Financial Analysis Assignment: Capital Budgeting and Valuation

This document contains the solutions to a finance homework assignment. The assignment covers several key financial concepts. The first part of the solution addresses investment valuation, calculating the dividends to be received over time, and determining the amount an investor can consume in the present. It also explores the concept of present value. The second part focuses on capital budgeting, comparing the annual equivalent costs of two different systems and recommending the more cost-effective option. The next part of the solution delves into bond valuation, calculating the current value of an unsecured note based on its coupon rate, required rate of return, and payment schedule. Finally, the assignment addresses a capital budgeting problem involving the purchase of new trucks. The solution analyzes the cash flows associated with the investment, calculates the net present value (NPV), and provides a recommendation on whether the company should proceed with the investment.

Answer 1
a)
Dividend to be received in May 2018 (in $)
= Net profit for 2018 x share % x dividend pay-out ratio
= 600000 x 15% x 75%
= 67,500
Dividend to be received in May 2019 (in $)
= Net profit for 2018 x (1 + growth rate) x share % x dividend pay-out ratio
= 600000 x (1 + 30%) x 15% x 75%
= 87,750
Amount required in late May 2019 (in $) = 100,000
Dividend to be received in May 2019 (in $) = 87,750
Remaining (in $) = 100000 - 87750
= 12,250
Value of 12,250 in May 2018 (in $)
= Present value of 12,250 for one year at interest rate of 10%
= 12250 / (1 + 10%)
= 11,136
She can consume in May 2018 (in $) = 67500 - 11136
= 56,364
b)
Discount rate = 6%
Cost of System P (in $) = 200,000

Useful life (in years) = 3
Operating cost per annum (in $) = 10,000
Present value annuity factor for 3 years at 6% = 2.6730
Annual Equivalent cost (in $)
= (Cost of system / PVAF) + operating cost
= (200000 / 2.6730) + 10000
= 84,822
Discount rate = 6%
Cost of System Q (in $) = 240,000
Useful life (in years) = 4
Operating cost per annum (in $) = 12,000
Present value annuity factor for 4 years at 6% = 3.4651
Annual Equivalent cost (in $)
= (Cost of system / PVAF) + operating cost
= (240000 / 3.4651) + 12000
= 81,262
Since AEC of system Q is less than that of system P. System Q should be selected.
c)
Face value of Notes (in $) = 1,000.00
Coupon rate per annum = 14%
Interest amount (in $) = Face value x coupon rate
= 1000 x 14%
= 140.00

Required rate of return = 18%
As per details given in the question, payment will be done as given below.
Particulars Amount ($)
Payment year
no.
Interest of May-19 paid in May-23 140.00 5
Interest of May-20 paid in May-23 140.00 5
Interest of May-21 paid in May-21 140.00 3
Interest of May-22 paid in May-22 140.00 4
Interest of May-23 paid in May-23 140.00 5
Repayment 1,000.00 5
Yea
r Amount PVF PV
3 140.00 0.6086 85.21
4 140.00 0.5158 72.21
5 1,420.00 0.4371 620.70
778.11
Current value of each unsecured note (in $) = 778.11
Answer 4
a)
Tax rate = 30%
Cost of capital = 10%
Working capital requirement (in $) = 30,000
New Trucks
Cost of each truck (in $) = 500,000
Total cost of truck (in $) = Cost of each truck x 2
= 500000 x 2

= 1,000,000
Useful life of new trucks (in years) = 4
Total depreciation on new trucks (in $) = 1000000 / 4
= 250,000.00
Total salvage value new trucks (in $) = 150000 x 2
= 300,000
Savings in storage costs (in $) = 50,000
Savings in labour costs (in $) = 200,000
Tax deductible expenses in year 2 (in $) = 40,000
Tax deductible expenses in year 3 (in $) = 50,000
Old Trucks
Carrying value of old trucks (in $) = Cost of truck x 3 x (1 - 20%)
= 250000 x 3 x (1 - 20%)
= 600,000
Sale price of old trucks (in $) = 100000 x 3
= 300,000
Initial cash outflow (in $) = Working capital + cost of new trucks
= 30000 + 1000000
= 1,030,000
Loss on sale of old trucks (in $)
= Carrying value of old trucks - Sale price of old trucks
= 600000 - 300000
= 300,000

Tax savings on loss (in $) = 300000 x 30%
= 90,000
Net cash outflow on sale of old trucks (in $)
= Loss on sale of old trucks - tax savings
= 300000 - 90000
= 210,000
Profit on sale of old trucks (in $)
= Sale price of old trucks - Carrying value of old trucks
= 300000 - 0
= 300000
Tax on profit (in $) = 300000 x 30%
= 90,000
Net cash inflow on sale of new trucks (in $)
= Profit on sale of old trucks - tax on profit
= 300000 - 90000
= 210,000
Total terminal cash inflow
= Working capital - Net cash outflow on sale of old trucks + Net cash inflow
on sale of new trucks
= 30000 - 210000 + 210000
= 30,000
Year 1 2 3 4
Savings in storage costs 50,000 50,000 50,000 50,000
Savings in labour costs 200,000 200,000 200,000 200,000
Less: Depreciation -250,000 -250,000 -250,000 -250,000
Less: Overhauling expenses -40,000 -50,000
Profit before tax - -40,000 -50,000 -
Add: Tax savings - 12,000 15,000 -
Net profit - -28,000 -35,000 -

Add: Depreciation 250,000 250,000 250,000 250,000
Cash flow from
operations 250,000 222,000 215,000 250,000
Year Cash flow PVF PV
0 -1,030,000 1.0000 - 1,030,000.00
1 250,000 0.9091 227,272.73
2 222,000 0.8264 183,471.07
3 215,000 0.7513 161,532.68
4 280,000 0.6830 191,243.77
- 266,479.75
Net Present Value (in $) = -266,479.75
b)
No. Company should not buy new trucks.
Company should not accept this proposal because NPV is negative. It means there will be
loss of $266,479.75 on purchase of new trucks given the existing circumstances.