Corporate Finance Report: FIN351e Analysis, Evaluation, and Solutions

This report provides a comprehensive analysis of various corporate finance topics, including the impact of dilution on stock prices, the integration of debt financing in capital budgeting using the APV approach, and the rationale behind mergers and acquisitions. It differentiates between various forms of mergers and acquisitions, describes the takeover process, and appraises accounting procedures. The report further demonstrates how tax effects are considered in M&A, analyzes costs and benefits, and discusses financial distress situations and Z-score models for predicting default. It also covers the process of issuing securities, the costs involved, and issues in multinational capital budgeting. The report includes evaluations of capital budgeting projects, advantages of leasing, and detailed case studies with calculations related to acquisition costs, WACC, NPV, and Altman Z-score, providing a thorough understanding of corporate finance principles and their practical application.

CORPORATE FINANCE

TABLE OF CONTENTS
FIN351e 2016 JUL.....................................................................................................................1
1. Analyse the effect of dilution on stock price......................................................................1
2. Assess how debt financing can be included in a capital budgeting exercise using APV
approach.................................................................................................................................1
3. Analyse the rationale for mergers and acquisitions............................................................1
4. Differentiate the various forms of mergers and acquisitions..............................................1
5. Describe the process of takeover........................................................................................2
6. Appraise the accounting procedures for mergers and acquisition......................................2
7. Demonstrate how tax effects are considered in merger and acquisitions...........................3
8. Analyse the costs and benefits of mergers and acquisitions...............................................3
9. Discuss the situations of financial distress and how firms deal with the financial distress3
10. Appraise the Z-score models that are used to predict the default or bankruptcy.............4
FIN351e 2015 JUL.....................................................................................................................4
1. Discuss the process of issuing securities to the public.......................................................4
2. Analyse the cost of issuing new securities.........................................................................4
3. Analyse the issues that need to be considered in multinational capital budgeting.............5
FIN351e 2014 JUL.....................................................................................................................5
1. Analyse how capital budgeting projects are evaluated.......................................................5
2. Appraise the advantages of leasing equipment. Evaluate the decision to lease against
decision to buy........................................................................................................................5
QUESTION 1.............................................................................................................................6
a) Summarize the current quantitative and qualitative requirements to seek a listing on
Singapore exchange Main board............................................................................................6
b) Discuss the eligibility of Conrail for meeting the listing requirement by assuming its
financial results at the time of IPO were substantially the same in FY 1992.........................6
QUESTION 2.............................................................................................................................7
a) Calculate the costs of acquisition under the agreement.....................................................7
b) Cost of acquisition by issuing five new CSX share for three Conrail shares....................7
QUESTION 3.............................................................................................................................8
a) Compute the cash part in the total consideration required by CSX to acquire Conrail.....8
b) Discuss the issues consider by the finance manager of CSX while making right issue....8

c) Apply Altman’s Z score on CSX current financial results for the year 1995 and appraises
the inclination of the financial institution to fund the acquisition entirely by debt................8
QUESTION 4...........................................................................................................................10
a) Calculate the present value of synergies from the merger...............................................10
b) Analyze the issues that should be considered by a financial manager if Conrail were
located in a foreign jurisdiction............................................................................................10
QUESTION 1...........................................................................................................................10
a) Summarize the rational of Broadway industries Inc’s acquisition of landmark facility
solutions................................................................................................................................10
b) List different kinds of acquisition and identify the type of acquisition undertaken by
broadways.............................................................................................................................11
c) Describe the activities undertaken by broadways from pre-bid to post bid regarding the
acquisition of Landmark.......................................................................................................11
QUESTION 2...........................................................................................................................11
a) Calculate WACC for both Broadway and landmark using exhibit 4 and 5 by assuming
the credit rating for both the firm as A.................................................................................11
b) Calculate the cash flows arising from synergies over the next five years starting from
2015-2019.............................................................................................................................12
c) Calculate the NPV of the acquisition of landmark by Broadway....................................13
QUESTION 3...........................................................................................................................13
a) Calculate Broadway’s Altman Z score for 2014..............................................................13
b) Discuss the significance of Altman Z score and evaluate the financing alternatives are
viable....................................................................................................................................14
QUESTION 4...........................................................................................................................14
a) State the main steps in applying APV method.................................................................14
b) Calculate the present value of interest tax shield of $120 million borrowings................15
c) Explain why APV method is more appropriate than the NPV method............................15
QUESTION 1...........................................................................................................................15
Analyze the accuracy of the statement in the evaluation of the project, if not the state
appropriate method...............................................................................................................15
QUESTION 2...........................................................................................................................16
Calculate adjusted NPV with bank loan and assess whether this method of funding should
be used..................................................................................................................................16
QUESTION 3...........................................................................................................................16
a) Compare NPV of buying and NPV of leasing the machinery..........................................16
3

