Corporate Finance Homework: NPV, WACC, and Option Pricing

This document provides a comprehensive solution to a corporate finance assignment. The solution covers various aspects of corporate finance, including the computation of net cash flow, assessing Net Present Value (NPV) and conducting sensitivity analysis. It delves into calculations related to NPV, Internal Rate of Return (IRR), share price valuation, and the assessment of beta values for different entities. The assignment also explores the Weighted Average Cost of Capital (WACC) calculation, unlevered cost of capital, and the justification behind variations in equity costs of capital. Furthermore, it examines option pricing, including call and put options, and provides recommendations based on different scenarios with discounted cash flow analysis. The document offers detailed calculations and explanations, making it a valuable resource for students studying corporate finance.

Corporate Finance

TABLE OF CONTENTS
QUESTION 1.......................................................................................................................................4
a. Computation of net cash flow .................................................................................................4
b. Assessing NPV as per the case situation ................................................................................5
c. Sensitivity analysis ..................................................................................................................6
QUESTION 2.......................................................................................................................................7
QUESTION 3.......................................................................................................................................8
a....................................................................................................................................................8
b...................................................................................................................................................9
QUESTION 4.......................................................................................................................................9
QUESTION 5.....................................................................................................................................10
QUESTION 6.....................................................................................................................................12
QUESTION 7.....................................................................................................................................14
A. Measuring WACC for MLC.................................................................................................14
B. Unlevered cost of capital:......................................................................................................16
C. Justifying the reason behind variations in equity costs of capital, unlevered costs of capital and WACC......................................17
QUESTION 8.....................................................................................................................................17

QUESTION 9.....................................................................................................................................18
QUESTION 10...................................................................................................................................21

QUESTION 1
a. Computation of net cash flow
Year 0
Year
1
Year
2 Year 4
Year
5
Year
6
Year
7
Year
8
Year
9 Year 10
Sales revenue
105.0
0
105.0
0 105.00
105.0
0
105.0
0
105.0
0
105.0
0
105.0
0 105.00
Manufacturing expenses other
than depreciation 35.00 35.00 35.00 35.00 35.00 35.00 35.00 35.00 35.00
Marketing expenses 10.00 10.00 10.00 10.00 10.00 10.00 10.00 10.00 10.00
Depreciation 16.00 16.00 16.00 16.00 16.00 16.00 16.00 16.00 16.00
Equals net operating income
$44.0
0
$44.0
0 $44.00
$44.0
0
$44.0
0
$44.0
0
$44.0
0
$44.0
0 $44.00
Minus income tax 15.40 15.40 15.40 15.40 15.40 15.40 15.40 15.40 15.40
Equals Unlevered Net income
$28.6
0
$28.6
0 $28.60
$28.6
0
$28.6
0
$28.6
0
$28.6
0
$28.6
0 $28.60
Plus depreciation 16.00 16.00 16.00 16.00 16.00 16.00 16.00 16.00 16.00
Additions to net working
capital (5.00) (5.00) (5.00) (5.00) (5.00) (5.00) (5.00)
(5.00
) (5.00)
Capital Expenditures (160.00)
Continuation value 12.00
Free cash flow
($160.00
)
$39.6
0
$39.6
0 $39.60
$39.6
0
$39.6
0
$39.6
0
$39.6
0
$39.6
0 $51.60

b. Assessing NPV as per the case situation
Computation of NPV
year Cash inflows PV factor @ 11% Discounted cash inflow
1 39.6 0.901 35.68
2 39.6 0.812 32.14
3 39.6 0.731 28.96
4 39.6 0.659 26.09
5 39.6 0.593 23.50
6 39.6 0.535 21.17
7 39.6 0.482 19.07
8 39.6 0.434 17.18
9 39.6 0.391 15.48
10 51.6 0.352 18.17
Total discounted cash inflows 237.44
Less: initial investment 160
NPV 77.44
Cost of capital 11.00%
NPV 77.44

c. Sensitivity analysis
Discount Rate NPV
NPV 77.44
5.00% 153.15
6.00% 138.16
7.00% 124.23
8.00% 111.28
9.00% 99.21
10.00% 87.95
11.00% 77.44
12.00% 67.61
13.00% 58.41
14.00% 49.80
15.00% 41.71
16.00% 34.12
17.00% 26.98
18.00% 20.26
19.00% 13.93
20.00% 7.96
21.00% 2.33
22.00% (3.00)
23.00% (8.03)
24.00% (12.80)
25.00% (17.32)

