Ba7064 first internal test q.p financial management
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This document discusses various topics related to financial management including time value of money, methods of evaluating capital expenditures, bond and option valuation, yield to maturity, portfolio risk-return tradeoff, and weighted average cost of capital. It also provides multiple word problems to solve related to these topics. The document covers key financial management concepts and calculations.
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This document discusses criteria for properly identifying and calculating cash flows for valuation using discounted cash flow analysis. It emphasizes that cash flows, not accounting income, should be used. An example compares NPV using cash flows versus accounting income to show the difference. The document also discusses factors like incremental cash flows, sunk costs, opportunity costs, working capital, inflation, and methods for calculating total cash flow from capital investments, working capital, and operations.
Net operating income approach
The Net Operating Income Approach suggests that a firm's capital structure and use of leverage is irrelevant to the total value or market price of the firm. It also claims that the overall cost of capital remains constant regardless of leverage. Key assumptions are that there are no taxes, debt costs remain constant, and the overall cost remains constant. An example shows that even if leverage increases from $200k to $300k debt, the total firm value, stock price, and overall cost of capital remain the same at $400k, proving the approach's claim of irrelevance.
Chap010
This document provides an overview of capital budgeting techniques for project analysis, including sensitivity analysis, scenario analysis, break-even analysis, operating leverage, and real options. It includes examples demonstrating how to perform sensitivity analysis by changing variables like sales and fixed costs, scenario analysis by introducing competition, and calculating break-even points and degree of operating leverage. The document emphasizes that these techniques help analyze the robustness of projects and value the flexibility provided by real options.
Traditional approach
Watch out full video on Youtube -
https://youtu.be/VP2ZqqWmUvM
It suggests that the firm value is maximum with right proportion of debt and equity mix
As per this approach, debt funding should exist in the capital structure only up to a certain level, after which, any increase in debt funding would result in the reduction in value of the firm by increasing cost of equity
It advocates that there exists an optimum level of debt and equity at which the WACC is the lowest and the market value of the firm is the highest
Assumptions
There are only two sources of financing – Debt and Equity
The interest rate on debt remains constant to a certain level after which it increases with an increase in debt financing
The expected rate of return on equity increases gradually to a certain level after which it increases speedily with increase in debt because of the financial risk involved
WACC first decreases and then starts increasing with increased interest rate on debt and increased required rate of return on equity
No taxes & transaction cost
Thank you for Watching
Subscribe to DevTech Finance
M&m2
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2) When corporate taxes exist, the value of a company increases with debt as interest payments are tax deductible, lowering the overall cost of capital. The value of a levered firm equals the value of an unlevered firm plus the present value of tax shields provided by debt.
3) An example calculation is provided to illustrate how to determine the value of an unlever
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This chapter discusses various capital budgeting techniques used to evaluate investment projects, including net present value (NPV), internal rate of return (IRR), payback period, and profitability index. It provides examples of calculating and applying each method, and highlights potential pitfalls in using some techniques like IRR. Financial calculators and Excel can be used to calculate metrics like NPV and IRR.
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This document discusses criteria for properly identifying and calculating cash flows for valuation using discounted cash flow analysis. It emphasizes that cash flows, not accounting income, should be used. An example compares NPV using cash flows versus accounting income to show the difference. The document also discusses factors like incremental cash flows, sunk costs, opportunity costs, working capital, inflation, and methods for calculating total cash flow from capital investments, working capital, and operations.
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The Net Operating Income Approach suggests that a firm's capital structure and use of leverage is irrelevant to the total value or market price of the firm. It also claims that the overall cost of capital remains constant regardless of leverage. Key assumptions are that there are no taxes, debt costs remain constant, and the overall cost remains constant. An example shows that even if leverage increases from $200k to $300k debt, the total firm value, stock price, and overall cost of capital remain the same at $400k, proving the approach's claim of irrelevance.
