Comprehensive Financial Analysis of VMX Ltd: Assignment Solution

This document presents a comprehensive solution to a financial management assignment. The assignment analyzes bond valuation, differentiating between premium and discount bonds and providing four reasons for their occurrence. It calculates the weighted average cost of capital (WACC) for VM...Read More

Running Head: ESSENTIAL FINANCIAL MANAGEMENT
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ESSENTIAL FINANCIAL MANAGEMENT

ESSENTIAL FINANCIAL MANAGEMENT
Table of Contents
Question 3...................................................................................................................................................3
A)............................................................................................................................................................3
B).............................................................................................................................................................3
C).............................................................................................................................................................4
D)............................................................................................................................................................5
References...................................................................................................................................................6

ESSENTIAL FINANCIAL MANAGEMENT
Question 3
A)
As per the case study it can be seen that bonds have been classified into three categories,
such as par, premium and discount. Under the scenario of the par value of the bonds, the bonds
are issued at the normal price. The case of the premium is different as the bonds are issues at the
price above the par level and in case of the discount; the bonds are issues at the value which is
lower than the par value. Each of the bonds has its own significance and it’s important to invest,
as per the situation (Fleckenstein, Longstaff & Lustig, 2016).
 Generally a bond trades at a premium, when its interest rates are lower than the coupon
rate associated with the bonds. A bond trades at a discount when its coupon rate is lower
than prevailing interest rates.
 When the investors seek for the high yield, they likely to pay low and hence, the bonds
are issued at discount. Also if the company is not performing well, they may sell the
bonds even at discounted price to get funds into the business.
 The premium bonds are issued when the company has higher creditworthiness in terms of
the other companies operating in the industry and investors are ready to pay on the basis
of the credibility and brand value (Salt & Satchell, 2018).
 The bonds which are purchased on discount are also due to the capital gain which the
investors can gain.
B)
S&P CAPITAL IQ
Cost of equity
Risk free rate 3%

ESSENTIAL FINANCIAL MANAGEMENT
Beta 1.3
Market risk premium 6%
Rf + Beta * (Market Risk - Risk Free rate)
Cost of equity 6.90%
Cost of debt
Yield on AAA rated bonds 5%
Bond price 1000
Coupon (6%/2) 3%
Coupons 30.00
Years (8*2) 16
Yield to Maturity (C+FV-MV/N)/(FV+MV)/2) 1.92%
Cost of debt 3.08%
Cost of debt 2.558%
Particulars Amount
Cost of equity * Weight of equity 4.60%
Cost of debt * Weight of debt 0.85%
Weighted average cost of capital 5.45%
From the above table it can be seen that the weighted average cost of capital for VMX is
5.45%.
C)
Given data
Current price 25.8
Earnings per share 1.2
Years
Earnings per
share DPS PV
Present
value
1 1.44 0.720 0.9483 0.683
2 1.73 0.864 0.8993 0.777
3 2.07 1.037 0.8528 0.884
4 AND ONWARDS 2.14 1.602 53.400
As the price is currently trading at $25.80 and it is lower than the market price

ESSENTIAL FINANCIAL MANAGEMENT
Hence, the share price is undervalued.
The price of the company is not
correct
**While making the calculation the cost of capital for present value has been taken at 5.45%.
D)
The more obligation an organization takes on, the more it dangers being not able to meet
its budgetary commitments to leasers. An exceptionally utilized firm is increasingly helpless
against a diminishing in gainfulness. Consequently a profoundly turned firm has a higher danger.
The bankruptcy costs are also responsible for tarnishing the equity value of the firm. The three
scenarios have been discussed below (Reindl, Stoughton & Zechner, 2017). The capital structure
is affected with the inclusion of the bankruptcy costs and the overall equity is compromised.
1) No corporate tax no bankruptcy cost
Particulars Amount
Equity $ 50.00
Debt $ 5.00
Bonds $ 20.00
Total $ 75.00
2) Corporate tax is 17%
Particulars Amount Amount
Equity $ 50.00 $ 50.00
Debt $ 5.00 $ 4.15
Bonds $ 20.00 $ 16.60
Total $ 75.00 $ 70.75
3) Corporate tax is 17% with bankruptcy cost
Taking 20% probability
Particulars Amount Amount
Equity $ 50.00 $ 50.00
Debt $ 5.00 $ 1.04
Bonds $ 20.00 $ 4.15
Total $ 75.00 $ 55.19

ESSENTIAL FINANCIAL MANAGEMENT
References
Fleckenstein, M., Longstaff, F., & Lustig, H. (2016). Inflation‐Adjusted Bonds and the Inflation
Risk Premium. Handbook of Fixed
‐Income Securities, 41-52.
Reindl, J., Stoughton, N., & Zechner, J. (2017). Market implied costs of bankruptcy. Available at
SSRN 2324097.
Salt, J., & Satchell, S. (2018). New issuance premium in European corporate bonds.