Corporate Finance FIN304/1 Final Exam Spring 2021 Analysis

This document presents a comprehensive solution to the FIN304/1 Corporate Finance final exam. The solution begins with calculating the Weighted Average Cost of Capital (WACC), debt/equity, and current ratios for a hypothetical company, Albeit Asitis Corporation, and provides an analysis of the company's financial position. It then delves into a capital budgeting analysis for a new project, including revenue, variable costs, fixed costs, and tax implications, leading to the calculation of Net Present Value (NPV) and Internal Rate of Return (IRR). The assignment further explores the topic of Islamic finance, discussing its principles, advantages, and disadvantages. Additionally, it analyzes the impact of recent news stories, such as Tesla's decision to stop accepting Bitcoin and NVIDIA's stock split, on financial markets. Finally, the solution explains the Capital Asset Pricing Model (CAPM), its uses, reliability, and the role and limitations of Beta in financial analysis. The document provides detailed calculations and explanations to support the answers, offering a complete and thorough response to the exam questions.

Paula Morales
FIN304/1 Spring 2021
Final Exam
Student: Paula Morales
Course Leader: David Muir
Course: FIN304/1 Corporate Finance- Spring 2021
Date Due: Sunday 30th May 2021
Date Submitted: Sunday 30th May 2021
Word Length:
Comments:
Grade:

Paula Morales
FIN304/1 Spring 2021
1. Data Q1
The Albeit Asitis Corporation is known for the high quality of its Snirfel Sprocket Inverters
internationally. It has undertaken to expand recently, and requires your assistance in
determining first the Weighted Average Cost of Capital, and the determination of a capital
budget for the purchase of a new machine which is expected to last about seven years.
To determine the WACC, the following information is helpful:
The calculation is done on the basis of total debt, short and long term, for which the
company pays 9%, and the Tax Rate is 25%
The company will determine the cost equity using the CAPM model, which is based on
the following information:
Standard deviation of the market – 5.00%
Standard deviation of Albeit - 7.00%
Covariance 43.75
T-bond rate – 3 month - 3.00%
Expected Market return - 12.00%
The Balance Sheet looks like this:
Albeit Asitis Corporation
December 31, 2020
Assets Liabilities
Cash 2,523 Operating Bank Loan 1,745
Accounts Receivable 5,636 Payables 3,256
Inventory 7,522 Current portion of LT loan 4,722
Current Assets 15,681 Current Liabilities 9,723
Machinery 58,200 Long term loan 20,875
Accumulated Depreciation 27,450- 30,750 Mortgage 72,200
Buildings 259,720 Bonds 50,000
Accumulated Depreciation 76,730- 182,990
Long Term Liabilities 143,075
Fixed Assets 213,740
TOTAL LIABILITIES 152,798
TOTAL ASSETS 229,421
Shareholder's Equity
Capital Stock 30,000
Retained Earnings 46,623
TOTAL SHAREHOLDER'S EQUITY 76,623
TOTAL EQUITY AND LIABILITIES 229,421

Paula Morales
FIN304/1 Spring 2021
a) Calculate the Debt/Equity and working capital (current) ratios. What is
your professional opinion, given that for the sector, the ratios are usually 3
and 1.2 respectively?
Debt Equity Ratio = Total long-term debt of the company / Shareholder’s fund
= 152798 / 76623 = 1.99
The debt-equity ratio of the company is currently at 1.99 but usually, the debt-equity
ratio of the companies is at 3 which shows that the company can have debt at 3 times
from the current level of equity but currently the company has only 1.99 times debt
of the shareholder's fund. That shows currently the company can increase its funds
with the debt at a cheaper cost, therefore the company should consider borrowing
funds from debt funds and bank financing.
Current ratio = Current assets / current liabilities
= 15681 / 9723 = 1.61
In the current case usually, a current ratio is 1.2, but the company has a current ratio
of 1.61 which means the company has excess working capital as compared to the
usual trend.
On accessing both conditions about the debt-equity ratio and the current ratio it can be
concluded that the company has excess funds with themselves and also the company
can increase the funds and invest the funds in the various opportunities ahead to the
company.
b) Calculate the WACC of the firm and explain what it is used for. How
would you tell the owners how this figure will help them?
Calculation of cost of equity
Beta of the stock = Covariance / Variance of market
Standard deviation of market = 5%
Variance of market = 25
Covariance = 43.75
Beta of the stock = 43.75 /25 = 1.75
Rf = 3 %
Rm = 12 %
E(r) = 3 + (12-3) * 1.75