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Traditional approach
Watch out full video on Youtube -
https://youtu.be/VP2ZqqWmUvM
It suggests that the firm value is maximum with right proportion of debt and equity mix
As per this approach, debt funding should exist in the capital structure only up to a certain level, after which, any increase in debt funding would result in the reduction in value of the firm by increasing cost of equity
It advocates that there exists an optimum level of debt and equity at which the WACC is the lowest and the market value of the firm is the highest
Assumptions
There are only two sources of financing – Debt and Equity
The interest rate on debt remains constant to a certain level after which it increases with an increase in debt financing
The expected rate of return on equity increases gradually to a certain level after which it increases speedily with increase in debt because of the financial risk involved
WACC first decreases and then starts increasing with increased interest rate on debt and increased required rate of return on equity
No taxes & transaction cost
Thank you for Watching
Subscribe to DevTech Finance
M&m2
This document summarizes Modigliani & Miller's capital structure theory. It discusses two key aspects of their approach:
1) In the absence of taxes, the capital structure of a company is irrelevant as arbitrage will cause identical firms to have the same market value regardless of debt use. Investors can replicate corporate financing decisions individually.
2) When corporate taxes exist, the value of a company increases with debt as interest payments are tax deductible, lowering the overall cost of capital. The value of a levered firm equals the value of an unlevered firm plus the present value of tax shields provided by debt.
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Fonderia di Torino is considering purchasing a new automated molding machine to reduce costs and improve production quality. The initial investment is €1.01 million but after accounting for the sale of old machines, the net cost is €813,296. Using a weighted average cost of capital of 9.86%, the net present value of the investment is positive at €22,916, indicating it would be profitable. While there may be layoff costs for workers on old machines, the company would still profit even after paying one year of salaries. Sensitivity analysis shows the investment remains profitable even if inflation increases to 5% annually. Non-financial benefits also support the new machine purchase.
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The document then explains arbitrage as the process that justifies this hypothesis. Arbitrage involves buying securities cheaply and selling them where prices are higher, restoring market equilibrium. This implies that identical securities cannot sell at different prices.
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- The relationship between interest rates and inflation and how this affects real returns
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1) Capital budgeting involves estimating cash flows, cost of capital, and selecting a decision criterion.
2) For a new machinery investment, the initial cash outflow is Rs. 120,000 and annual cash flows are calculated over 5 years based on revenues, expenses, depreciation, and taxes.
3) The example calculates the annual and terminal cash flows after tax for the machinery project.
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EPS = (EBIT (1−Tax rate)−Pref. Dividend)/(No. of Outstanding Shares)
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Subscribe to DevTech Finance
Block 2, unit 2
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Cost of capital
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- The weighted average cost of capital (WACC) is calculated by weighting the cost of each individual source of capital according to its proportion of total capital structure. WACC is used to evaluate whether potential projects or investments will increase shareholder value.
- Case studies are provided to demonstrate calculating WACC using different capital structures, costs of individual sources, tax rates, and market values. WACC is recalculated based on changes to financing decisions and market conditions.
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The document then explains arbitrage as the process that justifies this hypothesis. Arbitrage involves buying securities cheaply and selling them where prices are higher, restoring market equilibrium. This implies that identical securities cannot sell at different prices.
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ABC Ltd, an Indian exporter, has a Rs. 82.25 crore term loan at 12.5% interest that it wants to reduce costs on. It receives USD and wants to leverage its net USD receivables. Through a rupee-dollar swap, ABC Ltd can shift its rupee liability to USD at a fixed rate of 62.02. This would reduce ABC Ltd's interest rate to 6.9% while receiving principal repayments in rupees on maturity dates. The swap provides benefits if the rupee depreciates versus the dollar but risks if the rupee appreciates beyond 6.9%. RBI regulations allow such swaps for companies meeting certain criteria to hedge foreign currency exposures.
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This document discusses the Modigliani-Miller capital structure theory, which states that a firm's value and cost of capital are independent of its capital structure under certain assumptions. It provides examples to illustrate the theory, showing that the overall cost of capital remains constant regardless of the debt-to-equity ratio. The document also notes that according to MM, while the cost of debt is lower than the cost of equity, the cost of equity increases in a way that offsets the benefits of using debt.