b) Advantages of leasing of the machinery if the probability of sales of 500,000 units is
0.35.......................................................................................................................................18
QUESTION 4...........................................................................................................................18
Analyze critically the rationale for nature Cola to purchase low C cola..............................18
REFERENCES.........................................................................................................................19
4

FIN351E 2016 JUL
1. Analyse the effect of dilution on stock price
The effect of dilution is that it increases the float of a company that is outstanding
number of shares held in an entity which, in turn, decreases earning per shares. Decreasing
earning per share directly affects the stock price of a common stock in an enterprise (Effect of
dilution on stock price, 2011). Apart from negative effect, one positive effect is that an entity
can overcome this problem by using buy back share option.
2. Assess how debt financing can be included in a capital budgeting exercise using APV
approach
Adjusted Present value is an unique concept which fulfils the weakness of the net
present value method as in this method valuation of the project is done by considering NPV
and present value of debt financing costs (Moradi and et.al., 2017). Through interest tax
shield, debt financing will be consider in the capital appraisal method as inclusion of only
equity will turn into the rejection of the project.
3. Analyse the rationale for mergers and acquisitions
Mergers and acquisition of firms based on different circumstances which will results
into merger or acquisitions by an entity. Merger of the business allows an entity to capture
large base of customers quickly without spending much time and money in establishing the
business concern in the new market (Altman, Iwanicz‐Drozdowska, Laitinen & Suvas, 2017).
Motive behind the merger is the financial and operating synergy. Bankruptcy is one of the
reasons behind the acquisition of the business by other strong firm.
4. Differentiate the various forms of mergers and acquisitions
Basis Horizontal
merger
Vertical merger Concentric
merger
Conglomerate
merger
Definition Similar product
selling company
merge with each
other
Two firms
merge with each
other lies in
similar value
chain process
Two firms
merge with each
dealing with
same customer
by offering
different
Products (Forms
of merger,
Two business
merge with each
other belongs to
different
industry
1

2017.).
Example Lucky and gold
star merge to
form LG
company
Clothing
industry merge
with textile
industry
Sainsbury and
Marks and
Spencer
Clothing
industry merge
with cosmetics
firms
Basis Asset acquisition Stock/ shares acquisition
Define Asset acquired by an entity to
compensate the overall loss
Shares ownership taken by
an entity by converting the
shares of weaker companies
into strong company
5. Describe the process of takeover
 Researching target firms- This step is a preliminary stage under which the strong
entity will search about all the weak companies whose capacity has evaluated on
various parameters such as revenue, profitability, cash flow, growth rate, employee
base, products, and market segmentation.
 Initial contact- With the help of telephonic inquiry or by taking help of third party
search of finding companies can be successful in acquiring the firm.
 Non-disclosure agreement- By taking interest of selling company non disclosure
agreement can be signed by both the parties.
 Letter of intent- After signing of NDA, financial statements and other documents
will be transferred by selling company to the buyer (Acquisition process, 2017).
 Due diligence- buyer sends list of due diligence to the target company taking
response of the seller on various matters such as reason of selling, previous selling
efforts, business plans, complexity in operating business, market review, entry in the
market and reporting charts.
 Final negotiation- After taking response of the seller on various matters, final
negotiation is to be filed by both the parties.
6. Appraise the accounting procedures for mergers and acquisition
Two method of accounting has used to consider the merger and acquisition business
transactions (Accounting procedure for merger and acquisition, 2017). It includes pooling
2

