Capital Budgeting Analysis

The provided content describes a bond investment scenario where two bonds (Bond-1 and Bond-2) with different face values, coupon rates, maturity periods, and yields are compared to determine their prices at a given date. The assignment also presents a capital budgeting problem involving a project with cash inflows and outflows. After calculating the net present value of the project's cash flows, it is recommended that the company should not invest in this project as its net benefit or loss in present value terms is negative ($175,371.80).

Fundamentals of corporate finance
1

Que 1)
a)
Two period certainty Problem:
Income estimations
Year 2017 2018
Net profit 6,00,000.00 7,50,000.00
Dividend payout 70.00% 70.00%
Dividend 4,20,000.00 5,25,000.00
Jack Black Equity holding 12.00% 12.00%
Dividend of Jack Black 50,400.00 63,000.00
Two Period Certainty Problem
Years Income Opening Amount Interest Consumption Balance
2016-17 50,400.00 4536 54936 26100 28836
2017-18 63,000.00 28836 8265.24
10010
1 100000 101.24
Total 126100
b)
Valuation of share:
Given,
Dividend per share in 2017 $ 1.20
Required annual return 12%
Further dividends per
share
In the year of 2018 1.44
In the year of 2019 1.656
In the year of 2020 1.8216
In the year of 2021 1.91268
Value of common equity
3.398095845
Que 2)
2

a) Ttime value of money and deferred perpetuities:
i) Present value of the fund:
Ending of 3rd
year $ 50,000.00
Required return 5%
Time 0.03
PV 0.863837599
NPV $ 43,191.88
ii) Extra required fund:
3rd Year $ 50,000.00
Required return 3%
Time 0.03
PV 0.915141659
NPV
$
45,757.08
b) Loan repayment and loan terms:
i) Effective annual interest rate:
The Effective annual interest rate of this loan is 0.65% per month.
ii) Monthly repayment amount:
Loan 540000
Tenure (months) 240
Interest rate
monthly 0.65%
EMI $4,449.79
iii) EMI amount if the given alteration is adopted:
In first Year
Loan 5,40,000.00
Tenure (months) 12
Interest rate
monthly 0.65%
EMI $3,300.00
3

In Second Year
Loan 5,42,612.07
Tenure (months) 12
Interest rate
monthly 0.65%
EMI $3,750.00
In third Year
Loan 5,39,838.03
Tenure (months) 216
Interest rate
monthly 0.65%
EMI $4,658.29
iv) Total required time to repay the loan:
Loan 5,40,000.00
Interest rate monthly 0.65%
EMI $2,500.00
New Tenure (months) 135
Existing Tenure (months) 240
Extra period (105)
Que 3)
a) Alternative investment choice:
i) Payback period:
Payback period Payback period
Time
Cash
Flow Cash inflow
Cumulative
Cash Flow Time
Cash
Flow Cash inflow
Cumulative
Cash Flow
£
Millio
n £ Million
£
Millio
n £ Million
4

0
-
4000
0 12000 -28000 0
-
4000
0 18000 -22000
1 18000 -10000 1 18000 -4000
2 27000 17000 2 18000 14000
Payback
Period 1.37037
Payback
Period 1.22222
Payback period Payback period
Time
Cash
Flow
Cumulative
Cash Flow Time
Cash
Flow
Cumulative
Cash Flow
£
Millio
n £ Million
£
Millio
n £ Million
0
-
4000
0 -40000 0
-
4000
0 -40000
1
1200
0 -28000 1
1800
0 -22000
2
1800
0 -10000 2
1800
0 -4000
3
2700
0 17000 3
1800
0 14000
Payback
Period 2.37037037
Payback
Period 2.22222
ii) Difference in the answer:
By conducting the analysis, it has been evaluated that the outcome of payback period calculation of
both the projects is different. The differences have taken place due to the time period factor.
iii) NPV:
Net Present Value
Time Cash Flow Discount rate Cash flow
£ Million
0 -40000 1 -40000
1 12000 0.971 11652
2 18000 0.943 16974
3 27000 0.915 24705
Net Present Value 13331
5

