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Accounting, Finance, SPSS

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

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PAPER DESCRIPTION

The work was to appraise a company using various project evaluation techniques

Content:

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

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

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