method and purchase method in the amalgamation of two or more firms by taking separate
name. In pooling method, assets and liabilities are recorded in books of accounts at their book
value by excluding the amount of goodwill. On another hand, purchase methods consider
purchase consideration paid by the acquirer to the acquiree for buying their business (Forms
of acquisition, 2017).
7. Demonstrate how tax effects are considered in merger and acquisitions
Amount received on selling of shares in merger or acquisition affects the tax
obligations as it has two provisions whether taxable or non-taxable. If this transaction is
taxable then shareholder is required to pay capital gain tax on the premium earned on selling
of shares, On the contra ray to this, if this transaction is not taxable then an individual is not
required to pay the tax amount until an entity receive the payment for selling of shares (Geng,
Yonghui, Jiangwei & Long, 2017).
8. Analyse the costs and benefits of mergers and acquisitions
Costs
 Purchase consideration paid to the acquirer
 Paying tax amount on Selig of shares
Benefits
 Synergy
 Increased financial figures
 Higher employee base
9. Discuss the situations of financial distress and how firms deal with the financial distress
Financial distress is a situation that shows the incapability of an entity when operating
cash flows of an entity is not sufficient to pay off all the liabilities incurred on an individual
(Wang, Hong, Liu & Zhang, 2017). There are various situations that create financial distress
in an entity are given as below:
 Dividend reductions
 Plant closings
 Loss on sale of plant
 Layoffs
Ways to reduce financial distress
3

 Asset expansion policies- Decreasing operating cash flows generated y an entity
increases the risk of financial distress can be avoided by expanding the overall size of
assets used by an entity in their business. By increasing number of assets an
individual will, in turn, increases the overall returns generated by them to meet all the
deficiency in the business concern.
 Restructuring financial policy- The problem of liquidity is regarded as one of the
biggest issue in increasing the level of financial distress in an entity. By making
changes in the equity and debt components of a capital structure, the problem of
decreased dividend can be resolved by an entity.
10. Appraise the Z-score models that are used to predict the default or bankruptcy
This tool is a suitable approach in predicting the future performance of an entity by
forecasting the business situation and various traits of bankruptcy in the future. Altman Z
score is a combination of five important business ratios that helps in determining the overall
performance of an entity in the external environment by considering all the factors taken into
account (Jurlander and et. al., 2017). Z score categorizes the overall performance of an entity
into various categories such as safe zones, grey zones and distress zone. On these three
parameters, the performance of an entity will be tested to determine the future.
FIN351E 2015 JUL
1. Discuss the process of issuing securities to the public
 Issue of prospectus- Public company raise capital by inviting general public to invest
one by taking shares of the public company in the form of prospectus.
 Receive application- After launching prospectus in the external invitations sent to the
public to invest in the shares held by the public enterprise.
 Allotment of shares- After receiving application money of all the shareholders,
shares allotment is given to all the authorized shareholders.
 Make share calls- After share allotment, first and second call payment is made by all
the shareholders in an entity.
2. Analyse the cost of issuing new securities
Different security has different costs such as cost of debt and cost of equity in an
entity. Cost of equity includes dividend payable by an individual on the overall equity shares
held by an entity for a specific period of time (Leyman & Vanhoucke, 2017). Cost of debt
includes interest paid on total debt held by an entity within a stipulated time period.
4

3. Analyse the issues that need to be considered in multinational capital budgeting
Issues faced by an entity while using multinational capital budgeting tool is rigid
regulations imposed on an entity. Rigid tax laws and regulations imposed on an entity affect
the overall financial performance of the business concern. Cash flow generated by the
business concern depends on the changing capital structure of debt and equity.
FIN351E 2014 JUL
1. Analyse how capital budgeting projects are evaluated
Capital budgeting is that concept in which different tools and technique used by an
entity to valuate various projects as the best suitable project will be consider by an entity for
the future purpose (Han, Huang, Kalimipalli & Wang, 2017). Net present value method
assesses the feasibility of the project as this tests that future profitability generated by an
entity shortly. Payback period is another technique shows the return produces by a particular
project within a given san of time. An enterprise owner will selects one of the suitable
projects out of two or more projects which generate returns in lower time period. Time value
of money concept has used in net present value method.
2. Appraise the advantages of leasing equipment. Evaluate the decision to lease against
decision to buy
One of the advantages of leasing equipment is that it helps in reducing cash expenses
incurred by an entity within a particular financial year. It has easy approval process in which
leasing payment can be made in easy instalments to give relief in making payment by an
individual (Ndungo, Tobias & Florence, 2017). An individual get the tax deductions by
making easy instalments in leasing equipment as compared to the purchasing of the
equipment by an individual in an entity.
5