Paula Morales
FIN304/1 Spring 2021
E(R) = 3 + 15.75 = 18.75 %
The average cost of debt = 9 %
Tax rate = 25 %
Cost of debt (after tax) = 9 * (1-.25) = 6.75 %
Calculation of weighted average cost of capital
WACC
Details Value Weights Cost WAC
C
Debt 152798 0,50 6,75 3,37
Equity 76623 0,33 18,75 6,26
229421 0,83 9,63
The weighted average cost of capital is the cost of funding to the company, it can be
work as a hurdle rate for any decision making, any investment opportunity if earns
below the weighted average cost of capital then the project should not be acceptable
by the company.
2. Data Q2
The firm is planning on starting a new operation which will last for about seven years. The
initial cash injection will be $35,000. The revenues for the seven years are expected to be:
1 2 3 4 5 6 7
13,000.0
0
14,000.0
0
17,000.0
0
18,000.0
0
20,000.0
0
25,000.0
0
20,000.0
0
The variable costs are 35%
The tax rate remains at 25%
Fixed costs are $2,500 per month
The company expects a recovery on concluding operations of $12,000. This amount is
taxable.

Paula Morales
FIN304/1 Spring 2021
(a) The capital budget of the company
Capital budget
Details 1 2 3 4 5 6 7
Opening balance 0 -30538 -25588 -19175 -12275 -4400 5913
Revenue 13000 14000 17000 18000 20000 25000 20000
Variable cost 4550 4900 5950 6300 7000 8750 7000
Fixed cost 2500 2500 2500 2500 2500 2500 2500
Tax Expense 1488 1650 2138 2300 2625 3438 5625
Cash Injection 35000
Cash withdrawals 12000
closing balance -30538 -25588 -19175 -12275 -4400 5913 10788
(b) Calculation of net present value
Net present value
Details 0 1 2 3 4 5 6 7
Revenue 13000 14000 17000 18000 20000 25000 20000
Variable cost 4550 4900 5950 6300 7000 8750 7000
Fixed cost 2500 2500 2500 2500 2500 2500 2500
Tax Expense 1488 1650 2138 2300 2625 3438 5625
Cash Injection 35000
Cash withdrwals 12000
Net cash flows -35000 4463 4950 6413 6900 7875 10313 16875
Present value factor 1 0,912 0,832 0,759 0,692 0,631 0,576 0,525
closing balance -35000
4070,509
9
4118,
6
4866,75
1
4776,7
4
4972,
8
5940,0
1
8866,2
1
Net present value
2611,6
2
(c) Calculation of internal rate of return
Calculation of internal rate of
return
Year
Cash
flow
0 -35000
1 4462,5
2 4950
3 6412,5
4 6900
5 7875
6 10312,5

Paula Morales
FIN304/1 Spring 2021
7 16875
Internal rate of return 11%
The above discussion showed that the company currently have a cost of capital of
9.63 % and the Internal rate of return is 11 % that shows that the project has earned 11
% but the cost of the company is 9.63 % that shows that the project is profitable for
the company and the project should be accepted and in the current case the net present
value of the project is also positive that indicates that the project is profitable to the
company.
3. There are many who feel that Islamic finance is being used to back terrorist
organizations such as ISIS. That probably explains the “different way” they
go about making money. What do you think? What are the advantages and
disadvantages of dealing with an Islamic financial institution?
Islamic finance is a financial system that is based on Islamic Law. Under this finance, interest
is not charged for lending and accepting money. Money is considered as a tool of exchange
and will not consider as an asset and therefore Islamic finance is not considered money as a
mode to earn a direct return. Thus Islamic finance is a system where the lender of money
does not receive interest in a monetary term as a return but receives interest in non-monetary
assets or obtains ownership in the business. It means lenders also share the risk of the
borrower. (Al Rahahleh, Ishaq Bhatti, &NajunaMisman,2019). Dealing with Islamic financial
institutions presents its advantages and disadvantages.
Here are some advantages of Islamic finance:
 It avoids charging rates on money lending
 It avoids contracts that involve uncertainty for example- providing financial assistance
for the sale of an object that does not own by the seller
 It does not involve a speculative transaction
 Islamic finance does not assist harmful industries such as drugs, weapons that are not
permitted, prostitution, etc.
 Its dealing involves fairness, profit or loss in the business will be divided amongst
bank and the customer in proportion to their investment
 It makes the bank an investor, not a lender as Islamic finance is not based on interest
but risk sharing.
 It promotes ethics as it distributes money between the needy and poor and not based
on financial conditions, caste, culture, etc.
Some disadvantages of Islamic Finance are:
 Here Banks and owners of the business share profit at a rate that is determined at the
starting of the contract but the loss is distributed in proportion to the investment.

