Financial Management Assignment: NPV, IRR, and WACC Analysis

This document presents a solution to a financial management assignment, focusing on key concepts such as Net Present Value (NPV), Internal Rate of Return (IRR), and Weighted Average Cost of Capital (WACC). The solution begins by calculating incremental cash flows, considering factors like EBITDA, revenue, operating expenses, and depreciation. The NPV is then computed to assess the project's feasibility, followed by the calculation of the IRR. Furthermore, the cost of equity is determined using the CAPM approach, and the WACC for Amazon Ltd. is calculated based on market values of equity and debt. The analysis concludes whether the project should be accepted based on the NPV and IRR results. Desklib provides a platform for students to access this solution along with other solved assignments and past papers to aid in their studies.

FINANCIAL MANAGEMENT
STUDENT ID:
[Pick the date]

Section 2
Question 1
A) The incremental cash flows from this project are indicated below.
Explanations
1) EBITDA = Revenue – Operating Expenses
2) Incremental Annual Revenue = 300500*4 + 4500*3000 = $14,702,000 = $ 14.702 million
3) Operating expenses for year 1 and year at 75% of incremental revenues while for the later
years charged at 60%.
4) EBIT = EBITDA- D&A
5) D&A = (15.3/5) = $ 3.06 million
6) (1-t) = 1-0.15 = 0.85
7) D&A is added back after net income computation since it is a non-cash charge and was
included only for the tax shield.
8) Cash flow from operations = Net income + D&A
9) Working capital initially invested in recovered at the end of the project.

B) The discount rate is given as 12% and the NPV has been computed using EXCEL and
comes out as $ 0.557 million. It can also be computed manually as shown below.
NPV = -16.8 + (3.583175/1.12) + (3.583175/1.122) + (5.45768/1.123) + (5.45768/1.124) +
(6.95768/1.125) = $ 0.557 million
Since the NPV has come out to be positive, hence the given project is feasible and must be
accepted.
C) Let the IRR of the project be X%. IRR is defined as the discount rate for which NPV is
zero.
0 = -16.8 + (3.583175/(1+X%)) + (3.583175/(1+X%)2) + (5.45768/(1+X%)3) +
(5.45768/(1+X%)4) + (6.95768/(1+X%)5)
Solving the above, we get X = 13.18%
Since IRR is greater than the discount rate of 12%, hence the given project is financially
feasible and must be accepted.
D) The cost of equity can be computed using the CAPM Approach whose equation is given
below.
Cost of equity = Risk free Rate + Beta *(Market Returns – Risk free rate)
Based on the given data,
Cost of equity for Amazon Ltd = 6 + 1.2*(8-6) = 8.4%
Pre-tax cost of debt = (1+(7%/2))2 -1 = 7.12%
Post tax cost of debt = 7.12%* (1-15%) = 6.05%
Market value of equity = Number of shares outstanding * Market price of each share =
100000*3.85 = $385,000

The par value of each bond has been assumed $100
Market value of debt = Number of bonds * Market price of each bond = 5000*0.92*100 =
$460,000
Hence, weight of equity = (385000/(385000+460000)) = 0.4556
Also, weight of debt = (460000/(385000+460000)) = 0.5444
WACC of Amazon Ltd. = 0.4556*8.4 + 0.5444*6.05 = 7.12% p.a.