Case Study 1
The Acquisition of consolidated rail corporation
QUESTION 1
a) Summarize the current quantitative and qualitative requirements to seek a listing on
Singapore exchange Main board
There are two requirements to list the shares under Singapore exchange main board
consists of both qualitative as well as quantitative requirements to enlist in the Singapore
stock exchange. The motive behind the listing of the shares is to avail the advantage of the
external market volatility. Fluctuations in the external market will enhance the overall returns
generated y the business concern within a short span of time.
Quantitative requirements
An issuer is required to follow some of the criteria’s decided by the higher authority about the
listing of Singapore Exchange Main board is mention as below:
 Consolidated pre-tax profit of $30 million for the current financial year with an
operating track record for at least three years.
 Threshold for market capitalization is set as less than the value of $150 million based
on the issue price and post-invitation of issued share capital.
 Operating revenue of not less than $300 million based on issue price and after
invitation
Qualitative requirements
Eligibility of a qualified member is to be determining by following some of the provisions
mention below:
 Professional qualified and licensed member in recognized professional association
 Professional experience of five years in the estimation, assessment and evaluation of
mineral, oil or gas and undertaking of activities by the issuer.
b) Discuss the eligibility of Conrail for meeting the listing requirement by assuming its
financial results at the time of IPO were substantially the same in FY 1992
Income before tax threshold limit is $30 million in order to qualify the quantitative
requirements for listing the stock or shares under the Singapore exchange Main board.
6

Current income before tax in the financial year 1992 is $460 million but the limit is $30
million that is Conrail does not qualify one of the criteria of quantitative requirements for
listing the shares.
Another requirement of listing of the shares is to qualify the limit of market
capitalization is of $150 million based on the issue price of stock. Current market
capitalization of Conrail consolidated financial statements is calculated by multiplying
outstanding shares by share price of all the stocks held by the consolidated firm Conrail.
Market capitalization= Outstanding shares* stock price
= 79742 shares*$2.31
= $184204.02
Limit of market capitalization is 150 million but the market capitalization of consolidated
firm Conrail is $$184204.02 which does not qualify this particular condition.
Operating revenue of Conrail is $8734 but the quantitative limit is $300 million which does
not qualify the limit of the operating revenue.
QUESTION 2
a) Calculate the costs of acquisition under the agreement
Shares acquired 90.5 million
Stock price $71
Cash for first 40% $92.50
Remaining 60% 1.85619:1
CSX stock price $46.75
Blended value $89.07
Purchase consideration $8,060.84
First 40% 36.2
Rate $ 92.50
Cash consideration $ 3,348.50
Remaining 60% $ 54.30
Ratio 1.85619:1
Remaining consideration $ 35.29
Total acquisition costs $ 3,383.79
b) Cost of acquisition by issuing five new CSX share for three Conrail shares
Issue of new shares
Existing shares 213 million
7

Issue new share 355
Total shares 568
First @40% 227.2
Rate $ 92.50
Cash consideration $ 21,016.00
Remaining 60% 340.8
Ratio $ 221.48
Total acquisition costs $ 21,237.48
QUESTION 3
a) Compute the cash part in the total consideration required by CSX to acquire Conrail
Cash balance $450 million
Borrowing rate 5.11%
Pv@5.11% 0.951384
Discounting cash balance 428.1229
Cash portion of consideration in Acquisition $ 428.12
b) Discuss the issues consider by the finance manager of CSX while making right issue
There are various reasons behind the issue of right issue by an entity is given as
below:
 An entity chooses this particular option to expand their current business size or able to
grab large amount of capital.
 Inability of an entity in paying off all the debt or loan on an entity
 Stabilizing the debt to equity ratio of the firm
 Relieving the firm’s financial strain.
A finance manager of CSX will face various issues while making right in an entity as
after making right issue, the financial performance of an entity may get affected due to
various factors such as turbulences in the external business market, growth rate of the
business concern, higher expectations of all the shareholders.
c) Apply Altman’s Z score on CSX current financial results for the year 1995 and appraises
the inclination of the financial institution to fund the acquisition entirely by debt
Altman Z score of CSX for 1995
Z 1.2X1+1.4X2+3.3X3+0.6X4+1.0X5
X1 Working capital/total assets
X2 Retained earnings/Total assets
X3 EBIT/total assets
8

