FINS1612 Chapter quiz 2: FINS1612 textbook smmary q2

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5.1 Understand issues related to the capital budgeting investment decision

- Main objective of business corporation is to maximise shareholder value- consider

investment decision (capital budgeting process), financing decision (capital structure

process), management of liquidity and working capital and distribution of profits to

shareholders

- Investment decisions are based on the objectives of the corporation, which state, in part

those activities that the business intends to conduct. This determines the assets required to

carry out those activities

- Quantitative methods determine profitable activities- NPV, IRR (limitations and rely on

forecasts)

- NPV difference in cost of A/project and PV of future returns (discounted value of future CF,

at the fi’s euied ate of etu o iestet). Aept +e NPV pojets

- IRR is discount rate on a project that results in NPV = 0, if fi’s  is loe tha foeasted

IRR, it may be acceptable → non-conventional CF and mutually exclusive investment

opportunities

5.2 Idetify issues eleat to a opoatio’s fudig hoie etee det ad equity (financing

decision)

- Consider current D/E ratio and associated degree of financial risk. If the ratio is such that

increased debt can be sustained w/out an undue increase in financial risk, it is in the

interests of the shareholders of the expansion to be funded through debt rather than equity

- Debt commitments (interest and principal) must be paid when due. Therefore, a

corporation must forecast the business environment in which it operates and the impact of

changes on future CF

- Once a business reaches an appropriate D/E ratio, further expansion requires additional

equity

5.3 Examine the listing and flotation or IPO of a business on a stock exchange, including equity-

funding alternatives that are available to a newly listed corporation

- Limited liability companies and issue ordinary shares vs. no liability (mining)

- Promoter (party seeking to list), Business advisers w expertise in listing procedures,

appropriate form of incorporation, in preparation of a prospectus, timing, structure and

pricing of share flotation (IPO)

- Underwriters of the issue and ensure its structure meets prereq for admission and

quotation of shares

5.4 Consider important issues associated w listing on stock exchange

- Primary concern of stock exchange is to maintain efficiency and integrity of markets

- Require company seeking admission to stock exchange to comply w exchange listing rules

- Once listed, corporations must continue to comply w rules or risk suspension or de-listing of

securities

- Dual listing on several stock exchanges to access the wider international capital markets and

increase liquidity in trading of securities

5.5 Equity funding alternatives available to an established listed corporation, incl rights issue, share

purchase plans, placements, takeover issues, dividend reinvestment schemes, preference shares,

convertible notes and other quasi-equity securities

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- Additional ordinary shares may be issued on a pro-rata rights basis to existing shareholders-

rights issue usually offered at a discount to current market price, however pro-rata rights

issue requires a prospectus and takes time

- Share purchase plan- offer existing shareholders the opportunity to invest a fixed dollar

amount to purchase additional shares in a company

- Rather than offer additional share to all existing shareholders, some companies prefer a

direct placement of shares with selected institutional investors (does not require

prospectus, only memorandum of information, at smaller discount)

- Additional ordinary shares may also be issued by a takeover company as full payment, or

part payment with cash component, in M&A bid

- Dividend reinvestment- allows shareholders to elect to convert their dividends into new

shares in the company- give existing shareholders the opportunity to increase their equity

holding, usually w/out transaction costs

- Preference shares (hybrid securities)- offer a fixed dividend that is set at issue date and

usually have fixed term to maturity- rank behind creditors in claim on company A.

preference share issue may/may not be cumulative, redeemable, participating, convertible,

or issued w different rankings

- Convertible notes (hybrid securities)- holders receive a predetermined rate of interest on

their investment, however notes may be converted into shares at a future date at a

predetermined price

- Other forms of quasi-equity are company issued options/equity warrants. A company

issued option provides the holder w the right to purchase ordinary shares at a predet price

on a specified date. A company issued warrant may be attached to a corporate bond debt

issue and provides the holder w the right to convert the warrant into ordinary shares in the

issuer company (at predet)- warrants may be detachable and sold separately to host bond

6.1 Consider the role of an investor in the share market, appreciate the wide range of investment

choices that are available, and understand risks associated w investments in shares of listed

corporations.