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This document provides an overview of key concepts for valuing and analyzing bonds, including:
- Bond basics like face value, coupon, and coupon rate
- How to calculate the price of a bond using principles of present value
- How bond prices change with interest rates
- Methods for calculating bond yields like current yield and yield to maturity
- The relationship between interest rates and inflation and how this affects real returns
- The risks of default and how bonds are categorized based on their default risk.
Corp finance topics
This slide set is a work in progress and is embedded in my Principles of Finance course, which is also a work in progress, that I teach to computer scientists and engineers
http://awesomefinance.weebly.com/
Time value of money
The idea that money available at the present time is worth more than the same amount in the future due to its potential earning capacity. This core principle of finance holds that, provided money can earn interest, any amount of money is worth more the sooner it is received.
Sums on fm
1. The profit maximization objective focuses on increasing short-term profits, while the wealth maximization objective aims to continuously increase the market price of shares over the long-run.
2. Wealth maximization is a better objective as it considers the timing, risk, and dividend policy of investments and their impact on share price and firm value, unlike profit maximization.
3. Both objectives have weaknesses, as profit maximization does not ensure long-term share price increases, while wealth maximization does not specify the expected return or consider investment risk.
Lecture 24 capital budgeting
The document discusses the steps involved in capital budgeting decisions and cash flow calculations for capital projects. It provides an example calculation for a company considering investing Rs. 100,000 in new machinery. The summary is:
1) Capital budgeting involves estimating cash flows, cost of capital, and selecting a decision criterion.
2) For a new machinery investment, the initial cash outflow is Rs. 120,000 and annual cash flows are calculated over 5 years based on revenues, expenses, depreciation, and taxes.
3) The example calculates the annual and terminal cash flows after tax for the machinery project.
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Cbproblems solutions
This document provides solutions to practice problems related to capital budgeting techniques and risk analysis. It addresses topics like sunk costs, cash flows, internal rate of return (IRR), modified internal rate of return (MIRR), sensitivity analysis, beta calculation, and risk adjustment. For example, it explains that the MIRR overcomes the unrealistic reinvestment assumption of the IRR method. It also provides steps to estimate a project's beta and discusses using risk-adjusted discount rates for projects with different risk levels.
Decision making criteria
This document discusses various criteria for evaluating investment decisions: net present value, internal rate of return, discounted payback period, payback period, and break-even analysis. It provides definitions and formulas for calculating each, such as using net present value to determine if the NPV of an investment is greater than $0, or using internal rate of return to find the rate that results in an NPV of $0. Homework assignments 7A through 7E are also listed.
Lecture 13. cost of capital
This document discusses cost of capital and provides examples of how to calculate cost of different sources of capital. It defines cost of capital as the minimum rate of return a firm must earn on its investments to maintain its market value. Cost of capital is important for capital budgeting, capital structure decisions, and other financial decisions. It then discusses different classifications of cost of capital and provides formulas and examples for calculating the specific costs of different sources of capital, including debt, preference shares, and equity.
Equity venture capital part 1
The document discusses a venture capital investment in LeanTech, a startup software company. LeanTech has no revenue and needs $3.5 million in funding over the next 5 years. A venture capitalist wants to invest and targets a 50% annual return over 5 years. Using LeanTech's forecasted future earnings and typical industry valuation ratios, the expected value of LeanTech after 5 years is $37.5 million. For the venture capitalist to achieve a 50% annual return, they would need to invest $3.5 million and own 70.875% of LeanTech. This values LeanTech at $4.938 million immediately after the investment.
