Principles of Finance IRR Report 2022

Running Head: Principles of Finance
Principles of Finance
Name of the Student:
Name of the University:
Author’s Note:

1Principles of Finance
Table of Contents
Problem 1 .......................................................................................................................... 2
Problem 2.......................................................................................................................... 3
Problem 3 .......................................................................................................................... 6
Problem 4 .......................................................................................................................... 7
Problem 5 .......................................................................................................................... 9
References .......................................................................................................................12

2Principles of Finance
Problem 1: MISCELLANEOUS TOPICS
(i)
In the given scenario, all the three projects are favorable as all three projects yield a higher IRR than the
cost of capital (which is assumed to be 10%, since NPC is calculated by discounting future earnings at
that rate).
If we have to choose based on shareholder value maximization, I would recommend to choose Project C.
Since share value is based on discounted cash flow of future earnings, the Project with highest NPV is
best.
Project Rankings as per different capital budgeting criteria:
Criteria Rank 1 Rank 2 Rank 3 Remarks
IRR Project A Project B Project C Highest IRR is best
NPV Project C Project A Project B Highest NPV is best
EA Project B Project C Project A Most EA is best
(ii)
Immediate writing off of capital expenditure of bring down profits and reduce current tax burden of small
businesses. This ultimate form of accelerated depreciation is beneficial to companies and they shall have
to pay lower taxes in current year and would have a better liquidity position.
Going by the second statement that the benefit to the companies depends on the salvage value of the
asset at the time it is sold and that at Salvage value > Book Value, accelerated depreciation is less
attractive, I would state that this is true as with accelerated depreciation, higher taxes would have to be
paid at the time of sale of assets owing to increase in profits due to sale.
I disagree with the statement of the third colleague that depreciation being non-cash expenses only
impacts accounting entries. Depreciation although a non-cash expenses, plays a role in evaluation of Net
profit and taxes which is cash expenditure.
I would agree to the first and second colleague. The Obama Policy is actually attractive considering time
value of money.
(iii)
The cost of capital here would be the Weighted Average cost of capital of Equity and Debt.
WACC = (Kd * Weight of Debt) + (Ke * (1-Weight of Debt))
Since the target capital structure of the acquisition is 50% debt, we will ensure a mix of capital in a way
that the total debt component in the acquisition remains 50%. Rest shall be through equity.
Cost of Debt for American Chemical shall be 7.65% as its Bond rating is BBB.
For the equity component,
Cost of Equity = Risk Free Rate + Beta Coefficient × Market Risk Premium
We have the Beta Coefficient of American Chemical available and also the market risk premium available.
We need the Risk free rate to assess Cost of equity. Then we need to apply the cost of equity and cost of
debt in the WACC formula to evaluate the cost of capital.

3Principles of Finance
Problem 2: SECURITY VALUATION AND THE FUNDAMENTALS OF BOND AND STOCK PRICES
(i)
Effective YTM on Bonds issued by We Works competitors 5 years ago is 7.95%. (Calculation in
spreadsheet attached)
Par value $1,000.00
Current Price $910.88
Coupon rate 3.25%
Maturity 10yrs
To calculate YTM, we shall use the trial and error method.
Since, the bond is sold at a discount; we know YTM is greater than Coupon rate
In excel, we have used the goal seek Formula
YTM = 3.90%
Year Cash Flow Discounting Factor Present value
1 $32.50 0.9625 $31.28
2 $32.50 0.9263 $30.11
3 $32.50 0.8916 $28.98
4 $32.50 0.8581 $27.89
5 $32.50 0.8259 $26.84
6 $32.50 0.7949 $25.83
7 $32.50 0.7651 $24.86
8 $32.50 0.7363 $23.93
9 $32.50 0.7087 $23.03
10 $32.50 0.6821 $22.17
11 $32.50 0.6565 $21.34
12 $32.50 0.6319 $20.54
13 $32.50 0.6081 $19.76
14 $32.50 0.5853 $19.02
15 $32.50 0.5633 $18.31
16 $32.50 0.5422 $17.62
17 $32.50 0.5218 $16.96
18 $32.50 0.5023 $16.32
19 $32.50 0.4834 $15.71