Financial Management Case Study: WACC and Capital Budgeting

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Running head: Financial management group assignment semester 1 0
FINANCIAL MANAGEMENT GROUP ASSIGNMENT
SEMESTER 1

Financial management group assignment semester 1 1
Table of Contents
Introduction......................................................................................................................................2
Question 1: Assignment...................................................................................................................2
Part A...........................................................................................................................................2
Determination of weighted average cost of capital (WACC)......................................................2
Part B............................................................................................................................................7
Question 2: Scenario analysis........................................................................................................25
Scenario A..................................................................................................................................25
Scenario B..................................................................................................................................25
Scenario C..................................................................................................................................26
Scenario D..................................................................................................................................27
Scenario E..................................................................................................................................28
Conclusion.....................................................................................................................................29
Reference list.................................................................................................................................30

Financial management group assignment semester 1 2
Introduction
The weighted average cost of capital helps in the measurement of the total cost of capital
that is associated with the source of funds used by a business organisation. On the other hand,
capital budgeting techniques help in making decisions related to different projects and initiatives.
The study has highlighted the use of weighted average cost of capital and it has also been
determined with the help of given information. On the other hand, the study has also evaluated
the determination of internal rate of return as well as net present value. Moreover, the expected
NPV along with expected level of internal rate of return has been determined using probabilities.
Moreover, heuristics principles have also been discussed in the study. Its ability to make intuitive
judgments has also been provided.
Question 1: Assignment
Part A
Determination of weighted average cost of capital (WACC)
Determination of Weighted Average Cost of Capital
Cost of debt (Kd)
Number of years 5 years
current selling price $ 972.00
Face value $ 1,000.00

Financial management group assignment semester 1 3
Coupon rate 12%
Floatation costs $ 8.00
Periodic interest payment of the Bond [(.12x1000)/2]x(1-.30) $ 42.00
Therefore nominal cost of debt is I(1-t)/P 42/972-8 4.36%
Table 1: Cost of debt
(Source: learner)
Cost of preference share (Kp)
Dividend
$
9.23
Current selling price 88
Floatation costs
$
1.00
Tax on preference dividend 30%

Financial management group assignment semester 1 4
Cost of preference share d(1+dt)/P(1-f) 13.79%
Table 2: Cost of Preference share
(Source: learner)
Cost of capital (Ke)
Dividend
$
2.00
Risk free return
(Rf) 6.50%
growth
rate 5%
Market rate of
return (Rm) 12.40%
price per
share
$
20.29
Beta
value 1.5
Floatation
costs
$
0.95
Cost of equity as per Gordon growth rate
model
p=d/Ke-
g
18.29Ke-
0.9145=2 15.93%
Cost of equity as per CAPM
model Rf+(Rm-Rf)x beta value 15.35%
Table 3: Cost of ordinary shares
(Source: learner)

Financial management group assignment semester 1 5
Proportion of shares, debts and preference shares
Ordinary shares 1000000 41.67%
Preference share 900000 37.50%
Debt 500000 20.83%
Total 2400000 100.00%
Table 4: Calculation of proportions
(Source: learner)
Determination of WACC
Components Amount Weights
Cost of
capital
Weights x Cost of
capital
Ordinary
shares
$
1,000,000.00 41.67% 15.35% 6.40%
Preference
share
$
900,000.00 37.50% 13.79% 5.17%
Debt
$
500,000.00 20.83% 4.36% 0.91%
Total
$
2,400,000.00
100.00% 12.48%

Financial management group assignment semester 1 6
Table 5: Calculation of WACC
(Source: learner)
The weighted cost of capital of the sources of funds combined that is shares, preference
shares and debt or bond is determined to be 12.48%. For this, the cost of debts or bonds has been
calculated to be 4.36%. Moreover, the cost of preference shares has been found out to be
13.79%. On the other hand it has been found to be 15.35%. In addition to this for cost of equity
part the cost determined with the help of CAPM model has been taken into consideration. This is
due to the fact that it would help in finding the accurate cost of ordinary shares (Biørn, 2017).

