A Company Using Various Project Evaluation Techniques (Case Study Sample)

Name
Instructor
Course
Date
Financial Decision Making
Question 1
(a)
PV=FV/(1+r)^n =FV(1+r)^-n
Where;
r=interest rate
n=number of years
FV=Future Value
PV=Present Value
And;
r= 8%/2=4%
n=5*2=10
Therefore, PV=1000(1+0.04)^-10=675.56
PV of annuity=FV(1-(1/(1+r)^n))/r=FV(1-((1+r)^-n))/r
= 40(1-((1+0.04)^-10))/0.04=324.44
Therefore, the current market price=675.56+324.44= $1,000
(b)
PV=FV/(1+r)^n=FV(1+r)^-n
r= 10%
n=5
=1000(1+0.10)^-5=620.92
PV of annuity=FV(1-(1/(1+r)^n))/r=FV(1-((1+r)^-n))/r
= 40(1-((1+0.10)^-5))/0.10=151.63
Therefore, the current market price=620.92+151.63= $772.55
(c)
PV=FV/(1+r)^n =FV(1+r)^-n
r= 6%
n=5
=1000(1+0.06)^-5=747.26
PV of annuity=FV(1-(1/(1+r)^n))/r=FV(1-((1+r)^-n))/r
= 40(1-((1+0.06)^-5))/0.06=168.49
Therefore, the current market price=620.92+151.63= $915.75
(d)
The rate of interest is inversely proportional to the value of the bond. If the interest rate is low, then the value of the bond will be high and vice versa. Some of the factors that determine the degree of interest rate risk are inflation rate and the demand and supply forces. A rise in the demand for loans will improve interest rates and vice versa. Similarly, if the supply of credit is high, then the interest rates will reduce and vice versa. Also, an improvement in inflation rate will force investors to demand for an increase in the interest rates to compensate the purchasing power of money.
Question 2
(a)
EOQ=((2*Co*D)/Ch)^1/2
Where;
EOQ=economic order quantity
Co=ordering cost
D=annual demand
Ch=carrying cost
EOQ=((2*4*10,000)/0.4)^1/2 = 447.21 Kg
(b)
Number of orders = Yearly demand / EOQ
= 10,000 / 444.21 = 22.51
Time between the orders placed = the number of yearly working days / number of orders placed
= 200 / 22.51 = 8.88 days
Therefore, the frequency of placing the orders is 8.88 days
(c)
Reorder point = (daily usage*lead time) + safety stock
=daily spend= D/yearly working days
=10,000/200= 50Kg
Reorder point = (50*14)+100=800Kg
Therefore, the amount to be reordered = 800Kg – 447.21 Kg= 352.79 Kg
Question 3
(a)
The Australian firm will face several risks relating to the debt security. The first risk is the currency exchange rate risk, which is the difference in the spot exchange rate between the two currencies. In mitigating the risk, the owner will use a financial instrument such as FX option that gives the purchaser the right but not the obligation to buy or sell a security at a predetermined exchange rate (Charvin et al. 15). Also, the issue will be faced will call back risk in case the interest rate of the security falls. Borrowers will pay the existing cheaper loan and repurchase the available securities at a cheaper market price. Controlling the risk involves putting a condition when they are being issued that they will only be exercised at maturity. The condition will prevent calling back the bond before it matures to take advantage of a reduction in its price. To add, the instrument may face volatility risk (Dotsis, George and Nikolaos 489). The risk involves the changes in prices of the debt instrument, which is difficult to forecast andit is applicable to prepayment, call, and put option. Volatility risk can be reduced through diversification where a group of assets are created to so that if the price of one security changes, then the other security prices will remain stable.
(b)
A company can be financed through debt or equity. Debt financing involves the use of collateral or guarantor to obtain the funds required. The method involves repaying the principle amount together with the accumulated interest amounts over the period, which makes it costly than equity financing. Debt financing has a lot of risks attached to it. The risks include changes in inflation rate in a country due to dynamic economic situations. A change in inflation rate interferes with the future forecasted prices of the security that can make it expensive or cheaper. Contrarily, equity financing is cheaper. It involves receiving funds from the public through issuing securities such as shares. The owners of equity finance are known as shareholders and they receive dividends and capital gains from their investments (Coleman et al.108). Similarly, equity financing has risks attached to it. For instance, when new shares are issued, the number of owners increases which reduces the voting power of the existing shareholders. Voting power is the right to make decisions in a company and it is determined by the number of shares allocated to an individual investor. Those who own more shares have a higher voting power than those who own few shares. Therefore, an individual with more shares will make most of the firm’s decisions.
Question 4
(a)
Wombat Pty Ltd Income statement for the Year Ended 30 June 2017

sales

 