Ebit - Eps Analysis
This analysis is an important tool used to optimize the capital structure for highest earnings for shareholders
It helps in understanding the sensitivity of EPS at given level of Earning before Interest & Tax under different sources of financing
It helps in analyzing how capital structure decision is important to raise the value of firm
An optimal financing structure minimizes the cost of capital and maximizes the earnings
Earning Per Share under different Capital structure plans
Plan 1 ( Only Equity Shares )
EPS = (EBIT (1−Tax rate))/(No. of Outstanding Shares)
Plan 2 ( Equity Shares & Debt )
EPS = ((EBIT −Interest) (1−Tax rate))/(No. of Outstanding Shares)
Plan 3 (Equity, Debt & Preference Shares)
EPS = ((EBIT −Interest) (1−Tax rate)−Pref. Dividend)/(No. of Outstanding Shares)
Plan 4 (Equity shares & Preference Shares)
EPS = (EBIT (1−Tax rate)−Pref. Dividend)/(No. of Outstanding Shares)
Thank You For Waching
Subscribe to DevTech Finance
Block 2, unit 2
This document provides information about calculating the cost of capital. It defines cost of capital as the combined cost of equity, preference shares, debt, and retained earnings. It then discusses how to calculate the cost of different sources of financing like debt, preference shares, equity and term loans. It explains different approaches to calculate cost of equity like dividend price approach, dividend plus growth approach, earnings price ratio approach, and capital asset pricing model. Finally, it discusses weighted average cost of capital (WACC) and some of its limitations.
Ocean Carriers - Titanic
Ocean Carriers Inc. is evaluating commissioning a new capesize vessel to meet a potential charterer's needs. They must decide whether to accept the 3-year charter, register the ship in New York or Hong Kong, and operate it for 15 or 25 years. Registering in Hong Kong and operating for 25 years yields the highest NPV and IRR due to no taxation in Hong Kong. The company's current policy of operating ships for only 15 years results in significant capital losses, so operating for the full 25 years is recommended.
Cost of capital
The cost of capital is the minimum rate of return that a firm must earn on its investments to maintain its market value. It refers to the weighted average of the costs of a firm's various capital components, such as debt, preferred stock, common stock, and any retained earnings. The cost of each capital component depends on its risk level and the rates of return that suppliers of capital expect given the risk. The overall cost of capital is calculated as a weighted average of the costs of the individual capital components.
Lecture 14. cost of capital
This document contains a series of questions related to calculating the cost of equity share capital using different methods. It begins with an introduction to Amity Business School and its module on the cost of capital. It then provides background on four main methods for calculating cost of equity - dividend yield, dividend growth, earnings yield, and CAPM. The remainder of the document consists of 11 sample questions asking to calculate cost of equity using one or more of these methods based on financial information provided, such as dividend rates, growth rates, share prices, betas, and risk-free rates.
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- Cost of capital is the minimum rate of return expected by investors to compensate for the risk of investing in a company. It includes the cost of different sources of financing like debt, preferred stock, common stock, and retained earnings.
- The weighted average cost of capital (WACC) is calculated by weighting the cost of each individual source of capital according to its proportion of total capital structure. WACC is used to evaluate whether potential projects or investments will increase shareholder value.
- Case studies are provided to demonstrate calculating WACC using different capital structures, costs of individual sources, tax rates, and market values. WACC is recalculated based on changes to financing decisions and market conditions.
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This document provides a summary of the questions from the FIN 515 Week 4 Midterm exam, including 10 multiple choice questions and 1 long question involving capital budgeting analysis of multiple projects. The questions cover topics such as asset turnover, retirement planning calculations, loan and investment growth calculations, capital structure, bond yields, risk and required returns.
Devry fin 515 week 4 midterm
This document provides a summary of the questions from the FIN 515 Week 4 Midterm exam, including 10 multiple choice questions and 1 long question involving capital budgeting analysis of multiple projects. The questions cover topics such as asset turnover, retirement planning calculations, loan and investment growth calculations, capital structure, bond yields, risk and required returns.
