕ ) + ( R2 −Ŕ ) +…+ ( R T − Ŕ ) ]
2 2 2
]
Var ( R i )=∑ ¿

SD ( Ri ) ×Corr ( Ri , R Mkt )
 β i=
SD ( R Mkt )
Value of Investment i
 ωi =
Total Valueof Portfolio

 E [ RP ] =ω1 E [ R1 ] +ω2 E [ R2 ]+ …+ω n E [ Rn ]

 Var ( R P ) =ω 21 SD ( R 1) 2+ω22 SD ( R2 )2 +2 ω1 ω2 Corr ( R 1 , R2 ) SD ( R1 ) SD ( R2 )

 √ 2 2
σ ( R P )= ω 21 SD ( R1 ) +ω22 SD ( R2 ) +2 ω 1 ω 2 Corr ( R1 , R2 ) SD ( R 1) SD ( R 2 )

 E ( Ri )=r f +β i ( E [ R Mkt ]−r f )

 B P =ω1 β 1+ω2 β 2 +…+ωn β n

Week 9 – The Cost of Capital

¿ pfd
 Cost of preferred stock capital=
P pfd

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 ¿1
 Cost of equity= +g
PE

 r wacc =r E E % +r pfd P % +r D ( 1−T C ) D%

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Week 10 – Capital Structure
 V =V + PV ( Interest Tax Shield )
L U

 L
V =D+ E
 Interest Tax Shield=Corporate Tax Rate × Interest Payments

 PV ( Interest Ta x Shield )=PV ( T C × Future Interest Payments )

 PV ( Interest Tax Shield of Permenant Debt ) =T C × D

D
 r E=r U + ( r −r )
E U D
D
 r E=r U + ( r −r ) ( 1−T C )
E U D
E D
 r wacc =r E +r D ( 1−T C )
E+D E+D

 V L =V U + PV ( Interest Tax Shield ) −PV ( Financial Distress Costs )

Market value of equity
 Number of shares outstanding =
Stock price
Market Value of Equity
 Price per share=
Shares Outstanding

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