Financial management group assignment semester 1 7
Part B
Relevant cash flows for
Small plant
Particular
s 1 2 3 4 5 6 7 8 9 10
Sales High
demand
605
000
0
6248
138
637
134
6
66222
53.09
6820
635.2
7034
647
7175
911
802
756
9
8188
660
8487
838
Less
variable
costs
151
250
0
1562
034
159
283
7
16555
63.27
1705
158.8
1758
662
1793
978
200
689
2
2047
165
2121
959
Gross
profit
453
750
0
4686
103
477
851
0
49666
89.81
5115
476.4
5275
985
5381
933
602
067
6
6141
495
6365
878
less fixed
expenses
830
000
8300
00
830
000
83000
0
8300
00
8300
00
8300
00
830
000
8300
00
8300
00
less:
selling
and
administr
ative costs
453
750
4686
10.3
477
851
49666
8.981
5115
47.64
5275
98.5
5381
93.3
602
067.
6
6141
49.5
6365
87.8

Financial management group assignment semester 1 8
less: cost
of
overhaul
200
000
2000
00
Operating
profit
325
375
0
3387
493
327
065
9
36400
20.83
3773
928.8
3918
387
3813
740
458
860
9
4697
345
4899
290
Income
tax rate @
30%
976
125
1016
248
981
198
10920
06.25
1132
178.6
1175
516
1144
122
137
658
3
1409
204
1469
787
Net profit
227
762
5
2371
245
228
946
1
25480
14.58
2641
750.1
2742
871
2669
618
321
202
6
3288
142
3429
503
Table 6: Cash flows for Small plant
(Source: learner)
Relevant cash flows for
Large plant
Particul
ars 1 2 3 4 5 6 7 8 9 10
Sales
High
demand
660
000
0
6816
150
695
055
9
72242
76.09
74406
93
767
416
0
782
826
6
8757
348
8933
084
9259
459
Less
variable
165
000
1704
038
173
764
18060
69.02
18601
73.2
191
854
195
706
2189
337
2233
271
2314
865

Financial management group assignment semester 1 9
costs 0 0 0 7
Gross
profit
495
000
0
5112
113
521
292
0
54182
07.07
55805
19.7
575
562
0
587
120
0
6568
011
6699
813
6944
594
less
fixed
expense
s
980
000
9800
00
980
000
98000
0
98000
0
980
000
980
000
9800
00
9800
00
9800
00
less:
selling
and
adminis
trative
costs
495
000
5112
11.3
521
292
54182
0.707
55805
1.97
575
562
587
120
6568
01.1
6699
81.3
6944
59.4
less:
cost of
overhau
l
48000
0
Operati
ng
profit
347
500
0
3620
901
371
162
8
38963
86.36
35624
67.8
420
005
8
430
408
0
4931
210
5049
831
5270
135
Income
tax rate
@ 30%
104
250
0
1086
270
111
348
8
11689
15.91
10687
40.3
126
001
7
129
122
4
1479
363
1514
949
1581
040
Net
profit
243
250
0
2534
631
259
813
9
27274
70.45
24937
27.4
294
004
1
301
285
6
3451
847
3534
882
3689
094
Table 7: Cash flows for large plant
(Source: learner)
Relevant cash flows for expanded plant

Financial management group assignment semester 1 10
Particulars 3 4 5 6 7 8 9
Sales High demand
73446
81
75647
05
78020
63
79587
37
89033
03
90819
68
94137
84
Less variable costs
18361
70
18911
76
19505
16
19896
84
22258
26
22704
92
23534
46
Gross profit
55085
11
56735
28
58515
47
59690
53
66774
78
68114
76
70603
38
less fixed expenses
98000
0
98000
0
98000
0
98000
0
98000
0
98000
0
98000
0
less: selling and
administrative costs
55085
1.1
56735
2.8
58515
4.7
59690
5.3
66774
7.8
68114
7.6
70603
3.8
less: cost of overhaul
62000
0
62000
0
Operating profit
39776
59
41261
76
36663
93
37721
48
50297
30
45303
29
47543
04
Income tax rate @
30%
11932
98
12378
53
10999
18
11316
44
15089
19
13590
99
14262
91
Net profit
27843
62
28883
23
25664
75
26405
03
35208
11
31712
30
33280
13
Table 8: Cash flows for expanded plant

Financial management group assignment semester 1 11
(Source: learner)
Calculation of Net present value for Small plant Present value of cash flows
Year Net profit
Discounting factor
@10%
1 2277625 0.909091 2070568
2 2371245 0.826446 1959707
3 2289461 0.751315 1720106
4 2548015 0.683013 1740328
5 2641750 0.620921 1640319
6 2742871 0.564474 1548279
7 2669618 0.513158 1369936
8 3212026 0.466507 1498434
9 3288142 0.424098 1394493
10 3429503 0.385543 1322222
Total 27470256 16264392