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Question paper bank
This document contains questions from 8 chapters on financial management. Chapter one covers topics like defining financial management, the primary market, rights issues, and stock splits. It asks about the objectives of financial management and differences between primary/secondary markets and capital/money markets. Chapter two addresses risk, CAPM, discounting, bonds, and preference shares. It includes questions on calculating beta, valuation of bonds, and the assumptions of CAPM. Chapter three is about capital budgeting techniques like IRR, NPV, payback period, and capital rationing. It includes calculation questions on projects. Chapter four covers costs of capital like cost of debt, equity, and WACC. Chapter five addresses optimal capital structure and theories like MM approaches
Fin 515 Education Redefined - snaptutorial.com
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FIN 515 Week 6 Project Calculating the Weighted Average Cost of Capital (Nike)
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Fin 2732 cost of capital
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Monte Carl Simulation is a powerful and effective tool when used properly helps to navigate the expected Net Present Value NPV. This presentation helps to improve the pattern to ackowlege onthe Odessa Investment by Decision Dres.
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FIN 515 Week 2 Project Financial Statement Analysis (Nike)
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FIN 515 Week 2 Project Financial Statement Analysis (Nike)
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FIN 515 Week 6 Project Calculating the Weighted Average Cost of Capital (Nike)
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FIN 515 Week 2 Project Financial Statement Analysis (Nike)
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FIN 515 Week 6 Project Calculating the Weighted Average Cost of Capital (Nike)
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FIN 515 Week 2 Project Financial Statement Analysis (Nike)
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FIN 515 Week 2 Project Financial Statement Analysis (Nike)
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FIN 515 Week 2 Project Financial Statement Analysis (Nike)
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FIN 515 Week 6 Project Calculating the Weighted Average Cost of Capital (Nike)
99700905 cost-of-capital-solved-problems
The document provides solved problems related to calculating cost of capital. It includes examples of calculating cost of debt, cost of preference shares, and weighted average cost of capital (WACC) for companies based on information about their capital structure, dividend rates, issue prices of securities, tax rates, and other financial details. The problems cover a range of scenarios and teach the methodology for determining the effective cost of different sources of capital and the overall WACC.
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- 1. 1. What is financial management? 2. Explain the Time Value of Money. 3. What are the various methods of evaluating the Capital Expenditure Proposals? 4. Define Valuation of Bond &Option? 5. What is meant by Yield to Maturity (YTM) 1. Explain the Concept of Wealth Maximisation and risk-return-trade-off in a portfolio (Or) What are the various methods of valuing the Shares and Bonds? 2. A firm deposits a sum of Rs.5000 at the end of each year for 4 years at 6% interest rate . What would be the final value amount at the end of four years. (or) If you have borrowed a sum of Rs.10, 000 from your employer at the rate of 9% to buy a motor cycle and the employer want the amount to be repaid in three equal end of year payments. What would be the instalment amount to be repaid at the end of each year? 3. (a) What are the features of a Capital budget? (b) Which is the best Evaluation Technique in evaluating the Capital Expenditure proposals? (or) How do you arrive at the Cash inflow from the operation of a Project. 4. A company’s debentures with face value of Rs.100 bear an 8 % coupon rate . Debentures of this type currently yield 10 Percent. a) What is the market price of debentures of the company? b) What would happen to the market price of debentures if the interest rises to 16 % c) What would be the market price of the debentures if it is assumed that debentures were having a maturity period of 4 years from now?(based on situation (a)? d) Would you pay Rs.90 to purchase a debentures specified in situation (iii) above. Explain (Or) “The goal of profit maximisation does not provide an operationally useful criterion “– Explain.