X4 Market value of equity/book value of liabilities
X5 Sales/total assets
Particulars 1995
Working capital 4242
Total assets 14282
Retained earnings 0
EBIT 974
Market value of equity 4242
Book value of liabilities 10040
Sales 10504
Particulars Formula Amount
Working capital 4242
Total assets 14282
X1 Working capital/total assets 0.30
Retained earnings 0
Total assets 14282
X2 Retained earnings/Total assets 0
EBIT 974
Total assets 14282
X3 EBIT/total assets 0.07
Market value of equity 4242
Book value of liabilities 10040
X4 Market value of equity/book value of liabilities 0.42
Sales 10504
Total assets 14282
X5 Sales/total assets 0.74
Z Score 1.57045
In current situation, the proportion of debt and equity in the overall capital structure of
the consolidated financial statement of Conrail shows the burden of debt on an entity. It
reflects higher debt as compared to overall debt incurred in the capital structure of the
business concern. The financial institution gets indifferent while funding the acquisition of
one entity by another as acquisition transactions cover only debt. It refers to funding the debt
that involves high level of liability pass on from weaker firm towards the business of the
strong entity which increases overall interest expenses.
9

QUESTION 4
a) Calculate the present value of synergies from the merger
Calculate Present value of synergies
Operating income growth rate 2%
Discounting rate 13.38%
After growth operating income 578.34
Discounting rate 13.38%
Pv@13.38% 0.88199
Present value $ 510.09
b) Analyze the issues that should be considered by a financial manager if Conrail were
located in a foreign jurisdiction.
After the consolidation of two rails company merged and become Conrail the finance
manger of the new merged have to face issues post consolidation from the changing structure
of the external environment emphasises on restructuring of legal entity. Various risks
incurred in an entity have to face by a finance manager includes contagion risk, systemic
risks, lender of last resort assistance. After consolidation, foreign jurisdictions force an entity
to follow international financial reporting standards to increase the quality of the business.
Case Study 2
Landmark Facility solutions
QUESTION 1
a) Summarize the rational of Broadway industries Inc’s acquisition of landmark facility
solutions
Acquiring Landmark facility solutions was such a big opportunity grab by Harris the
founder of Broadway incorporation as despite of seeing its current performance he seek its
future performance by forecasting the industry targets. Landmark being a large integrated
facility owner, the market of Broadway will boost in the future after consolidation. Harries
can provide quality oriented services to its large customer base and able to grab higher share
in the external market. Landmark two business segments Building and engineering sections
helps in grabbing higher customers in East coast area
10

b) List different kinds of acquisition and identify the type of acquisition undertaken by
broadways
There are two kinds of acquisition takes places among two companies among which
one will be strong and another will be weaker company. Asset acquisition is one of the type
in which a strong entity will acquire all the assets of the acquiree business. Another kind of
acquisition is the acquisition of overall equity shares held by the old firm converted into
newly formed entity.
In the current case, the acquisition of landmark facility solutions by Broadway shows
the asset acquisitions and stock acquisitions as all the assets held by Landmark facility has
transfer to the new company along with old equity shares converted into new equity shares.
c) Describe the activities undertaken by broadways from pre-bid to post bid regarding the
acquisition of Landmark
Pre bid activities of Broadway includes searching about the target company and
discuss the selling of the old firm by bargaining about monetary compensations with the
seller. After discussing the monetary considerations with the seller, prior consent of all the
board member has taken by Harris the owner of Broadway which results into negative
response of two directors of Broadway regarding the acquisition. Signing of mutual
agreement results into acquisition of firms. Post bid activities are conducted by the owner of
Broadway includes taking consent of the acquiree about the preference of paying the
acquisition amount by wholly debt or mixture of debt and equity. Landmark decided to get
the whole acquisition payment with 100% debt through loan package by paying $120
Million.
QUESTION 2
a) Calculate WACC for both Broadway and landmark using exhibit 4 and 5 by assuming the
credit rating for both the firm as A.
Calculate WACC
Landmark
Particulars Amount Cost% Weight WACC
Equity 6186.91 0.2 0.51242 0.102484
Debt 5887 0.0452 0.48758 0.022039
12073.91 12.45%
Working notes
11