- A share in a listed company, in part, entitles an investor to receive a return on the

investment in the form of dividends paid and any capital gain or loss accumulated on the

current market value of the share

- Risks associated w share investments are described as systematic and unsystematic

(idiosyncratic). Systematic risk exposures affect the price of most shares listed on a stock

exchange, to a greater or lesser extent. Unsystematic risk specifically impacts on the share

price of individual stocks

- Portfolio theory- unsystematic risk can be diversified out, systematic risk is measured using

beta coefficient (statistical measure of sensitivity of a share price relative to an average

share listed on a stock exchange)

- Investor consider CF and investment characteristics of share- active approach (fundamental

or technical analysis) or passive approach (replicate structure and return of index),

correlation of risk and return between shares

- Share allocation in portfolio will be strategic and tactical

6.2 Detail the process for buying and selling shares + 6.3 taxation in investment decision process

- Direct or indirect investment approach

- Taxation process- income and capital gains tax; dividend imputation system (reduces tax

payable by share holder)

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Document Summary

5. 1 understand issues related to the capital budgeting investment decision. Main objective of business corporation is to maximise shareholder value- consider investment decision (capital budgeting process), financing decision (capital structure process), management of liquidity and working capital and distribution of profits to shareholders. Investment decisions are based on the objectives of the corporation, which state, in part those activities that the business intends to conduct. This determines the assets required to carry out those activities. Quantitative methods determine profitable activities- npv, irr (limitations and rely on forecasts) Npv difference in cost of a/project and pv of future returns (discounted value of future cf, at the fi(cid:396)(cid:373)"s (cid:396)e(cid:395)ui(cid:396)ed (cid:396)ate of (cid:396)etu(cid:396)(cid:374) o(cid:374) i(cid:374)(cid:448)est(cid:373)e(cid:374)t). Irr is discount rate on a project that results in npv = 0, if fi(cid:396)(cid:373)"s (cid:396) is lo(cid:449)e(cid:396) tha(cid:374) fo(cid:396)e(cid:272)asted. Irr, it may be acceptable non-conventional cf and mutually exclusive investment opportunities. 5. 2 ide(cid:374)tify issues (cid:396)ele(cid:448)a(cid:374)t to a (cid:272)o(cid:396)po(cid:396)atio(cid:374)"s fu(cid:374)di(cid:374)g (cid:272)hoi(cid:272)e (cid:271)et(cid:449)ee(cid:374) de(cid:271)t a(cid:374)d equity (financing decision)

Related Questions

Jackson Resources is evaluating 4 major projects which have either two or three year lives. The company has raised all of its capital in the form of equity and has never borrowed money. This is partly due to the success of the business in generating income and partly due to an insistence by the dominant managing director that borrowing is to be avoided if at all possible. Shareholders in Jackson resources regard the company as relatively risky, given its existing portfolio of projects. Other company's share in this risk class have generally given a return of 16% per annum and this is taken as the opportunity cost of capital for the investment projects. The risk level for the proposed projects is the same as that of the existing range of activities.

	Years
Projects (Dollars)	T0	T1	T2	T3
A	-5266	2500	2500	2500
B	-8000	0	0	10000
C	-2100	200	2900	0
D	-1975	1600	800	0

Ignore taxation and inflation.

1.1 The managing diretor has been on a one-day intensive course to learn about project appraisal techniques. Unfortunately, during the one slot given over to NPV he had to leave the room to deal with a business crisis, and therefore does not understand it. He vaguely understands IRR and insists that you use this to calculate which of the 4 projects should be proceeded with, if there are no limitations on the number which can be undertaken. (10 marks)

1.2 Sate which is the best project if they are mutually exclusive (i.e accepting one excludes the possibility of accepting others) using IRR. (3 marks)

1.3 Use the NPV decision rule to rank the projects and explain why, under conditions of mutual exclusivity, the selected project differs from that under (1.2 above)... (4 marks)

1.4 Write a report for the managing director, detailing the value of the net present value method for shareholder wealth enhancement and explaining why it may be considered of greater use than IRR. (8 marks)

tansea-lion662

1. Which of the following is true?

The corporation model can be used to value divisions and firms that do not pay dividends.
The discounted dividend model can be used to value divisions and firms that do not pay dividends.
For the discounted dividend model, a firm's weighted average cost of capital is used as the discount rate.
For the corporate valuation model, a firm's cost of equity is used as the discount rate.