- 2. 5. Best Ltd., has a Rs.1000/- Per value bond, carrying coupon rate of 12 % and maturity after 7 years. The market value of this bond is Rs.750. What is the yield to Maturity of this bond? What will be the yield to Maturity if the market price is Rs.1050 (or) A company has on its books the following amounts and specific costs of each type of Capital: Type of Capital Book Value Market Value Specific Cost (%) Debt 4,00,000 3,80,000 5 Preference 1,00,000 1,10,000 8 Equity 6,00,000 15 Retained Earnings 2,00,000 12,00,000 13 Determine the Weighted average Cost of Capital using Book value weights and Market value weights. How are they different? Can you think of a situation where the weighted average cost of capital would be the same using either weights. Part-C ( Case Study - 10 Marks) Read the Following Situations and answer the following question: ABC Ltd., is proposing to invest in a project requiring a capital outlay of Rs.50,000. Cost for annual income after depreciation but before tax is as follows: Year 1 2 3 4 5 Rs. 20,000 20,000 16,000 16,000 8,000 Depreciation may be taken at 20% on original cost and taxation at 50% of net income. You are required to evaluate the project according to each of the following methods. 1) Pay back Method 2) Rate of return on Original Investment and on averag3e investment methods. 3) DCF method by 10%. 4) Excess Present value index. (2+2+4+2)
- 3. Solution for the Problems -------------------------------------------------------
- 4. Market price of debentures = int/(1+ke) +D/(1+ke) =8/(1.10) +100/1.10) = 7.27+90.90 = 98.17 If interest rises to 16%: 16/(1.10) +100/(1.10) = 14.55+90.90 = 105.46 If it has maturity of 4 years : 8/(1.10) +8/(1.10)^2 + 8/(1.10)^3+8/91.10)^4+100/(1.10) 7.27+6.60+6.01+5.46+68.30 = Rs.93.65 . If market price is 93.65 and it is advisable to bujy for Rs.90/= Annual Interest = 1000x12/100 = 120 @18% = PV of an annuity of Re.1 at 18% (r= 18%) for 7 years = 3.812 PV of Interest for 7 Years = 3.812x120 = 457.44 PV of Maturity value of Re1 after 7 Years at 18% = 0.314 = 314 Total PV of Inflows = at 18% = 457.44+314 = 771.44 Similar to the above calculate for 20 % = 711.60 so the YTM = 18% to 20 % YTM = 18%+( 771.44 -750) / ( 771.44-711.60) x (20-18) = 18%+21.44/59.84x2 = 18% + 0.72 = 18.72%
- 5. For Rs.1050 PV of Interest for 7 years @12% = 4.564x120 = 547.68 PV of Maturity value = 0.452x1000 = 452 Hence PV of inflows = 547.62+452 = 999.68 For 14 % = PV of all Cash inflows = 914.56 ( (4.288x120= 514.56 ) +(0.400x1000) For 10% = PV of all cash inflows= 1097.16 ( 120x4.868)+(0.513x1000) For Purchase price of Rs.1050 = YTM lies between 10 and 12% 10% + (1097.16-1050) / (1097-999.68) ( 12% -10%) = 10% +0.097 = YTM for Rs.1050 = 10.97 ------------------------------- Components cost x Book Value Proportion = Total W.C.O as per book value. Components of cost x Market value proportion = Total WCO as per Market value Particulars 1 2 3 4 5 CI after Dep. 20,000 20,000 16,000 16,000 8,000 Tax @50% 10,000 10,000 8,000 8,000 4,000 CFAT 10,000 10,000 8,000 8,000 4,000 +Depn. 10,000 10,000 10,000 10,000 10,000 CIAT but before Depn. (Operating profits) 20,000 20,000 18,000 18,000 14,000 Pay back period= 2+10,000/ 18000 = 2.56 Years Rate of Return on original Investment= (10000+10000=8000+8000+4000) /5 = CFAT/5 -------------------------------------------- = 16% 50,000 Rate of Return on Original Investment = (10000+10000=8000+8000+4000) /5 = CFAT/5 -------------------------------------------- = 16% 50,000/2 = 32%
- 6. DCE @ 10% Year Cost of Capital @ 10% CI DCF 1 0.909 20,000 18180 2 0.826 20,000 16,520 3 0.751 18000 13518 4 0.683 18000 12294 5 0.621 14,000 8694 Total DCF Value = 69206 . NPV = (69206-50000) = 19206 Excess Present Value Index = 69206/50000 = 1.38 (Or Profitability Index)