Cost of equity
Beta 1.69
Risk free return(Rf) 0.10%
Market risk premium(Rm) 5.90%
CAPM Rf+beta*(rm-rf)
Cost of equity 20%
Cost of debt
Credit rating A bond rate 4.52%
Broadway
Calculate WACC
Particulars Amount Cost% Weight WACC
Equity 3151.66 0.17 0.898764 0.15279
Debt 355 0.0452 0.101236 0.004576
3506.66 15.74%
Working notes
Cost of equity
Beta 1.25
Risk free return(Rf) 0.10%
Market risk premium(Rm) 5.90%
CAPM Rf+beta*(rm-rf)
Cost of equity 17%
Cost of debt
Credit rating A bond rate 4.52%
b) Calculate the cash flows arising from synergies over the next five years starting from
2015-2019.
Calculate cash flow arising from synergies
Particulars 2015 2016 2017 2018 2019
Net income 3.5 3.7 3.9 4.1 4.3
Depreciation and amortization -2.1 -2.4 -2.7 -3 -3.3
Change in Working capital 1.3 1.3 1.4 1.5 1.6
2.7 2.6 2.6 2.6 2.6
Add: depreciation 2.1 2.4 2.7 3 3.3
Cash inflow 4.8 5 5.3 5.6 5.9
c) Calculate the NPV of the acquisition of landmark by Broadway
Calculate NPV of acquisition
12

Consideration
Cash 60 million
New shares 60 million
Total 120 million
New share issue 25%
NPV of synergies 55 million
Current shares 231.2 million
25% 57.8
Total new shares 289
Present value of Landmark 23.75 12.16842
Present value of Broadway 46 6.282609
Particulars Landmark Broadway
Initial investment -60 -60
Present value 12.17 6.28
NPV -47.83 -53.72
QUESTION 3
a) Calculate Broadway’s Altman Z score for 2014
Altman Z score of CSX for 1995
Z 1.2X1+1.4X2+3.3X3+0.6X4+1.0X5
X1 Working capital/total assets
X2 Retained earnings/Total assets
X3 EBIT/total assets
X4 Market value of equity/book value of liabilities
X5 Sales/total assets
Particulars 2014
Working capital 43.1
Total assets 86.8
Retained earnings 0
EBIT 7.4
Market value of equity 43.1
Book value of liabilities 43.7
Sales 161.9
Particulars Formula Amount
Working capital 43.1
13

Total assets 86.8
X1 Working capital/total assets 0.50
Retained earnings 0
Total assets 86.8
X2 Retained earnings/Total assets 0
EBIT 7.4
Total assets 86.8
X3 EBIT/total assets 0.09
Market value of equity 43.1
Book value of liabilities 43.7
X4 Market value of equity/book value of liabilities 0.99
Sales 161.9
Total assets 86.8
X5 Sales/total assets 1.87
Z Score 3.334158
b) Discuss the significance of Altman Z score and evaluate the financing alternatives are
viable
 Z score helps in evaluating the overall financial performance of an entity as it targets
four factors of an entity (Altman Z score, 2017).
 It emphasises on four factors such as working capital, retained earnings, total assets
and total equity& liabilities.
 It helps in categorizing the firm by identifying the zones of discrimination namely
distress, grey and safe zone.
The viability of various financing alternatives is check by using Z score of an entity as it
helps in testing the liquidity of the business enterprise. Entire business concern’s profitability
is also checked using this score.
QUESTION 4
a) State the main steps in applying APV method
Adjusted present value
= Net present value+ Present value of debt financing
NPV= Initial Investment+ (annual return/return equity)
Present value of debt financing= (Tax rate*(Debt*interest rate))/ (1-(1/(1+debt cost)))
14

b) Calculate the present value of interest tax shield of $120 million borrowings
Calculate interest tax shield of borrowing
Borrowing 120
Tax rate 35%
Interest rate 4.25%
Interest $ 5.10
Tax rate 35%
Interest tax shield $ 3.32
c) Explain why APV method is more appropriate than the NPV method
Adjusted present value is one of the important tool of capital budgeting used to tests
the feasibility of various projects. It includes base value of the project along with various
costs such as interest tax shields, costs of financial distress, subsidies, hedges, issue costs and
other costs to determine the adjusted present value of a particular project (Adjusted present
value, 1997). It is regarded as the best suitable method that helps in considering both equity
and debt incurred in a project as NPV considers only equity sources involved in a project.
Case study 3
Nature Cola
QUESTION 1
Analyze the accuracy of the statement in the evaluation of the project, if not the state
appropriate method
The uncertainty of the projects can be tested by using probability of the demand for
nature Cola Company. This entity was struggling to meet the desired sales targets of the
business can be tracked by using probability method. This method used by an entity is true
but the way of using the method by nature cola is not appropriate (Mohagheghi, Mousavi,
Vahdani & Shahriari, 2017). This problem can be resolved by adding discounting rate of
return which helps in determining the present value.
For example
Year Sales PV% Present value Probability
1 4250000 5% 0.50
15

