National University fin609 week 2 HW

docx

School

National University College *

*We aren’t endorsed by this school

Course

609

Subject

Finance

Date

Feb 20, 2024

Type

docx

Pages

Uploaded by BaronAntelopeMaster3170

1 FIN609 Homework FIN609A Seminar in Financial Management 11/12/2023 Week Three Assignment

2 FIN609 Homework Pg.409 1. (9-17): Assume that you were recently hired by TII as a financial analyst and that your boss, the treasurer, has asked you to estimate the company’s WACC under the assumption that no new equity will be issued. Your cost of capital should be appropriate for use in evaluating projects that are in the same risk class as the assets TII now operates. To calculate the Weighted Average Cost of Capital (WACC) for Travellers Inn Inc. (TII), we need to determine the cost of each component of the capital structure, as well as their respective weights (Hargrave, 2023).. a. Cost of Equity (Ke): The cost of equity represents the return required by equity investors. We can use the Capital Asset Pricing Model (CAPM) to calculate the cost of equity. The CAPM formula is as follows: Ke = Rf + β * RPM Where: a. Rf is the risk-free rate, which is the rate of return on a T-bond. Let's assume it is 10%. b. β is the beta of the company's stock, which reflects the riskiness of the stock compared to the overall market. We are given a range of betas from 1.3 to 1.7, so let's use the average beta of 1.5.

3 FIN609 Homework c. RPM is the equity risk premium, which compensates investors for taking on additional risk by investing in stocks. The average range of equity risk premiums is 4.5% to 5.5%, so let's use the average of 5%. Ke = 10% + 1.5 * 5% a. WACC = (We * Ke) + (Wd * Kd) Cost of Debt (Kd): The cost of debt represents the interest rate paid on debt. We need to calculate the after-tax cost of debt. Given that the short-term debt cost is 10% and the company has a tax rate of 40%, the after-tax cost of debt (Kd) can be calculated as follows: Kd = (1 - Tax Rate) * Cost of Debt Kd = (1 - 0.4) * 10% b. Weight of Equity (We): The weight of equity represents the proportion of equity in the company's capital structure. The weight of equity can be calculated as: We = (Common Equity / Total Assets) c. Weight of Debt (Wd): The weight of debt represents the proportion of debt in the company's capital structure. The weight of debt can be calculated as: Wd = (Total Debt / Total Assets) d. Weighted Average Cost of Capital (WACC): The WACC is the average cost of all sources of capital and can be calculated using the following formula:

Your preview ends here

Eager to read complete document? Join bartleby learn and gain access to the full version

Access to all documents
Unlimited textbook solutions
24/7 expert homework help

4 FIN609 Homework Now, let's calculate each component and the WACC for Travellers Inn Inc. (TII): a. Cost of Equity (Ke): Ke = 10% + 1.5 * 5% = 17.5% b. Cost of Debt (Kd): Kd = (1 - 0.4) * 10% = 6% c. Weight of Equity (We): We = Common Equity / Total Assets = $100 / $100 = 1 d. Weight of Debt (Wd): Wd = Total Debt / Total Assets = $50 / $100 = 0.5 e. Weighted Average Cost of Capital (WACC): WACC = (We * Ke) + (Wd * Kd) = (1 * 17.5%) + (0.5 * 6%) = 17.5% + 3% = 20.5% Therefore, the estimated WACC for Travellers Inn Inc. (TII) is 20.5%. This is the rate at which the company should discount its cash flows when evaluating investment projects with similar risk. Pg. 444 2. (10-12): After discovering a new gold vein in the Colorado mountains, CTC Mining Corporation must decide whether to go ahead and develop the deposit. The most cost- effective method of mining gold is sulfuric acid extraction, a process that could result in environmental damage. Before proceeding with the extraction, CTC must spend $900,000 for new mining equipment and pay $165,000 for its installation. The gold mined will net the firm an estimated $350,000 each year for the 5-year life of the vein. CTC’s cost of

5 FIN609 Homework capital is 14%. For the purposes of this problem, assume that the cash inflows occur at the end of the year. a. What are the project’s NPV and IRR? To determine whether the project should proceed, we can calculate its NPV (Net Present Value) and IRR (Internal Rate of Return). (Gallant, 2023). The NPV is obtained by deducting the initial investment from the present value of the expected cash inflows. In this case, the initial investment includes $900,000 for new mining equipment and $165,000 for installation. The projected annual cash inflow for the 5-year lifespan of the gold vein is $350,000. The cash inflows are discounted using the firm's cost of capital, which is 14%. The formula for calculating NPV is: NPV = Initial Investment + PV of Cash Inflows Using this formula, we can determine the NPV as follows: NPV = -$900,000 - $165,000 + ($350,000 / (1 + 0.14)^1) + ($350,000 / (1 + 0.14)^2) + ($350,000 / (1 + 0.14)^3) + ($350,000 / (1 + 0.14)^4) + ($350,000 / (1 + 0.14)^5) After performing the calculations, we find that the NPV of the project is $1,821,184.21. The IRR is the discount rate that makes the NPV of the project equal to zero. This rate represents the project's rate of return. To calculate the IRR, we can set up the equation as follows: NPV = 0 = -$900,000 - $165,000 + ($350,000 / (1 + IRR)^1) + ($350,000 / (1 + IRR)^2) + ($350,000 / (1 + IRR)^3) + ($350,000 / (1 + IRR)^4) + ($350,000 / (1 + IRR)^5)

