FIN201 Corporate Finance: Investment Appraisal and Stock Valuation

This corporate finance assignment provides solutions to questions related to investment decisions and stock valuation. It includes calculations of present value of annuity, simple and compound interest. It also covers project evaluation using Net Present Value (NPV) and Internal Rate of Return (IRR) methods, along with a profitability index comparison for mutually exclusive projects. Furthermore, the assignment explains how to determine if a stock is undervalued or overvalued using the Capital Asset Pricing Model (CAPM) and differentiates between fundamental and technical analysis. Desklib provides a platform for students to access similar solved assignments and study resources.

Running head: CORPORATE FINANCE
Corporate Finance
Name of the student:
Name of the University:
Author Note:

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Table of Contents
Answer 1..........................................................................................................................................2
A..................................................................................................................................................2
B...................................................................................................................................................2
C...................................................................................................................................................2
Answer 2..........................................................................................................................................3
Project A..........................................................................................................................................3
Project B......................................................................................................................................4
c) What about if these two projects are two mutually exclusive ones......................................4
d) Will IRR and NPV always give you the same results?.....................................................4
Answer 3..........................................................................................................................................5
How do you find whether a stock is undervalued or overvalued? Give one example and
explain..........................................................................................................................................5
The difference of fundamental analysis vs. technical analysis................................................6
Reference:........................................................................................................................................8
Appendix:........................................................................................................................................9

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Answer 1
A
Time in months and years 24 12
monthly Receipt
$
3,600.00
Rate 12%
Semi-annually rate 6%
value of annuity as per tables per 6%, 24
months 12.51
PV
$
45,018
B
Simple Interest
amount of interest $ 432.00
Amount of interest after 12 years $ 5,184.00
Total Balance $ 8,784.00
Compounded Annually
Future value $ 14,025.51
Amount of Interest if compounded $ 5,241.51
C
Particulars
Percen
t
Cost$ in
million
Rat
e
Market
Value$ in
million
Common Equity 35.5 12% 46.6
Long term Debt 31.9 8% 35
Preferred Equity 10.3 10% 10.3
Tax 30%
Total Market Value 91.9
WACC 27.66

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Answer 2
Project A
Calculation of NPV and IRR
Year 0 1 2 3 4 5 6
Rate 20%
Cash flow
$
(6,000)
$
2,200
$
2,200
$
2,200
$
2,200
$
2,200
$
2,200
Discounting
Factor 1 0.833333 0.694444
0.57870
4 0.482253
0.40187
8 0.334898
PV of Cash flow
$
(6,000)
$
1,833
$
1,528
$
1,273
$
1,061
$
884
$
737
NPV $1,316
IRR 29%
ABC Company shall buy project A as the NPV derived $1316 is positive. As per the rule
if NPV positive that means the project would fetch a higher rate of return than the rate of return
mentioned by the management that is 20 percent.
If the company does not buy the equipment and decide to invest the amount somewhere
else. The company shall earn a handsome figure of return in 20 percent. In the above project rate
is cast-off to discount the inflows of cash to its present value. The rate of return is also identified
as discount rate.

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Project B
As per the NPV method, Smart Manufacturing Company shall purchase the machine, as
the cost of saving value is higher than the cost of initial value of buying the machine.
(Fernandez, 2013).
C) What about if these two projects are two mutually exclusive ones
The profitability index of both the Projects are:
Calculation of Profitability Index
of Project B
Particulars
Initial Investment $15,000
PV of Cash flow $ 16,209
Profitability Index 1.08
However, Project B has the highest NPV but the investment is not preferable. Project A
has the index value of profitability 1.22 and it is preferable project for investment. As it is
fetching 1.22 value presently for every dollar that is invested.
Year 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
Rate 25%
Cash flow (15,000)$ 4,200$ 4,200$ 4,200$ 4,200$ 4,200$ 4,200$ 4,200$ 4,200$ 4,200$ 4,200$ 4,200$ 4,200$ 4,200$ 4,200$ 4,200$
Discounting Factor 1 0.8 0.64 0.512 0.4096 0.32768 0.26214 0.20972 0.16777 0.13422 0.10737 0.0859 0.06872 0.05498 0.04398 0.03518
PV of Cash flow (15,000)$ 3,360$ 2,688$ 2,150$ 1,720$ 1,376$ 1,101$ 881$ 705$ 564$ 451$ 361$ 289$ 231$ 185$ 148$
NPV 1,208.90$
IRR 27%
Calculation of NPV and IRR
Profitability Index of Project A
Particulars
Initial Investment $ 6,000.00
PV of Cash flow $ 7,316
Profitability Index 1.22