QUESTION 2
Calculate adjusted NPV with bank loan and assess whether this method of funding should be
used
Particulars Amount
EBIT $ 1,360,000.00
Taxes on EBIT $ 408,000.00
Net operating profit after tax $ 952,000.00
Add: Non-cash items in EBIT
Depreciation $ 500,000.00
Less Working capital changes $ 392,000.00
Less: capital expenses and other operating investments $ 400,000.00
Free cash flow $ 660,000.00
Discounting rate 7%
Present value of Free cash flow 470570.88
Present value of terminal value 852731.47
Value of unlevered assets $ 1,323,302.35
Add: Excess cash and other assets $ 220,000.00
Value of unlevered firm $ 1,543,302.35
Add: Present value of debt's periodic interest tax shield 235628.69
Value of levered firm $ 1,778,931.04
Less: Value of debt 6196000
Adjusted present value $ (4,417,068.96)
Negative adjusted present value is due to wrong selection of funding option that is
bank loan in the current case. Due to higher value of debt it increases the value of negative
adjusted present value that shows the inefficiency of bank loan. The amount of bank loan can
be reduces by taking equity sources of finance which indirectly improves the current
condition of nature cola while taking leasing of machinery whose capacity is 200,000 bottles
per month.
QUESTION 3
a) Compare NPV of buying and NPV of leasing the machinery
NPV of 200000
bottles 0 1 2 3 4 5
Cash flow
$
1,452,000.
00
$
1,452,000.
00
$
1,452,000.00
$
1,452,000.
00
$
2,844,000.00
Discounting
rate 1
0.9291089
845
0.8632435
050
0.802047296
3
0.7451893
490
0.692362119
3
Present value of
cash flow
$
1,349,066
$
1,253,430
$
1,164,573
$
1,082,015
$
1,969,078
16

Total
$
6,818,161.29
Initial investment 6392000
NPV
$
426,161.29
NPV of 500000
0 1 2 3 4 5
Cash flow
$
4,860,000.
00
$
4,860,000.
00
$
4,860,000.00
$
4,860,000.
00
$
(7,840,000.0
0)
Discounting
rate 1
0.9291089
845
0.8632435
050
0.802047296
3
0.7451893
490
0.692362119
3
Present value of
cash flow
$
4,515,470
$
4,195,363
$
3,897,950
$
3,621,620
$
(5,428,119)
Total
$
21,658,522.2
1
Initial investment 12980000
NPV
$
8,678,522.21
NPV of 800000
0 1 2 3 4 5
Cash flow
$
8,580,000.
00
$
8,580,000.
00
$
8,580,000.00
$
8,580,000.
00
$
(14,148,000.
00)
Discounting
rate 1
0.9291089
845
0.8632435
050
0.802047296
3
0.7451893
490
0.692362119
3
Present value of
cash flow
$
7,971,755
$
7,406,629
$
6,881,566
$
6,393,725
$
(9,795,539)
Total
$
38,449,214.0
4
Initial investment 21568000
NPV
$
16,881,214.0
4
Buying of machinery
Cash flow $ 444,000.00
Pv@8.50% 0.921658986
Present value of cash flow $ 409,216.59
Initial investment $ 7,000,000.00
17

NPV $ (6,590,783.41)
Net present value of leasing of machinery of three different capacities such as
200000,500000 and 800000 are positive. On another hand, buying of the machinery has net
negative NPV of $6590783. Positive and higher results of NPV of 800000 capacity bottles
has higher NPV of 16,881,214.04 is to be consider by nature Cola Company.
b) Advantages of leasing of the machinery if the probability of sales of 500,000 units is 0.35
Probability of leasing of the machinery shows the future returns generated by an
entity by using the machinery capacity of 500000 by nature Cola Company. This leasing give
full assurance to an entity that costs of the lease of the machinery is less as compared to the
overall returns generated in the overall lease period (Advantages of leasing, 2017). After the
end of the period of the lease, lease can be renewed after the end of total period. Interest
payable on lease of the machinery is generally tax deductible which decreases overall tax
obligations of Nature Cola Company.
QUESTION 4
Analyze critically the rationale for nature Cola to purchase low C cola
Nature Cola decides to purchase the affordable low C cola due to the reduction of
costs incurred in the current project as compared to other project that is based on leasing of
the machinery on different capacities such as 200000, 500000 and 800000. The decision of
purchase taken by nature Cola as the sale price has reduced from $2 to $1.50 per bottle but
overall costs of operating in manufacturing the bottle has reduces such as reduction of raw
material costs from $0.25 to $0.20 per bottle, general and administrative costs from $200000
to $50000 and decreasing marketing costs from $100000 to $50000.
18