Question 2.2. Which of the following is false?

For the constant growth model to hold, a firm's cost of equity needs to be smaller than its constant dividend growth rate (i.e., rs < g).
For the constant growth model to hold, a firm's cost of equity needs to be greater than its constant dividend growth rate (i.e., rs > g).
From the constant growth model, if the constant dividend growth rate is equal to zero, a firm's share price is equal to the constant dividend divided by the cost of equity (i.e., g=0).
If a company's constant dividend growth rate is negative, the formula for the constant growth model cannot be applied.

Question 3.3. From the discussion of a firm's capital budgeting problem in chapter 11, which of the following is false? (Points : 3.5)

The net present value method (NPV) assumes that cash flows are reinvested at the weighted average cost of capital (WACC).
The internal rate of return method (IRR) assumes that cash flows are reinvested at the internal rate of return.
The modified internal rate of return method (MIRR) assumes that cash flows are reinvested at the weighted average cost of cpaital.
For mutually exclusive projects, if there is a conflict between NPV and IRR, the project with the highest IRR is chosen.
The IRR is independent of a firm's weighted average cost of capital.

Question 4.4. Which of the following is true? (

As a firm's dividend payout ratio increases, the firm's WACC decreases.
The WACC only represents the "hurdle rate" for a typical project with average risk. Therefore, the project's WACC should be adjusted to reflect the project's risk.
Firms with riskier projects generally have a lower WACC.
Holding all else constant, an increase in the target debt ratio tends to lower the WACC.

Question 5.5. Which of the following is false?

If interest rates rise, the price of the bond will rise and its YTM (yield to maturity) will fall.
Short-term bond prices are less sensitive than long-term bond prices to interest rate changes.
Companies are not likely to call bonds unless interest rates have declined significantly. Thus, the call provision is valuable to firms but detrimental to long term investors.
On balance, bonds that have a sinking fund are regarded as being safer than those without such a provision.

Question 6.6. Which of the following is not true? (Points : 3.5)

According to SML (security market line), the risk premium on a high-beta stock would increase more than that on a low-beta stock.
If beta < 1.0, the security is less risky than average.
According to the Security Market Line (SML), in general, a companyâs expected return will double when its beta doubles.
According to the Security Market Line (SML), if a portfolio of real world stocks has a beta of zero, the required rate of return for the portfolio is equal to the risk-free rate.

Question 7.7. P&G Industries bonds have a maturity of 15 years with a $1,000 face value, have an 8% semiannual coupon, are callable in 10 years at $1,125, and currently sell at a price of $1,105. What is their nominal annual yield to call?

6.87%.
7.37%.
11.05%.
8.32%.

Question 8.8. Which of the following is not the flaw (weakness) of the discounted payback method? (Points : 3.5)

It does not tells us by how much the project should increase shareholder wealth, or by how much a project yields over the cost of capital; it merely tells us when we recover our investment.
It ignores cash flows occurring after the payback period.
It ignores the time value of money, that is, dollars received in different years are all given the same weight.

Question 9.9. Jermey Lin has $52,500 invested a stock with a beta of 0.80 and another $47,500 invested in a stock with a beta of 3.2. If these are the only two investments in his portfolio, what is his portfolio's beta?

1.56.
1.82.
2.00.
1.94

Question 10.10. According to CAPM, if the required rate of the return of Stock A obtained from the security market line (SML) is less than the expected rate of the return of stock A from the capital market transaction, then stock A is

fairly priced.
undervalued.
overvalued.

Question 11.11. Determine the yield-to-call (to nearest 0.1 of a percent) of an LTV bond with a 12 percent coupon, that pays interest annually. The bond can be called in 5 years, has a call premium of $114, and is currently selling for $912.50. The bond has a face value of $1,000.

14.58%.
13.92%.
16.34%.
12.17%.

Question 12.12. Project M costs $1,000, its expected cash inflows are $500 per year for 3 years, and its WACC is 11%. What is the project's NPV? (Points : 3.5)

$259.57.
$221.86.
$195.23.
$257.35.

Question 13.13. Project J costs $1,025, its expected cash inflows are $425 per year for 3 years, and its WACC is 10%. What is the project's IRR?

12.58%.
10.82%.
11.76%.
9.64%.