1,500,000

Less cost of sales

 

800,000

Less expenses

 

 

Interest payment

60,000

 

Operating expenses

300,000

 

Total Expenses

360,000

-360,000

Gross profit

 

1,940,000

Less depreciation

 

-80,000

Net Profit

 

1,860,000

(b)
Wombat Pty Ltd Statement of Financial Position for the Year Ended 30 June 2017

 

Assets

 

 

 

Fixed Assets

 

 

 

Buildings and Plants

1,000,000

 

 

Less Depreciation

80,000

 

 

Less accumulated depreciation

240,000

680,000

 

 

 

 

 

Current Assets

 

 

 

Borrowings

 

100,000

 

cash

 

200,000

 

Account receivables

 

450,000

 

Inventory

 

330,000

 

Prepayments

 

200,000

 

Total Assets

 

1,960,000

 

 

 

 

 

Liabilities

 

 

 

Non-current liabilities

 

 

 

Mortgage loan

 

400,000

 

Long-term debt security

 

200,000

 

 

 

 

 

Current liabilities

 

 

 

Account payables

 

180,000

 

Total Liabilities

 

780,000

 

 

 

 

 

Total Assets and Liabilities

 

 

2,740,000

 

 

 

 

Equity

 

 

 

Ordinary Shares

 

500,000

 

Retained earnings

 

1,860,000

 

Total Equity

 

 

2,360,000

Question 5
(a)
Risk return rate = beta(market rate – risk free rate) + risk free rate
= 1.5(0.08-0.03) + 0.03 = 0.105*100=10.50%
ABC Shipping Asia Ltd’s has 3 sources of financing:
* Ordinary Shares.
* Preference Shares
* Debentures
The market values of the three sources of finance are given as follows:
Ordinary Shares= 45,000,000
Preferred Shares= 5,000,000
Debentures=10,000,000
Total Market Value =MV of ordinary shares + MV of preference shares + MV of debt (debentures)
Therefore, total MV = 45,000 + 5,000,000 + 10,000,000 = 60,000,000
WACC = Weighted cost of ordinary shares + Weighted cost of preference shares + Weighted cost of debt.
Weighted cost for Common Shares
Weighted cost of ordinary shares = Cost of ordinary shares (Kc) * Weight of common shares (MV of common shares / Total MV)
The total number of ordinary Shares=45,000,000/1=45,000,000
The cost of equity is assumed to be the required rate of return from investment, which is 10.50%
Hence, the cost of common shares = 10.50%
The weight of ordinary shares =45,000,000/60,000,000=0.75
Weighted cost of ordinary shares= 10.50% * 0.75=0.07875
Weighted cost of common stock=0.07875
Weighted Cost for Preference Shares
Weighted cost of preference shares = cost of preference shares (Ke) * Weight of preference shares (MV of preference shares / total MV)
Weight= 5,000,000/60,000,000=0.0833
Cost of preference shares =12%
Weighted cost for preference shares= 12%*0.0833=0.009996
Weighted cost for preference share=0.009996
Weighted Cost for Debt
Weighted cost of debt = cost of debt (Kd) * Weight of debt (MV of debt / total MV)
Cost of debt (kd)= interest(1-t)/MV
=10% of 10,000,000(1-0.30)/10,000,000=0.07
Weight= 10,000,000/60,000,000=0.16667
Weighted cost for debt=0.07* 0.1667=0.011667
Weighted cost for debt=0.011667
Therefore, Total WACC=Weighted cost of ordinary shares + Weighted cost of preference shares + Weighted cost of debt = 0.07875+0.009996+0.011667=0.100413=10.04%
b(1)
We assume that the vessels are sold at the tenth year at the prevailing market price. Therefore, the market prices at the tenth year will be the residual value of the assets. However, the assets are depreciated on a straight line.
Therefore, depreciation = (cost-residual value)/useful life
Depreciation for project 1 = (15-2.5)/20=0.625 yearly