Net Present Value
Time
Cash
Flow
Discount
rate
Cash
flow
£ Million
0 -40000 1 -40000
1 18000 0.971 17478
2 18000 0.943 16974
3 18000 0.915 16470
Net Present Value 10922
iv) IRR:
IRR
Time
Cash
Flow
Cash
inflow
cash
flow
£ Million
£
Million
0 -40000 12000 -28000
1 18000 18000
2 27000 27000
Payback
Period 35%
6

IRR
Time
Cash
Flow
Cash
inflow
Cash
Flow
£ Million £ Million
0 -40000 18000 -22000
1 18000 18000
2 18000 18000
Payback
Period 40%
v) Exact crossover point:
By conducting the analysis over above given chart, it has been evaluated that the NPV
calculations cross point is on 10000 and at the same time IRR calculations cross point is 18000.
vi) Recommendation:
By conducting the analysis, it has been found that the NPV method is better and the first
project is the best appropriate project as the NPV of the first project is much better than the
second project.
b) Valuation of bonds:
i) Price of the bond:
7

Position on 15 November, 2016
Bond-1 Bond-2
Face value 100000 100000
Coupon (Half
yearly) 3% 3%
Maturity (Half
years) 7 13
15 Feb 2017 to 15 Aug
2020
15 Feb 2017 to 15 Aug
2023
Yield (Half yearly) 3% 3%
Price at 15 aug, 2017
Bond-1 Bond-2
Face value 1,00,000.00 1,00,000.00
Coupon (Half
yearly) 3% 3%
Maturity (Half
years) 7 13
Yield (Half yearly) 4.00% 4.00%
Interest amount 3,000.00 3,000.00
Price of bond 93,997.95 90,014.35
ii) Reason behind price movements:
The price of bond-1 has gone down from $100,000 to $93,997.95 and the price of bond-2
has gone down from $100,000 to $90,014.36.
iii) If alternative is used:
Price at 7 Nov, 2017
Bond-1 Bond-2
Face value 100000 100000
Coupon (Half yearly) 0.03 0.03
Maturity (Half years) 7 13
Yield (Half yearly) 0.04 0.04
Interest amount 1369.5652 1369.5652
Price of bond 84,211.99 73,733.40
Que 4)
8

Capital budgeting:
QUESTION 4-a
Cash outflows
Year $
0 -630000
Cost of technology and
additions to current assets
1 0
2 -20000
Cost of overhauling the
technology
Savings lost on building
PV of Rent for 4 years
net of tax
1,12,000.0
0 3.17
3,55,02
4.93
Less: PV of Payment to
cancel the lease 44,000.00 1.00
44,000.
00
PV of savings lost
3,11,02
4.93
Cash inflows
Year
Labour
costs
Savings
Tax savings on
depreciation
Salvag
e
Recovery of
current assets Total
1
1,90,000.0
0 42,750.00
2,32,7
50.00
2
1,90,000.0
0 42,750.00
2,32,7
50.00
3
1,90,000.0
0 42,750.00
2,32,7
50.00
4
1,90,000.0
0 42,750.00
30,000.
00 35,000.00
2,97,7
50.00
Net present value
Year
Net cash
flows PVF@10% PV
0 -630000 1.0000
9

(6,30,0
00.00)
1 232750 0.9091
2,11,59
0.91
2 212750 0.8264
1,75,82
6.45
3 232750 0.7513
1,74,86
8.52
4 297750 0.6830
2,03,36
7.26
PV of cash flows
1,35,65
3.13
Less: PV of savings
lost
3,11,02
4.93
Net benefit or loss in
present value terms
(1,75,3
71.80)
Recommendation:
Through the NPV calculation, it has been found that this project is not feasible and thus
the company must not invest into this project.
10