A Company Using Various Project Evaluation Techniques - 2200 Words

A Company Using Various Project Evaluation Techniques (Case Study Sample) Content: NameInstructorCourseDateFinancial Decision MakingQuestion 1(a)PV=FV/(1+r)^n =FV(1+r)^-nWhere;r=interest raten=number of yearsFV=Future ValuePV=Present ValueAnd;r= 8%/2=4%n=5*2=10Therefore, PV=1000(1+0.04)^-10=675.56PV of annuity=FV(1-(1/(1+r)^n))/r=FV(1-((1+r)^-n))/r= 40(1-((1+0.04)^-10))/0.04=324.44Therefore, the current market price=675.56+324.44= $1,000(b)PV=FV/(1+r)^n=FV(1+r)^-nr= 10%n=5=1000(1+0.10)^-5=620.92PV of annuity=FV(1-(1/(1+r)^n))/r=FV(1-((1+r)^-n))/r= 40(1-((1+0.10)^-5))/0.10=151.63Therefore, the current market price=620.92+151.63= $772.55(c)PV=FV/(1+r)^n =FV(1+r)^-nr= 6%n=5=1000(1+0.06)^-5=747.26PV of annuity=FV(1-(1/(1+r)^n))/r=FV(1-((1+r)^-n))/r= 40(1-((1+0.06)^-5))/0.06=168.49Therefore, 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 r ate 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)^1/2Where;EOQ=economic order quantityCo=ordering costD=annual demandCh=carrying costEOQ=((2*4*10,000)/0.4)^1/2 = 447.21 Kg(b)Number of orders = Yearly demand / EOQ= 10,000 / 444.21 = 22.51Time between the orders placed = the number of yearly working days / number of orders placed= 200 / 22.51 = 8.88 daysTherefore, 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= 50KgReorder point = (50*14)+100=800KgTherefore, the amount to be reordered = 800Kg 447.21 Kg= 352.79 KgQuestion 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 pri ces 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 firms 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 Ltds has 3 sources of financing: * Ordinary Shares. * Preference Shares * DebenturesThe market values of the three sources of finance are given as follows:Ordinary Shares= 45,000,000Preferred Shares= 5,000,000Debentu res=10,000,000Total 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 = 60,000,000WACC = Weighted cost of ordinary shares + Weighted cost of preference shares + Weighted cost of debt.Weighted cost for Common SharesWeighted 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=45,000,000The 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=0.75Weighted cost of ordinary shares= 10.50% * 0.75=0.07875Weighted cost of common stock=0.07875Weighted Cost for Preference SharesWeighted 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=0.0833Cost of preference sh ares =12%Weighted cost for preference shares= 12%*0.0833=0.009996Weighted cost for preference share=0.009996Weighted Cost for DebtWeighted 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=0.07Weight= 10,000,000/60,000,000=0.16667Weighted cost for debt=0.07* 0.1667=0.011667Weighted cost for debt=0.011667Therefore, 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 lifeDepreciation for project 1 = (15-2.5)/20=0.625 yearly