REFERENCES
Books and journals
Altman, E. I., Iwanicz‐Drozdowska, M., Laitinen, E. K., & Suvas, A. (2017). Financial
Distress Prediction in an International Context: A Review and Empirical Analysis of
Altman's Z‐Score Model. Journal of International Financial Management & Accounting.
28(2). 131-171.
Geng, C., Yonghui, C., Jiangwei, S., & Long, C. (2017). Newly developed technique and
analysis solution to accelerate consolidation of ultrasoft soil. Marine Georesources &
Geotechnology. 35(2). 292-299.
Han, S., Huang, A. G., Kalimipalli, M., & Wang, K. (2017). Information and Liquidity of
Over-the-Counter Securities: Evidence from Public Registration of Private Debt.
Jurlander, R., and et.al., (2017). P3326Diagnostic yield of cardiovascular magnetic resonance
in the screening of relatives to patients with arrhythmogenic right ventricular
cardiomyopathy. European Heart Journal, 38(suppl_1).
Leyman, P., & Vanhoucke, M. (2017). Capital-and resource-constrained project scheduling
with net present value optimization. European Journal of Operational Research.
256(3).757-776.
Moradi, N., and et.al., (2017). Monetary Value of Quality-Adjusted Life Years (QALY)
among Patients with Cardiovascular Disease: a Willingness to Pay Study (WTP). Iranian
journal of pharmaceutical research: IJPR. 16(2). 823.
Ndungo, J. M., Tobias, O., & Florence, M. (2017). EFFECT OF INFORMATION
SHARING FUNCTION ON FINANCIAL PERFORMANCE OF SAVINGS AND
CREDIT CO-OPERATIVE SOCIETIES. American Journal of Finance. 1(5). 49-62.
Wang, Z., Hong, J., Liu, P., & Zhang, L. (2017). Voltage fault diagnosis and prognosis of
battery systems based on entropy and Z-score for electric vehicles. Applied Energy. 196.
289-302.
Mohagheghi, V., Mousavi, S. M., Vahdani, B., & Shahriari, M. R. (2017). R&D project
evaluation and project portfolio selection by a new interval type-2 fuzzy optimization
approach. Neural Computing and Applications. 28(12). 3869-3888.
19

Online
Accounting procedure for merger and acquisition, 2017. Available through: <
https://www.enotes.com/research-starters/accounting-mergers-acquisitions> [Accessed on
9th November 2017].
Acquisition process, 2017. Available through: <
https://www.accountingtools.com/articles/2017/5/4/the-acquisition-process> [Accessed on
9th November 2017].
Adjusted present value, 1997. Available through: < https://hbr.org/1997/05/using-apv-a-
better-tool-for-valuing-operations> [Accessed on 10th November 2017].
Altman Z score, 2017. Available through: < http://www.investinganswers.com/financial-
dictionary/financial-statement-analysis/altman-z-score-5188> [Accessed on 10th November
2017].
Effect of dilution on stock price, 2011. Available through: <
https://finance.zacks.com/dilution-affects-stock-price-6875.html> [Accessed on 9th
November 2017].
Effects of tax in merger or acquisition, 1987. Available through: <
http://www.nber.org/chapters/c5822.pdf> [Accessed on 9th November 2017].
Financial distress and ways to overcome them, 2017. Available through: <
http://www.ateneonline.it/ross/studenti/temi_avanzati/isbn6582-0_Ross_ch30.pdf>
[Accessed on 9th November 2017].
Forms of acquisition, 2017. Available through: < http://macabacus.com/accounting/types-of-
acquisitions> [Accessed on 9th November 2017].
Forms of merger, 2017. Available through: < https://www.cleverism.com/different-types-of-
mergers-and-acquisitions-ma/> [Accessed on 9th November 2017].
Steps in applying APV, 2017. Available through: <
http://www.investinganswers.com/financial-dictionary/time-value-money/adjusted-present-
value-1384> [Accessed on 10th November 2017].
20

Advantages of leasing, 2017. Available through: < https://techfin.net/advantages-equipment-
machinery-leasing/> [Accessed on 10th November 2017].
21