Paula Morales
FIN304/1 Spring 2021
 There are only a few academic courses available to cover the concepts of Islamic
banking. As Islamic banking does not provide huge career opportunities professionals
prefer conventional banking.
 Islamic banks are unable to obtain support from central banks in the time of need as
they operate under different systems.
 Islamic Banks are not techno-friendly in terms of websites or applications.
 Religion interferes in a degree that creates limitations for international agreements or
for foreigners to participate freely.
4. There are many news stories which go unnoticed, but which influence
financial markets. Choose two stories and explain what the significance of
the story is, and what impact it has on financial markets.
1. Tesla says it will stop accepting Bitcoin for car payments over environmental
concerns
The electric cars company declared recently they will not accept Bit coins anymore; they will
not sell their Bitcoins but it will no longer be used for payments due to the environmental
impact caused when mining it. Bitcoin is a crypto currency that can be mined when solving
difficult puzzles and, in order to do so, it is needed a huge amount of computational energy
that increases as the difficulty grows. "We are concerned about rapid increasing use of fossil
fuels for Bitcoin mining and transactions, especially coal” (Press, 2021) . According to a
study from 2019 from MIT and Munich Technical University, the environmental impact that
the mining causes is about 23 million tons of C02 per year, which compared to the total
greenhouse impact, 37 million tons of C02, is about 62% of the total global emissions. The
impact of financial market is caused by Tesla´s statement, which will possibly impact the
crypto currency by decreasing its market value. The repercussions of Tesla statement might
even affect the company, as they have 1500 million dollars in Bitcoin. If the value decreases
too much the company might be accounting losses on the operating revenue.
2. NVIDIA (NVDA) to Split Stock in Four to Attract More Investors
The microprocessors company decided recently to split their stocks into four in the form of
stock dividend, the reason behind is to make the company stock more affordable, to boost
their demand. “Many would argue that the stock is a risky bet. However, we beg to differ due
to its consistent financial performance and strong growth opportunities in various untapped
markets like automotive, healthcare and manufacturing over the long term.” (Research,
2021). If a company has a very low number of shares, let´s say 1000 shares at a price as high
as 600 USD, they can split them into four and end up with 4000 shares of 150 USD, that way
all the shares reflect the same total value (market capitalization) but it achieves for more
people to easily buy their shares given that 600 USD it is difficult for many, otherwise a

Paula Morales
FIN304/1 Spring 2021
single share would be a good piece of their portfolio. The impact of financial market is
caused by the four-to-one shares split, making it easier for shareholders and investors to buy
the company shares. The best possible scenario for the company would be a raise of stock
prices.
5. We use Beta (β) as a term in the Capital Asset Pricing Model (CAPM).
Explain what CAPM is used for, and how reliable it is. What is beta used for,
and what or the limitations of using it?
Capital Asset Pricing Model (CAPM) is a theory of finance that establishes an equation-
based relationship between risk and return on investment. CAPM to establish relations uses
Beta of asset, the risk-free rate of return i.e., rate of return on risk-free securities like
government bonds, the Treasury bill, etc., and the difference between expected return in
market and risk-free return.
This model is widely used all over the world and involves an easy calculation of risk and
return. It provides more useful information than other models in many scenarios but it
involves assumptions that are unrealistic and for which this model is criticized more often
(Efendi, &Wihartati, 2021).
 It involves a simple calculation and provides approximately possible outcomes about
the required rate of return.
 It assumes that the investors hold a portfolio that has diversity similar to the market
and it eliminates Unsystematic risk.
 It covers systematic risk which is generally not considered by other models. Being
unforeseen is an important variable.
 When business mix and the financing of business differ from the current business then
other models like WACC cannot be used.
Uses and Limitations of beta
Beta measures how much volatility security or a portfolio as a whole is. A stock having a
higher beta means it is highly volatile and will majorly be affected by the change in the
market price of the share. The beta of the stock market as a whole is 1. The beta of security
depends on how much it deviates from the market (Suroso, Rusiadi, Purba, Sari, Novalina,
&Lubis, 2018).
Calculation of beta is based on past performance of the stock and a good performance in past
does not guarantee the continuously better performance in the future as in the case of a
technology industry it frequently tends to rise and fall below the market.

