BFIN 350 Assignment T2d

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Humber College *

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350

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Finance

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Jan 9, 2024

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6

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Corporate Finance BFIN350 Assignment #2 Complete all questions. Place only final answers in ‘boxed answer area’. Include details of your work below the ‘boxed answer area’ (mandatory). Show all calculations, formulas used, financial calculator inputs/buttons. State all assumptions. Submit a single MS Word document. Submit an attachment in the Assignment area of the course site. Submit on time per the Critical Path. Late assignments are subject to 20% penalty per day and will not be accepted after 5 days late. Note the Humber College policy on plagiarism. Please note this applies equally to copying copyright materials as it does to using your friends’ solutions to problems. If I notice ‘copy and paste’ duplications in submissions all parties identified will be awarded zero grades with potentially additional implications. While I encourage students to work together and support each other on course work, you are all aware of the differences between this and copying another’s work. Respect this and your will learn more, faster! Page 1 of 6
Corporate Finance BFIN350 There are two projects. Project Everest has an outflow of cash of $34,000 in years 0 and 1, followed by an inflow of $49,000 in each of the years 2 and 3. Project Seabed has a cash outflow of $60,000 in year 0, followed by an inflow of $29,000 in years 1, 2, and 3. a) If the profitability index decision rule applies and the required return is 7.5%, which project should be selected? b) If the NPV decision rule applies then which project should be selected? Answer Place only your final answer in the box. Question Your Response Profitability Index - Which Project? 2.41 1.26 NPV – Which Project? 16,216.46 15,363.32 Show your work here (mandatory): Both decision rules lead to the same conclusion, Project Everest should be selected. PI = Present Value of Cash Outflows / Present Value of Cash Inflows NPV = Present Value of Cash Inflows−Present Value of Cash Outflows Everest: PI 42243.53+39721.66 81965.19/ 34000 =2.41 26976.74+25042.97+23343. =75363.32/60000 1.26 Page 2 of 6
Corporate Finance BFIN350 You need to choose between two machines based on the following information: Machine 1 has a 4 year life, costs $322,500 with pre-tax operating costs of $64,500 per year. Machine 2 has a 3 year life, costs $425,250 with pre-tax operating costs of $39,600 per year. Both machines have a salvage value of $22,500 and are classed with a CCA rate of 18% per year. The company tax rate is 30% and the discount rate is 10%. a) What is the EAC? b) Which machine would you select as an investment? Answer Place only your final answer in the box. EAC? 1: 190,220.13 2: 227,813.13 Which Machine? Machine 1 ($42,094.73) is the better investment compared to Machine 2 ($-13,760.67). Show your work here (mandatory): Machine 1: 322,500+(64500 x 4) + 22500/ (1-0.6830)/.10 322500+258000+22500/0.3170/.10 =603000/3.17 =190, 220.13 Machine 2: 425250+(39600 x 3) + 22500/(1-0.7513)/.10 =425250+118800+22500/0.2487/.10 566550/2.487 = 227,813.13 Page 3 of 6
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Corporate Finance BFIN350 A stock has an expected return of 17.5% and a beta of 1.65. Another asset which has low risk with a beta of .25 is earning 3.25% a) What is the expected return on a portfolio that is comprised of one-half the higher risk stock and one-half the lower risk asset? b) Calculate the weights of each of these if they are the only 2 holdings in a portfolio which has a beta of 1.00. c) If the portfolio of these two holdings earned 10%, what would be the beta of the portfolio? Answer Place only your final answer in the box. Expected Return? 10.875% Weight of each holding? 53.57% Beta? 46.43% Show your work here (mandatory): Expected Portfolio Return= 0.5 x 17.5% + 0.5 x 3.25% Portfolio Beta =1 1= kx1.65 +(1-k) x 0.25 1=1.65k +(1-k)0.25 0.75/1.4k k=53.57% Beta = 100-53.57= 46.43 Beta of portfolio = 0.4737 x 1.65 + 0.5263 x 0.25 =0.91 Page 4 of 6
Corporate Finance BFIN350 If the market risk premium is 5.8% and company has the following: Common Stock: 6850000 shares outstanding, selling at $28 per share, beta 1.6 Preferred Stock: 350,000 shares outstanding, 4.8% yield, selling at $88.5 per share Debt: 138000 5.5% semi annual bonds outstanding, par value $1000 each with 12 years to maturity, selling at 117% of par Tax Rate: 30% a) Calculate the company`s market value b) Calculate the percentage of the market value capital structure that is debt c) Calculate the percentage of the market value capital structure that is common shares d) Calculate the percentage of the market value capital structure that is preferred shares e) Discuss (3 to 10 sentences) how the matter of risk relates to capital structure Answer Place only your final answer in the box. Market Value? $384,235,000 Debt percentage 42.02% Common Share percentage 49.92% Preferred Share percentage 8.06% Risk and Capital Structure Common stock, with a beta of 1.6, indicates higher volatility compared to the market, suggesting higher market risk. Preferred stock, being a hybrid instrument with a fixed yield, carries lower risk compared to common stock but higher risk than debt. The use of debt introduces financial risk due to interest obligations, especially when the bonds are selling at a premium. The company's beta is influenced by the mix of these different risk profiles. In this context, the market risk premium of 5.8% reflects the additional return investors demand for bearing the risk of the overall market. The company's decision on the proportion of equity and debt in its capital structure impacts its overall cost of capital. While debt offers tax advantages due to interest deductions, it also increases financial leverage and thus financial risk Show your work here (mandatory): Explanation: a) Calculate the company's market value: Page 5 of 6
Corporate Finance BFIN350 Market Value= (Common Stock Value + Preferred Stock Value + Debt Value) Common Stock: Market Value of Common Stock = Number of Shares x Selling Price per Share Number of shares outstanding = 6,850,000 Selling Price = $28 Market Value of Common Stock = 6,850,000 x $28 Market Value of Common Stock = $191,800,000 Preferred Stock: Market Value of Preferred Stock = Number of Shares x Selling Price per Share Number of shares outstanding = 350,000 Selling Price = $88.50 Market Value of Preferred Stock = 350,000 x $88.50 Market Value of Preferred Stock = $30,975,000 Debt: Market Value of Debt = Number of Bonds x Selling Price per Bond Number of Bonds Outstanding = 138,000 Par Value of Bond = $1,000 Selling price = 117% x $1,000 Selling price = $1,170 Market Value of Debt = 138,000 x $1,170 Market Value of Debt = $161,460,000 Market Value =(Common Stock Value + Preferred Stock Value + Debt Value) Market Value = ($191,800,000 + $30,975,000 + $161,460,000) Market Value = $384,235,000 Calculate the percentage of the market value capital structure that is debt: Debt Percentage = Debt Value / Market Value x 100 Debt Percentage = $161,460,000 / $384,235,000 Debt Percentage = 42.02% Common Percentage = Common Stock Value / Market Value x 100 Common Percentage = $191,800,000 / $384,235,000 Common Percentage = 49.92% Preferred Percentage = Preferred Stock Value / Market Value x 100 Preferred Percentage = $30,975,000 / $384,235,000 Preferred Percentage = 8.06% Page 6 of 6
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