Question 14.14. Project X costs $6,750, its expected cash inflows are $1250 per year for 10 years, and its WACC is 10%. What is the project's payback?(Note, the regular payback is asked in this question, not the discounted payback.) (Points : 3.5)

5.40 years.
10 years.
4.58 years.
6.12 years.

Question 15.15. Project S costs $800, its expected cash inflows are $350 per year for 3 years, and its WACC is 7%. What is the project's MIRR?

13.97%.
12.04%.
14.93%.
9.15%.

Question 16.16. Project Y costs $650, its expected cash inflows are $500 per year for 5 years, and its WACC is 10%. What is the project's discounted payback?

1.47 years.
1.24 years.
1.62 years.
1.15 years.

1. Which of the following is true?

Question 2.2. Which of the following is false?

Question 3.3. From the discussion of a firm's capital budgeting problem in chapter 11, which of the following is false?

Question 4.4. Which of the following is true? (Points : 3.5)

Question 5.5. Which of the following is false? (Points : 3.5)

Question 6.6. Which of the following is not true? (Points : 3.5)

6.87%.
7.37%.
11.05%.
8.32%.

Question 8.8. Which of the following is not the flaw (weakness) of the discounted payback method? (Points : 3.5)

1.56.
1.82.
2.00.
1.94

fairly priced.
undervalued.
overvalued.

14.58%.
13.92%.
16.34%.
12.17%.

Question 12.12. Project M costs $1,000, its expected cash inflows are $500 per year for 3 years, and its WACC is 11%. What is the project's NPV?

$259.57.
$221.86.
$195.23.
$257.35.

Question 13.13. Project J costs $1,025, its expected cash inflows are $425 per year for 3 years, and its WACC is 10%. What is the project's IRR? (

12.58%.
10.82%.
11.76%.
9.64%.

5.40 years.
10 years.
4.58 years.
6.12 years.

Question 15.15. Project S costs $800, its expected cash inflows are $350 per year for 3 years, and its WACC is 7%. What is the project's MIRR? (

13.97%.
12.04%.
14.93%.
9.15%.

Question 16.16. Project Y costs $650, its expected cash inflows are $500 per year for 5 years, and its WACC is 10%. What is the project's discounted payback?

1.47 years.
1.24 years.
1.62 years.
1.15 years.

Can somebody help me do the analysis for this capital budgeting case study? I've got everything calculate but I know what to write for the analysis

The questions that pertain to the analysis section are to help you in how you approach the analysis and drive the narrative of the analysis.

Third and Final Section â The Decision. In the a directed case, this would include those questions that pertain directly to the decision. Make your recommendation to your audience.This section can also contain any commentary relevant to the case and decision.

Based on your computations in requirement number one, which projects should be accepted? Note: Projects Exp2015-A, Exp2015-B and Exp2015-C are mutually exclusive.

	EXP2015-A	Exp215-B	Exp2015-C	TT2015-A	BH2015-A
Pay back period (years)	3.53 years	2.85 years	3.77 years	4.83 years	2.75 years
Net Present Value	527,068	278,826	1,557,757	316,521	263,743
IRR	25.26%	20.87%	23.21%	16.03%	23.93%
MIRR	16.39%	13.57%	15.66%	12.88%	17.47%
PI	1.7	1.33	1.60	1.25	1.36

Viking Freight Forwarding, LLC is a family run operation. It is owned by the Ostrem family, with the 2 Ostrem brothers and 1 sister making up the upper level management team. Tom Bertram, son-in-law of the youngest Ostrem brother, has been hired as the assistant financial vice president of the firm. His primary duties are to evaluate capital budgeting projects and other related long term projects of the operation.

Bertram is currently undertaking an analysis of five major capital budgeting projects for the coming year. All of the projects except for the Ankeny Satellite Terminal project would have the same level of risk as the other long term assets of the firm. Descriptions of the five projects are below and estimate of expected cash flows for each project is outlined in Table 1.

Project Exp2015-A: Expansion of existing facilities at Des Moines Terminal.

Viking Freight Forwarding operates primarily as a bonded freight forwarder, and thus must provide rapid delivery, on short notice, of freight temporarily stored in its bonded warehouse located on Guthrie Avenue on Des Moinesâ eastside. The terminal has six existing loading docks and this number is often insufficient for the amount of freight that must be forwarded for prompt delivery.