Paula Morales
FIN304/1 Spring 2021
6. Ethics is very much a concern in financial circles. What is the importance
of ethics in finance and how does it make the system more reliable? How can
ethics be applied in the field of Finance?
Ethics is generally concerned with human behavior which is acceptable in the normal course
of business as "right". Ethical norms are essential for maintaining relations between people.
Ethics help in resolving the conflict between personal interests and the interest of others.
Most of the financial services are outsourced to others due to a lack of ability and the lack of
time to manage them. Financial services are managed by others and human nature has
selfishness that declines morality in modern business (Bint-Tariq, &Nobanee, 2020). Front
running, Commingled funds, or practices like Insider Trading should not be implemented
inside companies, although this have been seen in Enron, Tyco or Baring Banks.
A company is required to comply with all the rules and regulations of the applicable law, has
to make full and fair disclosures in reports or documents that are required to be filed by the
company. People who handle the financial service of the company have to follow ethical
standards described by their profession. Ethical codes are provided by the institution for their
members so that members maintain a level of discipline which is different from applicable
law and regulation. The risk of getting caught is always high, therefore this practices
shouldn’t be worth it even if they are profitable.
The company is liable to disclose relevant information that is important from the user’s point
of view and that may affect the decision of the users. The accountant should try to reduce the
conflict of interest. The interest of an entity must be preferred over the interest of individuals.
To resolve the conflict of interest or ethical conflict he should follow the policies established
by the organization. If such policies are unable to help then he should discuss the issue with
the superiors and try to resolve the issue with the discussion by involving an advisor into it
and conclude an understanding over the situation. Even if all the efforts issue is not resolved
then
7. Data Q7
The following information has been delivered to you regarding a stock:
Covariance with the market: 24
Std deviation of the stock 8
Std deviation of the market 6

Paula Morales
FIN304/1 Spring 2021
What is the correlation coefficient of this stock with the market? Is it
significant, or is it neutral? What can a correlation coefficient tell us,
generally?
Here;
Std deviation of the stock (∑x) is 8
Std deviation of Market (∑m) is 6
Covariance with the market [Cov(XM)] is 24
= Cov (xm) / ∑x ∑m
= 24/ 8*6
= 0.5
The correlation coefficient which values less than 0.8 is not considered significant hence, the
Coefficient of this stock is not significant.
Correlation coefficients are used to tell us the relationship between two stocks. It tells us the
connection between two different stocks and the moment of their direction as a linear
relationship. It provides us that whether two different stocks are negatively correlated or
positively correlated. In other words, it describes how the moment of a stock affects the
moment of another stock (Jiang, 2018).
References
Al Rahahleh, N., Ishaq Bhatti, M., &NajunaMisman, F. (2019). Developments in risk
management in Islamic finance: A review. Journal of Risk and Financial
Management, 12(1), 37.
Bint-Tariq, M. N., &Nobanee, H. (2020). Business Ethics and Finance: A Mini-
Review. Available at SSRN 3538699.
Efendi, T. F., &Wihartati, A. P. (2021). Decision Support System for Share Investment Using
The Capital Assetpricing Method (CAPM). International Journal of Computer and
Information System (IJCIS), 2(1), 18-22.
Jiang, W. (2018). A correlation coefficient for belief functions. International Journal of
Approximate Reasoning, 103, 94-106.
Melé, D., Rosanas, J. M., &Fontrodona, J. (2017). Ethics in finance and accounting: Editorial
introduction. Journal of Business Ethics, 140(4), 609-613.

Paula Morales
FIN304/1 Spring 2021
Press, A. (2021, May 13). Euronews. https://www.euronews.com/2021/05/13/tesla-to-stop-
accepting-bitcoin-for-car-payments-over-environmental-concerns
Research, Z. E. (2021, May 24). Finance Yahoo. https://finance.yahoo.com/news/nvidia-
nvda-split-stock-four 153803439.html?
guce_referrer=aHR0cHM6Ly93d3cuZ29vZ2xlLmNvbS8&guce_referrer_sig=AQAAABSNF
K8o1R6VG7vVYIZVrLLoieArzviCVeHZO0rwSy18DXKEtreeWlOfAmYopPqytgr0zvjYKJ
KstGGf5Ns-fPjFeuiiTY5mjbTrgqEdAsohd-FI
Suroso, S., Rusiadi, R. B., Purba, A. P. U., Sari, A. K., Novalina, A., &Lubis, A. I. F. (2018).
Autoregression Vector Prediction on Banking Stock Return using CAPM Model Approach
and Multi-Factor APT. Int. J. Civ. Eng. Technol, 9(9), 1093-1103.