Business Finance: Analysis of WACC and NPV for Funding Options

This report analyzes the weighted average cost of capital (WACC) and net present value (NPV) for two funding options in business finance. It provides recommendations for Kidman Resource Management and discusses the analysis of beta risk.

Business Finance
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Contents
Business Finance.............................................................................................................................1
Executive Summary.........................................................................................................................3
Main Body.......................................................................................................................................4
Tables showing the calculation of Kidman WACC Using Market data......................................4
Tables showing the calculation of NPV for Both the options.....................................................6
Recommendation to the Kidman resource management as to which alternative the Company
should adopt.................................................................................................................................9
Analysis of Beta risk and the recommendation for the above.....................................................9
References......................................................................................................................................10
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Executive Summary
Business finance is considered as main activity of the company so as to operate their
daily obligations. As there are various sources of finance that are available for the company
hence they have to choose from the source which provides them maximum return and also cost
minimum to them. As in the case of TESLA Inc. this is seen that they had two option of
financing so as to promote their business hence they performed the an analysis such as weighted
average cost of capital to consider the information and the Net present value that they will get
from the funding source. Hence various funding options are available for the company which are
detailed in this report of which building a refinery and outsourcing the supply of ore is
considered two options for the same.
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Main Body
Tables showing the calculation of Kidman WACC Using Market data
Calculation of Weighted Average Cost of Capital for Option A, this is calculated as below:
1) Cost of ordinary shares by CAPM (Ke)
Formula for the same, Ke= Rf+(Rm-Rf)β
Rf 0.0238
Rm 7.80%
β 1.5409
hence Ke 2.38+(7.80-2.38)1.5409
which gives you 10.73%
2) Cost of the Preference shares (Kp)
0.5/0.7 0.07143
3) Cost Of Overdraft
Interest rate on Bank overdraft 6% P.a
Interest rate after tax 6(1-.028)%= 4.32%
Interest to be paid semi annually
Hence the effective cost [(1+4.32/2*100)^2-1)*100]= 4.38% p.a
4) Cost of Unsecured notes
Interest on unsecured notes 2.8% p.a
After tax cost on unsecured notes 2.8(1-.28)= 2.016
interest is to be paid semi-annually and the unsecured notes will mature in six months
therefore the effective cost [91+2.016/2*100)^1-1]= 1.08% p.a
5) Cost of Debenture
Interest rate on Debentures 8.5% p.a
After tax cost on debentures 8.5(1-.28)% = 6.12%
Interest is to be paid semi annually
therefore the effective cost would be [(1+6.12/2*100)^2-1]*100 = 6.21% p.a
6) Cost of term loan
Interest rate on the term loan 6% p.a
After tax interest 6(1-.28)% = 4.32%
therefore the effective cost [(1+4.32/2*100)^2-1)]*100 = 4.37%
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p.a.
7) Cost of Mortgage
Interest rate on Mortgage 5.25% p.a.
After tax Interest rate 5.25(1-.28) = 3.78% p.a
therefore the effective cost that is calculated for this
is [(1+3.76/2*100)^2-1)*100 = 3.82% p.a.
8) Calculation of WACC
Calculation of Weighted Average cost of capital
Name of the security Amount Cost percentage Weighted cost
Ordinary Shares 810 10.73% 86.913
Preference shares 1.5 7.14% 0.107
Bank overdraft 4 4.37% 0.1748
Unsecured Notes 7 1.08% 0.0756
Cost of debentures 16 6.21% 0.9936
Term Loans 8 4.37% 0.3496
Mortgage Loan 17 3.82% 0.6494
Total 863.5 89.268
Weighted average cost of
capital
Weighted
cost/Amount*100
89.263/863.5*100 =
10.33%
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Tables showing the calculation of NPV for Both the options
Calculation of Net present Value
500 tonnes for 3 years to tesla Inc.
