Corporate Finance - Present Value of Annuity, Bond Issues, WACC, NPV, IRR, Stock Valuation, Technical and Fundamental Analysis

This article covers topics such as Present Value of Annuity, Bond Issues, Weighted Average Cost of Capital (WACC), Net Present Value (NPV), Internal Rate of Return (IRR), Stock Valuation, Technical and Fundamental Analysis in Corporate Finance.

CORPORATE FINANCE
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Question 1
PART A
The formula for present value of annuity is indicated as follows (Damodaran, 2015).
Based on the given information, P = $3,600, r= 12% p.a but owing to monthly compounding
1% per month, n = 24 months
Hence, PV of annuity = 3600*(1-1.01-24)/0.01 = $ 76,476.19
PART B
The relevant details about the bonds issues are highlighted below.
Face value = $ 10,000
Time to maturity = 12 years
Interest rate = 10% p.a.
a) If simple interest is charged, then the interest paid would be same every year
Hence, interest paid over 12 years = P*R*T = 10000*10%*12 = $ 12,000
b) If compound interest is charted, then the interest paid would keep increasing every year.
Thus, the future value of a annuity paying $ 1,000 every year for 12 years needs to be
computed. The relevant formula is indicated.

For the given situation, P = $1,000, n =12, r=10%
Hence, total interest paid over 12 years = 1000*(1.112-1)/0.1 = $21,834.28
PART C
Market value of equity = $46.6 mn
Market value of long term debt = $35 mn
Market value of preference shares = $ 10.3 mn
Total capital used = 46.6 + 35 + 10.3 = $ 91.9 million
Weight of equity = (46.6/91.9) = 0.507
Weight of long term debt = (35/91.9) = 0.381
Weight of preference shares = (10.3/91.9) = 0.112
Cost of equity = 12% p.a.
After tax cost of debt = 8%*(1-0.3) = 5.6% p.a/
Cost of preference shares = 10%
WACC = 0.507*12% + 0.381*5.6% + 0.112*10% = 9.34%
Question 2
a) In order to ascertain, if Project A is feasible or not, NPV needs to be computed. The
discount rate would be taken as 20%.

NPV = -6000 + (2200/1.2) + (2200/1.22) + (2200/1.23) + (2200/1.24) + (2200/1.25) +
(2200/1.26) = $ 1,316.12
As per the NPV of project A is positive, I will go ahead with this project.
b) In order to ascertain, if Project B is feasible or not, NPV needs to be computed. The
discount rate would be taken as 25%. The annual cash inflow for the project from Year 1 to
Year 15 would be $ 4,200 owing to savings in labour cost.
The present value of annuity of $ 4,200 for a period of 15 years = 4200*(1-1.25-15)/0.25 = $
16,208.9
Hence, NPV = -15,000 + 16,208.9 = $ 1,208.90
As per the NPV of project B is positive, I will go ahead with this project.
c) If these are mutually exclusive projects, then only one of the projects can be selected. The
superior project between the two would be one which would produce a higher NPV. The
NPV is higher for Project A and hence it would be considered as the preferred project
between the two projects presented (Petty et. al., 2015).
d) IRR and NPV usually give the same results but this is not always the case. An example of
this is when there is net outflow in the project in any given year besides the starting. In such
cases, it is possible that IRR would give two values and hence the underlying result would be
different from NPV. The main reason for this difference is on account of IRR assumption that
money would be invested as the same rate as IRR which may not be practical (Parrino and
Kidwell, 2014).
Question 3
In order to determine whether the stock is undervalued or overvalued, it is imperative that the
market value of the stock is compared with the intrinsic value of the stock which can be
computed using the discounted cash flow and other such techniques. If the market value is
greater than the intrinsic value of the stock, then the stock is overvalued or else it is
undervalued. For instance, consider BHP Billiton stock whose intrinsic value has been
computed based on Gordon dividend approach as $ 30. However, the current market price of

BHP stock is $ 27 which would imply that the stock is undervalued as the fair value is larger
than the current market price (Brealey, Myers and Allen, 2014).
The technical analysis is based on the premise the future stock movements tend to have some
definite patterns and hence in technique levels these key levels are defined as support and
resistance for the stock and form the basis for taking decisions in the market (Damodaran,
2015). Technical analysis essentially provides estimates fo short term movement in the stock
based on the pattern since it is every changing. The fundamental analysis is based on
analysing the fundamentals of the company, underlying business model, financial
performance so as to determine if superior returns can be earned on the underlying stock
(Petty et. al., 2015).

References
Brealey, R. A., Myers, S. C. and Allen, F. (2014) Principles of corporate finance, 6th ed. New
York: McGraw-Hill Publications
Damodaran, A. (2015). Applied corporate finance: A user’s manual 3rd 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, 6th ed.. NSW: Pearson Education, French
Forest Australia