Because of growth in business, Viking has been unable to meet the needs of its customers on a number of occasions because of backlogs at the loading docks. Firms have begun using other freight forwarders in the area and is starting to have an effect on the revenues of the firm.

Project Exp2015-A calls for the building of an annex to the existing warehouse; the annex would provide 3 new loading docks and 5,000 square feet of additional storage space. This would take some time to construct and the amount of lost revenues would continue to mount so that the recouping the lost revenues would be spread out over a longer time period. However, the additional storage space would allow for more growth in the future.

Project Exp2015-B: Alternative expansion of existing facilities at Des Moines Terminal.

Project Exp2015-Bis to simply add 3 additional loading docks to the existing building. This would significantly reduce the construction time relative to project a so that lost revenues could be recouped faster. However, no additional storage space would be added. Project Exp2015-Bwould disrupt the current operation more and the warehouse layout would have to be reconfigured, so that the total cost of the project would be the same as Project Exp2015-A. While the cash inflows would be more rapid, the projects life would be much shorter. This solves the immediate problem but does not address the growth issue.

Project Exp2015-SAT: Build a new satellite terminal in Ankeny

Rather than expanding at the current Guthrie Avenue location, Bertram is considering building a satellite terminal in the industrial park in Ankeny which is located 6 miles from the current location. The current site in Des Moines does not have the potential for extensive expansion so he is considering this expansion in an off-site location. This is a much more expensive project and more risky in that excess capacity will be built and coordinating shipments will be more difficult

Project TT2015-A: Purchase of Three New Tractor-Trailers.

An increase in business has not only caused backlogs at the loading docks but also has forced Viking to lease tractor-trailers since they have insufficient quantity of their own. This increases the cost of transportation as well as making it difficult to do regularly scheduled maintenance on their tractor-trailers since they are being fully utilized with little down time. Project TT2015-A would alleviate this problem.

Project BH2015-A: Special equipment for handling bulk commodities.

A profitable capital investment made in 1990 to handle bulk commodities and forward them by rail would be upgraded under Project BH2015-A. This would involve the installation of a movable conveyor belt to increase rail car loading efficiency by reducing current labor costs.

Table 1	Mutually			Exclusive	Independent	Independent


	Project	Project		Project	Project	Project
	Exp2015-A	Exp2015-B		Exp2015-C	TT2015-A	BH2015-A
CFo	$(750,000.00)	$(840,000.00)		$(2,600,000.00)	$(1,250,000.00)	$(720,000.00)
1	$ 195,000.00	$ 275,000.00		$ 625,000.00	$ 258,900.00	$ 261,900.00
2	$ 225,000.00	$ 295,000.00		$ 650,000.00	$ 258,900.00	$ 261,900.00
3	$ 214,500.00	$ 315,900.00		$ 750,000.00	$ 258,900.00	$ 261,900.00
4	$ 216,500.00	$ 200,000.00		$ 750,000.00	$ 258,900.00	$ 261,900.00
5	$ 229,400.00	$ 110,000.00		$ 775,000.00	$ 258,900.00	$ 261,900.00
6	$ 219,400.00	$ 90,000.00		$ 800,000.00	$ 258,900.00
7	$ 210,400.00	$ 90,000.00		$ 675,000.00	$ 258,900.00
8	$ 205,400.00	$ 80,000.00		$ 650,000.00	$ 258,900.00
9	$ 195,400.00	$ 80,000.00		$ 625,000.00	$ 258,900.00
10	$ 185,400.00	$ 70,000.00		$ 500,000.00	$ 258,900.00
			Note all cash-flows are on an after tax basis.

The existing capital structure uses very little debt and relies mostly on retention of earnings and additional equity provided by the Ostrem family. While Bertram believes that the cost of capital could be reduced by changing the capital structure to include more debt, the current capital budget must be analyzed using the existing capital structure and the relevant component costs. See Table 2 for the cost of capital and the current capital structure.

	Table 2	Cost of capital and capital structure		Component
			weight	cost
Present		Debt	40%	7%
		Common Equity	60%	14%
		Tax rate =30%

FINS1612 Chapter quiz 2: FINS1612 textbook smmary q2

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