Hi! This is my first post on analystforum so I hope that I write in a good place. I have to do two exercises and I feel disappointed because they are harder than I fought… is there anyone who can help me with this stuff?
Management is considering the following investment:
Year Cash Flow (pre tax)
1 1 250
2 1 400
3 1 600
4 1 800
The investment will be financed by 50% equity and 50% debt.
The company’s capital structure after the investment will change to 60% equity and 40% debt.
The investment will cost 5400, paid immediately (including 600 for working capital, 300 for equity issue costs and 100 for debt issue costs).
The risk free rate is 4%, the market rate of return is 10% and the equity beta is equal to 1,5.
The cost of the associated debt is 8%.
The corporate tax rate is 30%.
At the end of year 4, the after tax realizable value is 1500 (this includes working capital).
Capital allowances are at 25% per year on a reducing balance basis.
Task 1: Calculate the NPV, MIRR and APV for the project.
Cost of Equity = Risk-Free Rate of Return + Beta * (Market Rate of Return - Risk-Free Rate of Return).
Cost of equity = 0,04 + 1,5*(0,1 – 0,04) = 0,04 + 0,09 = 13%
WACC (with new D/E proportion)
WACC = 0,4*(0,08*(1-0,3)) + 0,6*(0,13) =2,8% + 6,5% = 10,04%
NPV = -5400 + (1250*0,7)/1,1004 + (1400*0,7)/1,10042 + (1600*0,7)/1,1004 3 + (1800*0,7)/1,10044 + 1500/1,10044 = -5400 +795,17 + 809,33 + 840,56 + 859,35 + 1023,03 = -1072,57
Is it ok? Any idea for MIRR and APV?
Task 2: what** ’s the difference (in terms of profit before tax) between the two choices?**
The company is also considering two different approaches to receivables management:
Period of credit allowed – days of receivables /// Yearly revenue estimate
Method 1: Period of credit allowed – days of receivables 10
Yearly revenue estimate 7 000
Method 2: Period of credit allowed – days of receivables 20
Yearly revenue estimate 15 000
In both cases the company’s gross margin is expected at 12%, and the cost of debt necessary to finance receivables is 13%.