6 FIN609 Homework By solving this equation, we find that the IRR of the project is = 84.02%. b. Should this project be undertaken if environmental impacts were not a consideration? If environmental impacts were not considered, the decision to undertake the project would depend solely on financial factors. In this case, since the project's NPV is positive ($1,821,184.21), it indicates that the project is expected to generate value for the firm. Therefore, from a financial perspective, the project should be undertaken. c. How should environmental effects be considered when evaluating this, or any other project? How might these concepts affect the decision in Part b? Environmental effects should always be considered when evaluating any project. These considerations can significantly impact the decision-making process. It is essential to assess and quantify the potential environmental costs and benefits associated with the project. Various techniques, such as cost-benefit analysis, environmental impact assessments, and environmental and social risk assessments, can be utilized to evaluate these impacts (springer.com, 2021). One approach to incorporating environmental effects is by assigning a monetary value to them and including them in the calculations. By doing so, we ensure that the evaluation process accurately reflects both the financial and non-financial aspects of the project. Environmental considerations may introduce additional costs, legal and regulatory challenges, reputational

Your preview ends here

Eager to read complete document? Join bartleby learn and gain access to the full version

Access to all documents
Unlimited textbook solutions
24/7 expert homework help

7 FIN609 Homework risks, and long-term sustainability concerns. In some cases, the negative environmental impacts may outweigh the financial benefits, leading to the decision not to proceed with the project. By considering environmental effects, decision-makers can make more informed choices that align with sustainability goals and promote responsible decision-making (Damini, n.d.). Pg. 487 3. (11-8): Most firms generate cash inflows every day, not just once at the end of the year. In capital budgeting, should we recognize this fact by estimating daily project cash flows and then using them in the analysis? If we do not, will this bias our results? If it does, would the NPV be biased up or down? Explain. In capital budgeting, it's important to consider the timing of cash flows as it can greatly impact the accuracy of the analysis. While most firms generate cash inflows daily, it's standard practice to estimate and analyze cash flows on an annual basis. Estimating daily project cash flows and including them in the analysis provides a more accurate representation (Kenton, 2023). It captures the timing, frequency, and potential fluctuations of cash inflows throughout the year. This approach is particularly relevant for projects with irregular or intermittent cash flows. Failing to consider daily cash flows and relying solely on annual cash flows introduces bias to the results. This bias arises because the time value of money isn't fully accounted for. Aggregating daily cash flows into an annual figure overlooks the importance of timing, potentially leading to underestimation or overestimation of the project's actual value (Schwarz, 2022). If annual cash flows are used instead of daily cash flows and we

8 FIN609 Homework underestimate the cash flows, the Net Present Value (NPV) would be biased downward. This is due to the fact that cash flows received earlier hold greater value in today's dollars compared to cash flows received later. By aggregating daily cash flows into an average annual cash flow, we're essentially discounting the cash flows at an average rate, which underestimates the true value (Palmer, 2022). Conversely, if annual cash flows are overestimated, it would bias the NPV upward. In this scenario, aggregating daily cash flows into an annual figure would inflate the actual value. To minimize bias and enhance accuracy, it's beneficial to consider daily cash flows and incorporate them into the capital budgeting analysis. This ensures proper consideration of the time value of money and provides a more precise evaluation of the project's value. Resources: Damini. (N.d.).Sustainable cost management: the manufactures guide to profitability. https://www.deskera.com/blog/sustainable-cost-management-guide-manufacturer- profitability/ Gallant, C (Sep 25, 2023).. Net present value vs. internal rate of return. https://www.investopedia.com/ask/answers/05/npv-irr.asp Hargrave, M (Oct 31, 2023). Weighted average cost of capital (WACC): definition and formula. https://www.investopedia.com/terms/w/wacc.asp Kenton, w, (Apr 18, 2023). Capital budgeting: definition, methods, and examples. https://www.investopedia.com/terms/c/capitalbudgeting.asp

9 FIN609 Homework Palmer, B. (Jun 4, 2022). Valuing firms using present value of free cash flows. https://www.investopedia.com/articles/fundamental-analysis/11/present-value-free-cash- flow.asp Springer.com. (Mar 16, 2021). The cost and benefits of environmental sustainability. https://link.springer.com/article/10.1007/s11625-021-00910-5#article-info Schwarz. L. (Jul 6, 2022). Cash flow analysis: basics, benefits and how to do it. https://www.netsuite.com/portal/resource/articles/financial-management/cash-flow- analysis.shtml

Your preview ends here

Eager to read complete document? Join bartleby learn and gain access to the full version