Corporate Finance - Study Material with Solved Assignments.
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This text provides study material on Corporate Finance covering topics such as NPV computation, WACC, fair value of stocks, and more. It includes solved assignments and essays. The text does not mention any specific course code, college or university.
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Question 1 a) For the given situation, the value of the future payments can be estimated using a formula which highlights the present value of all the future annuity payments expected to begin from the next month. For the situation and hand, P is $ 3,600 with r as 1% per month and the time being 24 months with monthly deposits. b) The objective is to highlight the total interest that has been paid over the complete maturity period of 12 years. It is known that the face value of these bonds is $ 10,000 with a coupon payment of 10% p.a. and coupon is paid annually. a) Case 1: Simple Interest A key characteristic of simple interest is that there is no compounding of interest owing to which the quantum of interest does not alter on a y-o-y basis (Petty et. al., 2015). Annual interest outflow for the company = 10% * 10,000 = $ 1,000 Total interest outflow corresponding to the maturity of the bond = 1,000*12 = $12,000 b) Case 2: Compound Interest A key characteristic of compound interest is that owing to compounding the interest keeps on increasing on a y-o-y basis.As a result, the total amount paid as interest would be future value of annuity payment of annual interest of $ 1,000 paid over a 12 year period which is computed below (Damodaran, 2015). It is evident that in this scenario, the interest paid during the same period is significantly higher.
c) The information provided in respect of the used capital sources and the computation of their respective weight is highlighted as follows. It is evident that for the computation of the respective weights of each capital, the market value has been used instead of the book value as incremental capital needs to be raised in the present. The weight is determined by dividing the market value of capital by the total market value of capital. The cost corresponding to various capitals is highlighted as follows. Cost of equity capital = 12% per annum Cost of preference capital = 10% per annum Cost of debt (before tax) = 8% per annum Cost of debt (After tax) = (1-30%)*8% = 5.6% per annum The WACC computation based on the information provided is stated as follows. Question 2 a) In order to comment on the viability of the project, NPV computation ought to be performed in the wake of expected cashflows and also the rate of return expected. This is highlighted as follows. A positive NPV is testimony of the financial viability of the project and therefore I would go ahead with Project A (Brealey, Myers and Allen, 2014).
b) In order to comment on the viability of the project, NPV computation ought to be performed in the wake of expected cashflows and also the rate of return expected. This is highlighted as follows. The given project would result in reduced cash outflow in regards to labour cost whose PV over the project life time (i.e. 15 years) has been computed below. A positive NPV is testimony of the financial viability of the project and therefore I would go ahead with Project B (Damodaran, 2015). c) Since the projects are mutually exclusive, hence the one that is better requires to be selected. The appropriate selection criterion would be NPV which by referring to part (a) and (b) clearly highlight is higher for Project A. As a result, Project A should be chosen if the two projects are mutually exclusive (Petty et. al., 2015). d) The given statement is not correct as there are certain situations when the results obtained from NPV and IRR are not the same. A typical example of such a project would be one where after the beginning of the project, atleas.t one year would be there when there would be net cash outflow. In the given scenario, there would be multiple IRR values produced and hence there would be divergence in the decision produced by NPV and IRR (Parrino and Kidwell, 2014). Question 3 A key issue in investing is to determine if the stock is fairly valued or not, In this regards , the key requisite input is to determine the fair value of the stock based on the present and future information and guidance provided by the management. This is imperative as financial markets are typically inefficient and hence there is an aberration between the market value and fair value (Brealey, Myers and Allen, 2014). Stock is undervalued if Fair value > Market value Stock is overvalued if Fair value < Market value
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The overvaluation or undervaluation of stocks tends to arise only because of the financial markets being inefficient. Take for example the Wesfarmers stock which is trading at AUD 32. If the fair value of the stock is AUD 40, then it would be fair to conclude that this stock is undervalued and hence in the long term price would appreciate to bridge the divergence. The key differences between fundamental analysis and technical analysis are indicated below (Petty et. al., 2015). ï‚·Technical analysis is used to initiate short term trades unlike fundamental analysis which is used to initiate long term investment calls. ï‚·The technical analysis is based on the premise that the future stock price movement is afunctionofpaststockprices.However,fundamentalanalysistakesinto consideration whether the stock is undervalued or overvalued and then tends to make the requisite call. ï‚·Both fundamental and technical analysis have relevance only in an inefficient capital market.
References Brealey, R. A., Myers, S. C. and Allen, F. (2014)Principles of corporate finance, 6thed.New York: McGraw-Hill Publications Damodaran, A. (2015).Applied corporate finance: A user’s manual3rd ed. New York: Wiley, John & Sons. Parrino, R. and Kidwell, D. (2014)Fundamentals of Corporate Finance,3rd ed. London: Wiley Publications Petty, J.W., Titman, S., Keown, A., Martin, J.D., Martin, P., Burrow, M. and Nguyen, H. (2015). Financial Management, Principles and Applications, 6thed.. NSW: Pearson Education, French Forest Australia