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d) Will IRR and NPV always give you the same results.
In the following situation both NPV and IRR would give the same result.
1. When the plan under contemplation include conformist cash flow that is when a
preliminary cash disbursements is tracked by a sequences of cash inflows.
2. When the plans are self-regulating of one additional, that is applications the receipt of
which does not prevent the receipt of any other along with if the firm is not experiencing
any difficult in receiving funds constantly.
The explanations for similarity in results in the above suitcases are simple. In NPV method,
an application is acknowledged if NPV is optimistic. NPV will be optimistic only when the
definite rate of return on venture is supplementary than the cut off rate. In case of IRR
method, a plan is acknowledged only when the IRR is greater than the cut off rate.
(Chaudhary 2013).
Answer 3
How do you find whether a stock is undervalued or overvalued? Give one example
and explain
To determine that the stock is overvalued or undervalued can be measured through Capital Asset
Pricing Model (CAPM). This model is used to conclude the amount of expected return
constructed upon expected rate regarding return on the market including the beta coefficient
along with the risk free rate of the stock.

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Example- Mr. Smith predicts that stock A would reach $40 by the one year end. Stock a beta is
1.3, market expected return is 18% and risk free rate is 6%. Calculate the expected return of
Stock A is undervalued or overvalued?
Solution- Here, Rf = 6% ,Rm = 18% β=1.3 the expected return (E(R))
E(R)= Rf + β (Rm- Rf)
=6%+1.3*(18%-6%)
=21.6%
The given expected return if Stock A is 21.6%.
CAPM indicates that the stock that gives higher expected return than the required return, that
signifies that the stock is said to be undervalued and the investor shall buy the stock and vice
versa. (Džaja and Aljinović 2013).
In the above example, Stock A is undervalued, as its expected return is higher than the
required rate of return.
The difference of fundamental analysis vs. technical analysis.
Basis Fundamental Analysis Technical Analysis
Role Estimation of prices of shares
because of statists and the
facts related to the stock.
Stresses on the data related to
the market.
Cost of share The intrinsic value of the No accurate value of the

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share is concluded. share is there.
Time It is related for long-term
investments.
This is short-term
investments.
Use Detects undervalue and
overvalue prices of stock.
Helps in detecting the time
for purchasing and selling of
stocks. Guerrero-Baena,
Gómez-Limón and Fruet
Cardozo 2014).

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Reference:
Chaudhary, A.K., 2013. Impact of behavioral finance in investment decisions and strategies–a
fresh approach. International Journal of Management Research and Business Strategy, 2(2),
pp.85-92.
Chiarella, C. and Kang, B., 2013. The evaluation of American compound option prices under
stochastic volatility and stochastic interest rates. Journal of Computational Finance.
Durnev, A., Morck, R. and Yeung, B., 2004. Value‐enhancing capital budgeting and firm‐
specific stock return variation. The Journal of Finance, 59(1), pp.65-105.
Džaja, J. and Aljinović, Z., 2013. Testing CAPM model on the emerging markets of the Central
and Southeastern Europe. Croatian Operational Research Review, 4(1), pp.164-175.
Fernandez, P., 2013. Valuing Companies by Cash Flow Discounting: Fundamental relationships
and unnecessary complications (No. D/1062). IESE Business School.
Guerrero-Baena, M.D., Gómez-Limón, J.A. and Fruet Cardozo, J.V., 2014. Are multi-criteria
decision making techniques useful for solving corporate finance problems? A bibliometric
analysis. Revista de Métodos Cuantitativos para la Economía y la Empresa, 17, pp.60-79.
Han, Y., Yang, K. and Zhou, G., 2013. A new anomaly: The cross-sectional profitability of
technical analysis. Journal of Financial and Quantitative Analysis, 48(5), pp.1433-1461.

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Appendix: