FIN201 Corporate Finance Assignment: Investment Appraisal Methods

This assignment solution for a Corporate Finance course (FIN201) addresses key concepts such as present value calculations, investment analysis, and capital budgeting. It involves determining the present value of future payments, analyzing bond interest payments under simple and compound interest scenarios, and calculating the Weighted Average Cost of Capital (WACC). The assignment further evaluates the viability of investment projects using Net Present Value (NPV) analysis, comparing mutually exclusive projects, and discussing the differences between NPV and Internal Rate of Return (IRR) methods. Finally, it explores stock valuation, the efficiency of financial markets, and the distinctions between fundamental and technical analysis in investment decisions. Desklib provides access to similar solved assignments and past papers for students.

CORPORATE FINANCE
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Question 1
a) For the given situation, the value of the future payments can be estimated using a formula
which highlights the present value of all the future annuity payments expected to begin from
the next month.
For the situation and hand, P is $ 3,600 with r as 1% per month and the time being 24 months
with monthly deposits.
b) The objective is to highlight the total interest that has been paid over the complete maturity
period of 12 years. It is known that the face value of these bonds is $ 10,000 with a coupon
payment of 10% p.a. and coupon is paid annually.
a) Case 1: Simple Interest
A key characteristic of simple interest is that there is no compounding of interest owing to
which the quantum of interest does not alter on a y-o-y basis (Petty et. al., 2015).
Annual interest outflow for the company = 10% * 10,000 = $ 1,000
Total interest outflow corresponding to the maturity of the bond = 1,000*12 = $12,000
b) Case 2: Compound Interest
A key characteristic of compound interest is that owing to compounding the interest keeps on
increasing on a y-o-y basis. As a result, the total amount paid as interest would be future
value of annuity payment of annual interest of $ 1,000 paid over a 12 year period which is
computed below (Damodaran, 2015).
It is evident that in this scenario, the interest paid during the same period is significantly
higher.

c) The information provided in respect of the used capital sources and the computation of
their respective weight is highlighted as follows.
It is evident that for the computation of the respective weights of each capital, the market
value has been used instead of the book value as incremental capital needs to be raised in the
present. The weight is determined by dividing the market value of capital by the total market
value of capital.
The cost corresponding to various capitals is highlighted as follows.
Cost of equity capital = 12% per annum
Cost of preference capital = 10% per annum
Cost of debt (before tax) = 8% per annum
Cost of debt (After tax) = (1-30%)*8% = 5.6% per annum
The WACC computation based on the information provided is stated as follows.
Question 2
a) In order to comment on the viability of the project, NPV computation ought to be
performed in the wake of expected cashflows and also the rate of return expected. This is
highlighted as follows.
A positive NPV is testimony of the financial viability of the project and therefore I would go
ahead with Project A (Brealey, Myers and Allen, 2014).

b) In order to comment on the viability of the project, NPV computation ought to be
performed in the wake of expected cashflows and also the rate of return expected. This is
highlighted as follows.
The given project would result in reduced cash outflow in regards to labour cost whose PV
over the project life time (i.e. 15 years) has been computed below.
A positive NPV is testimony of the financial viability of the project and therefore I would go
ahead with Project B (Damodaran, 2015).
c) Since the projects are mutually exclusive, hence the one that is better requires to be
selected. The appropriate selection criterion would be NPV which by referring to part (a) and
(b) clearly highlight is higher for Project A. As a result, Project A should be chosen if the two
projects are mutually exclusive (Petty et. al., 2015).
d) The given statement is not correct as there are certain situations when the results obtained
from NPV and IRR are not the same. A typical example of such a project would be one
where after the beginning of the project, atleas.t one year would be there when there would be
net cash outflow. In the given scenario, there would be multiple IRR values produced and
hence there would be divergence in the decision produced by NPV and IRR (Parrino and
Kidwell, 2014).
Question 3
A key issue in investing is to determine if the stock is fairly valued or not, In this regards , the
key requisite input is to determine the fair value of the stock based on the present and future
information and guidance provided by the management. This is imperative as financial
markets are typically inefficient and hence there is an aberration between the market value
and fair value (Brealey, Myers and Allen, 2014).
Stock is undervalued if Fair value > Market value
Stock is overvalued if Fair value < Market value

The overvaluation or undervaluation of stocks tends to arise only because of the financial
markets being inefficient. Take for example the Wesfarmers stock which is trading at AUD
32. If the fair value of the stock is AUD 40, then it would be fair to conclude that this stock is
undervalued and hence in the long term price would appreciate to bridge the divergence.
The key differences between fundamental analysis and technical analysis are indicated below
(Petty et. al., 2015).
 Technical analysis is used to initiate short term trades unlike fundamental analysis
which is used to initiate long term investment calls.
 The technical analysis is based on the premise that the future stock price movement is
a function of past stock prices. However, fundamental analysis takes into
consideration whether the stock is undervalued or overvalued and then tends to make
the requisite call.
 Both fundamental and technical analysis have relevance only in an inefficient capital
market.

References
Brealey, R. A., Myers, S. C. and Allen, F. (2014) Principles of corporate finance, 6th ed. New
York: McGraw-Hill Publications
Damodaran, A. (2015). Applied corporate finance: A user’s manual 3rd ed. New York:
Wiley, John & Sons.
Parrino, R. and Kidwell, D. (2014) Fundamentals of Corporate Finance, 3rd ed. London:
Wiley Publications
Petty, J.W., Titman, S., Keown, A., Martin, J.D., Martin, P., Burrow, M. and Nguyen, H. (2015).
Financial Management, Principles and Applications, 6th ed.. NSW: Pearson Education, French
Forest Australia