Topic: Calculation of WACC and Capital Budgeting Analysis
ANF Inc., a garment manufacturer, is planning to install a new plant at a cost of Rs.
1,500,000. It also requires an initial investment of Rs. 200,000 in net working capital in
first year. This investment in net working capital will be recovered at the end of useful
life of plant. Plant’s expected economic life is 5 year. At the end of that period, its
salvage value is estimated to be Rs. 150,000.
Expected pre-tax cash inflows by installation of new plant are: Rs. 500,000 in year1,
Rs. 600,000 in year2, Rs. 700,000 in year3, Rs. 750,000 in year4 and Rs. 800,000 in
year5. ANF Inc. uses straight line method of depreciation for plant and its tax rate is
30%. For capital budgeting purposes, company’s policy is to assume that the cash flows
occur at the end of year. The plant will begin operations immediately after the
investment is made.
ANF Inc. stock currently sells for Rs. 50 and company is expected to pay a dividend of
Rs. 5 at the growth rate of 2% to its shareholders. ANF Inc. target debt to equity ratio is
40:60 and it’s before tax cost of debt is 10% and the company’s tax rate is 30%.
Requirements:
Based upon above given information, being the student of finance, you are required to
1) Calculate the Cost of Equity. (2 marks)
2) Calculate the Weighted Average Cost of Capital. (2 marks)
3) Calculate NPV of the project. (5 marks)
4) Calculate IRR by using interpolation formula.(5 marks)
5) Whether the project is feasible to undertake? Support your answer with logical
reason(s). (1 mark)
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Answer No. 01
Bond A | Bond B |
Given Time to maturity = n = 5 years Coupon Payments = 1000*16% = Rs.160 Market Required Rate YTM= 18% Current Market Price of Bond =?
Formula PV = Coupon Payment[ 1 – 1/(1+YTM)^{n} ]/YTM PV = 160[1-1/(1.18)^{5} ] / 0.18 PV = Rs. 500.26
Formula PV = Face Value/ (1+YTM)^{n} PV = 1000/2.2877 PV = Rs.437.12 Current market Price of Bond =500.26+437.12 Current market price of Bond =Rs.937.38 |
Given Time to maturity = n = 12 years Coupon Payments = 1000*16% = Rs.160 Market Required Rate YTM= 18% Current Market Price of Bond =?
Formula PV = Coupon Payment[ 1 – 1/(1+YTM)^{n}]/YTM PV = 160[1-1/(1.18)^{12} ] / 0.18 PV = Rs. 766.84
Formula PV = Face Value/ (1+YTM)^{n} PV = 1000/2.2875 PV = Rs.137.22 Current market Price of Bond =766.84+137.22 Current market price of Bond =Rs.904.06 |
Answer No. 02
Hence,
Therefore we can say that bond B ‘s interest rate will increase as compare to the short term bond A.
Also See “normal yield curve” page 19 of handouts for additional material.
Answer No. 03
Given
Market price of Bond A = Rs.850
Time to maturity = n = 5 years
Face value =Rs.1000
Coupon payments= 1000*16%=Rs.160
We here use trial and error through interpolation method to find out YTM
Bond Price at Lower YTM of 10%
Formula
P_{0}= Face value/(1+YTM)^{n} + Interest payments [1-1/(1+YTM)^{n}] / YTM
P_{0}= Rs.1227.43
Bond Price at Higher YTM of 25%
P_{0}= Face value/(1+YTM)^{n} + Interest payments [1-1/(1+YTM)^{n}] / YTM
P_{0}= Rs.757.96
YTM Approximation with Linear Interpolation
YTM_{L} = 10%
YTM_{H} = 25%
PV_{L} = Rs. 1227.43
PV_{H} = Rs. 757.96
YTM = YTM_{L} + [(YTM_{H}-YTM_{L}) (PV_{L}-PV_{YTM})] / [PV_{L}-PV_{H}]
YTM = 0.220466
YTM = 22.0466%
FIN622 - Assignment no.1_solution
See the attached file
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