Option 1 for the same
Initial year Amounts
Cost of the Refinery $25Mn
Processing Plant $5Mn
Floatation Machines $15Mn
Cost of Fleet $1 Lac per year
Working capital $2Mn
Employees cost $ 3Mn per year
Engineer Cost 60,000*5 = 300,000 or .03mn per year
Revenue $16Mn In 1st year
$16.4Mn in second Year
$16.81Mn in third year
Salvage value $9Mn
Hence from the table below this can be seen that,
Particulars 1 2 3
Sales 16 16.4 16.81
minus ACED -3.3 -3.3 -3.3
minus OC -0.1 -0.1 -0.1
Profit before Depreciation 12.6 13 13.41
Minus Depreciation -12 -12 -12
Profit before tax 0.6 1 1.41
Minus Tax -0.168 -0.28 -0.3948
Profit after Tax 0.432 0.72 1.0152
Plus Depreciation 12 12 12
12.432 12.72 13.0152
Last year terminal tax gain 8.48
Total 21.495
Last year terminal 9
Minus tax on gain (28%) -2.52
Plus weighted Cost 2
8.48
Cash Outflow in the Year Zero 25+5+15+2= 48
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year cash outflow
cash
inflow PVF 10.339
0 -48
1 12.432 0.906
11.2633
9
2 12.72 0.822
10.4558
4
3 21.4952 0.744 15.9924
Total
37.7116
3
Net present value = Present value of Cash inflow - present value of Cash outflow
= 37.711632-48
= -10.288368
As this is seen that the figure is showing the negative figure hence this is considered as
Unfavourable
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Option 2
Zero year
Total cost = $30Mn
20% in advance
Remaining in equal Instalment
Cost - 4.5 Mn $ year
(Processing)
Year cost
Revenu
e
Revenu
e Tax PAT
0 -6 -6 -6
1 -8 -4.5 16 3.5 0.98 2.52
2 -8 -4.5 16.4 3.9 1.092 2.808
3 -8 -4.5 16.81
4.3
1
1.206
8
3.103
2
Year Cash outflow
Cash
Inflow
Present Value
Factor
0 -6
1 2.52 0.906
2.2831
2
2 2.808 0.822 2.3081
3 3.1032 0.744 2.3087
Total 6.9
Net Present value = Present Value of Cash Inflow- Present value of Cash Overdraft
= 6.9-6
=.90
Hence this is showing positive figure.
Therefore this can be seen from the above data that option 2 better.
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Recommendation to the Kidman resource management as to which alternative the Company
should adopt.
This is seen that WACC is considered as the calculation of the firms cost of capital which is
determined by the company’s capital resources that they are using (Baker and Wurgler, 2015).
This may be included through all the sources of the resources such as the common stock,
preferred stocks, bonds and the other long term debt which are included here in for calculation
WACC.
The firms WACC increases as and after the Beta of the company increases as WACC denotes a
decrease in the valuation and also results in the increase in the risk (Frank and Shen, 2016).
As this is seen in the case of Kidman resource managements where the company has to achieve
the objective of minimising the cost of capital and increasing the output so as to satisfy the return
on the capital that is sourced by the company (Cenesizoglu, Ribeiro and Reeves, 2017). While
this is also seen that WACC of the company is 10.33% hence this is seen that cost of capital is
greater in this context and it would not be good for the company to use the funds at this rate as
this would lead to decrease the earning of the shareholders and would also lead to decrease in
profits. Hence this is recommended to Kidman resource management to use Outsource the
supply ores for the purpose.
Analysis of Beta risk and the recommendation for the above.
Beta coefficient is considered as the measure which is provided so as to consider the volatility of
the stock of the company and the return that this stock would provide so as to achieve the
objective of maximising the sales (Chincarini, Kim and Moneta, 2018). As this is given in the
situation that the Beta of the company would change significantly due to some of the Unforeseen
events that occur in front of them, which resulted in the increase in Beta from the current Beta to
20% higher which is not good for the company as this is seen that higher Beta means higher
Volatility in the company and due to which the cost of equity of the company would also
increase relating to decrease in the profits of the company (Dhaliwal and et. al., 2016). Hence the
company would not be able to give the result as demanded by the investors due to which the
company would lose their investors and as a result financial problem or crisis would come in
front of the company (Shu, Zeithammer and Payne, 2016).
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References
Books and Journals
Baker, M. and Wurgler, J., 2015. Do strict capital requirements raise the cost of capital? Bank
regulation, capital structure, and the low-risk anomaly. American Economic Review, 105(5),
pp.315-20.
Cenesizoglu, T., Ribeiro, F.D.O.F. and Reeves, J.J., 2017. Beta forecasting at long
horizons. International Journal of Forecasting, 33(4), pp.936-957.
Chincarini, L.B., Kim, D. and Moneta, F., 2018. Beta, Firm Age, and Estimation Risk. Available
at SSRN 2821852.
Dhaliwal, D., Judd, J.S., Serfling, M. and Shaikh, S., 2016. Customer concentration risk and the
cost of equity capital. Journal of Accounting and Economics, 61(1), pp.23-48.
Frank, M.Z. and Shen, T., 2016. Investment and the weighted average cost of capital. Journal of
Financial Economics, 119(2), pp.300-315.
Shu, S.B., Zeithammer, R. and Payne, J.W., 2016. Consumer preferences for annuity attributes:
Beyond net present value. Journal of Marketing Research, 53(2), pp.240-262.
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