Introduction to Financial Management

This document provides an introduction to financial management, covering topics such as cost of capital, annuity present value, types of bonds, and payback period calculations. It includes examples and solutions for each topic.

8
Introduction to Financial
Management

TABLE OF CONTENTS
TABLE OF CONTENTS................................................................................................................2
QUESTION 1..................................................................................................................................1
QUESTION 2..................................................................................................................................2
QUESTION 3..................................................................................................................................3
QUESTION 4..................................................................................................................................3
QUESTION 5..................................................................................................................................4
REFERENCES................................................................................................................................7

QUESTION 1
Item Symbol Value
Risk Free Rate Rf 7%
Stock Risk B 1.5
Market Return Rm 25%
Interest Rate for Debt Rd (B.T) 9%
TAX rate T 5%
Preferred Stock Dividend D(ps) 10
Preferred Stock Price P(ps) 100
floatation cost Ps FC 4%
Solution:
1. Calculate the cost of common stocks: (Rs)
Cost of common stock (Rs)
(Rf + (Rm - Rf)*beta
7% + (25%-7%)*1.5
7% + 27%
34%
2. Calculate the cost of Preferred stocks: (Rps)
Cost of preferred stock (Rps)
(D/ P)+FC
(10/100)+4
14%
3. Calculate the cost of Debt: (Rd)
Cost of debt (Rd)
D(1-t)
9(1-0.5)
8.55%
1

4. Calculate the weight of each component in the capital structure:
Item Amount
($)
Debt 50,000
Common Stocks 1,00,000
Preferred Stocks 50,000
Total 2,00,000
Weight
Debt / Total Capital 0.25
Common Stocks / Total Capital 0.5
Preferred Stocks / Total Capital 0.25
Total 1
5. Calculate the weighted average cost of capital WACC:
Weighted Average Cost of
Capital
(Rs*0.5)+(Rps*0.25)+(Rd*0.25)
= 22.64%
QUESTION 2
Calculate the ordinary annuity present value for $300 for 5 Years with 10% interest rate if
the amounts will be received semi-annually?
Solution:
2

PVOA
PV of annuity
C*[(1-(1+i)^n)/i]
300 [1-(1+0.05)^-10/0.05]
= $ 2316
QUESTION 3
A. Corporate Bonds
Corporate bonds are the debt securities that are issued by the companies and are sold to the
investors. After raising the capital from the market company is required to give the investors
interest payments either at variable or fixed rate.
B. Municipal Bonds
Municipal bonds are the debt securities that are issued by the countries, state, cities or other
government agencies for funding the daily obligations and for financing the capital projects.
C. Foreign Bonds
Foreign bond refers to the bond issued in domestic market by the foreign company in the
currency of domestic market for raising capital. These are issued by the foreign companies doing
business in domestic market.
QUESTION 4
In January 2020 investors purchased a two-year U.S. government bond. The bond has an
annual coupon rate of 10%. If investors demand a 20% return, calculate the price of the
bond if the coupon will be paid quarterly?
Solution:
Coupon rate 10%
3

Quarterly rate 2.5%
Bond yield 20%
Quarterly rate 5.0%
Par value 100
S.No
(Cn /
(1+YTM)^n+P/(1+i)^
n
1 2.38
2 2.27
3 2.16
4 2.06
5 1.96
6 1.87
7 1.78
8 69.38
Bond Price 83.84
QUESTION 5
A. Calculate the payback period for a project that has the following cash flows:
Year Cash flow ($)
0 -(200,000)
1 100,000
2 80,000
3 60,000
Solution:
Computation of Payback period
4

Year
Cash
inflows
Cumulative cash
inflows
1 100000 100000
2 80000 180000
3 60000 240000
Initial
investment 200000
Payback
period 2
0.3
Payback
period
2 year and 3
months
B .Calculate the Discounted payback period for a project that has the following cash flows: (3
marks)
Year Cash flow ($)
0 -(120,000)
1 50,000
2 50,000
3 50,000
4 50,000
Note: the required rate of return K = 15%
Solution:
Computation of Payback period
5

Year
Cash
inflows
PV
factor
@
15%
Discounted Cash
flows
Cumulative cash
inflows
1 50000 0.870 43478.26 43478.26
2 50000 0.756 37807.18 81285.44
3 50000 0.658 32875.81 114161.26
4 50000 0.572 28587.66 142748.92
Initial
investment 120000
Payback
period 3
0.2
Payback
period
2 year and 2
months
6