26.00% (21.60)
27.00% (25.67)
28.00% (29.53)
29.00% (33.21)
30.00% (36.70)
QUESTION 2
Calculation of NPV
Year Cash inflows PV factor @ 5% Present value of cash flows
1 25 0.952 23.81
2 25 0.907 22.68
3 25 0.864 21.60
4 25 0.823 20.57
5 25 0.784 19.59
6 25 0.746 18.66
7 25 0.711 17.77
8 25 0.677 16.92
9 25 0.645 16.12
10 25 0.614 15.35

Total discounted cash inflow 193.04
less: initial investment 150.00
NPV 43.04
Less: cost at perpetuity (2.2/.05) 44
Net value -0.96
IRR: From assessment, it has found that rule pertaining to IRR does not apply in the case of multiple variables
QUESTION 3
a.
G
i
v
e
n
E
s
t
i
m
a

t
e
d
o
r
p
r
o
j
e
c
t
e
d
Year 2 4 6 7 8 9 10 11
Free cash flow 48 68 74
76.9
6
80.0
4
83.2
4
86
.5
7 90.03
PV factor @ 16%
0.86
2
0.74
3
0.64
1
0.
55
2 0.476
Discounted cash flows
66.3
4
59.4
8
53.3
3
47
.8
1 42.87
Enterprise value (Sum of all the discounted cash
flows)
269.8
3
b.
Calculation of fair value

Particulars Figures (in €)
Enterprise value 269.83
Net debt 150
Fair value 119.83
Shares outstanding 40
Share price 2.99 or 3
QUESTION 4
Particulars
BHI’s equity 32*20 = £640
Debt level £64
Value of BHI 640 + 64 = 704
Beta assessment of BHI Equity value / total value (640 / 704)1.33 +(64/704)0 =
1.21
Burger’s holding 850 / 2 = £425
Value of soccer team Value of BHI – Value of BHI’s
share in BB
£704 – £425 = £279
Beta of BB .75
Equity beta of BB (850/1050)*β + (200/1050)0 =
0.75
Value of BHI’s investment in
BB is
50% * 850 million = 425
value of BHI’s investment in
Soccer Team
279 million
Beta value of soccer team (425/704) 0.93 +
(279/(425+279)) × β = 1.64

QUESTION 5
Capital Cost Allowance
Assumptions
Cost of Asset 72000000
Economic Life 6
Tax rate 40%
Discounte rate 17%
CCA rate of asset 9%
T-year
annuity of C/T
$17,378,
799.65
C*d*t/
(r+d)
100987
01.2987
013
(C*d*t/
(r+d))*(.5+.5/
(1+r))
100987
01.298
7013
PV of tax 28,800,0 PV of tax shields 12,445, PV of tax shields 6,951,9

shields 00.00 365.54 48.18
Straight-Line
Depreciation
Declining-
Balance
Depreciation
Declining
Balance with
half-year
Year Book value
Deprec
iation
Tax
Shield PV UCC CCA
Tax
Shield PV UCC CCA
Tax
Shield PV
1 72,000,000.00
12,000,
000.00
4,800,0
00.00
4,800,00
0.00 72,000,000.00
6,480,0
00.00
2,592,0
00.00
2,592,0
00.00 72,000,000.00
3,240,0
00.00
1,296,0
00.00
1,296,0
00.00
2 60,000,000.00
12,000,
000.00
4,800,0
00.00
4,800,00
0.00 65,520,000.00
5,896,8
00.00
2,358,7
20.00
2,358,7
20.00 68,760,000.00
3,094,2
00.00
1,237,6
80.00
1,237,6
80.00
3 48,000,000.00
12,000,
000.00
4,800,0
00.00
4,800,00
0.00 59,623,200.00
5,366,0
88.00
2,146,4
35.20
2,146,4
35.20 65,665,800.00
2,954,9
61.00
1,181,9
84.40
1,181,9
84.40
4 36,000,000.00
12,000,
000.00
4,800,0
00.00
4,800,00
0.00 54,257,112.00
4,883,1
40.08
1,953,2
56.03
1,953,2
56.03 62,710,839.00
2,821,9
87.76
1,128,7
95.10
1,128,7
95.10
5 24,000,000.00
12,000,
000.00
4,800,0
00.00
4,800,00
0.00 49,373,971.92
4,443,6
57.47
1,777,4
62.99
1,777,4
62.99 59,888,851.25
2,694,9
98.31
1,077,9
99.32
1,077,9
99.32
6 12,000,000.00
12,000,
000.00
4,800,0
00.00
4,800,00
0.00 44,930,314.45
4,043,7
28.30
1,617,4
91.32
1,617,4
91.32 57,193,852.94
2,573,7
23.38
1,029,4
89.35
1,029,4
89.35