Assignment 1 - Ivanova Olesia

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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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Corporate Finance BFIN350 Assignment #1 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 10

Corporate Finance BFIN350 Question 1 a) What is liquidity a measure of? Discuss the potential merits of high liquidity verses low liquidity. b) You are reviewing the books of a firm you are considering purchasing and notice a considerable difference between the market value of some assets and the book value. Why might there be a difference? c) If you consider purchasing a firm what is the firm’s enterprise value based on? (Hint: consider this in terms of the balance sheet entities). Comment on the difference between ‘enterprise value’ and ‘market value’. d) What is the purpose of a firm? Express your response in terms of owner’s perspective. e) A firm is engaging in a large capital project. It requires 100 million dollars for this project. What options does the firm have to raise funds to finance this large capital project. Answer Place only your final answer in the box. a) Liquidity is how easily assets can be converted to cash to pay bills. It's important in finance and economics, impacting a person or company's financial obligations. High liquidity allows for quick buying and selling of assets, lowering risk and costs. Conversely, low liquidity can lead to higher risk, costs, and default probability. b) Market value can differ from book value due to factors like market conditions (the market value of an asset can be influenced by supply and demand factors, which can cause the market value to fluctuate), depreciation (the book value of an asset is based on its original purchase cost, adjusted for any subsequent changes, such as for impairment or depreciation) , intangible assets (patents, trademarks, and goodwill, which are not reflected in the book value) , and future growth prospects ( for example, if investors believe that a company has strong growth potential, they may be willing to pay a higher price for its assets, which can cause the market value to be higher than the book value). c) Enterprise value is a financial metric that considers a company's debt obligations and cash reserves. It is calculated by adding the market capitalization of the company to its outstanding preferred stock and all debt obligations, then subtracting all of its cash and cash equivalents. Market value only considers outstanding shares, while enterprise value includes debt and cash. Enterprise value is a better measure of a company's worth as it considers its debt obligations. Page 2 of 10

Corporate Finance BFIN350 d) A firm's purpose from an owner's perspective is to maximize profits by producing goods or services that are in demand and selling them at a price higher than the cost of production:  to create value for shareholders by increasing profits  paying dividends, or increasing stock value  to provide in-demand goods or services  to maintain control over operations  to create a sustainable business for long-term profitability e) Firms can raise funds for capital projects through debt financing (borrowing money from banks or issuing bonds), or they can choose equity financing, which involves issuing shares of stock to investors or crowdfunding (attracting multiple small investors online). Funding options for firms include grants/competitions, vendor financing, private investors, and using self-managed superannuation funds. Page 3 of 10

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Corporate Finance BFIN350 Question 2 Your daughter is considering two options for her career. The first is to go to law school at Harvard. You estimate this will cost you $500,000 and you will have to pay this in one lump sum 5 years from today. Her alternative is to go to Europe to a musical conservatory school. For this she will need a violin worth $100,000 which you need to buy now. The cost of her schooling will be $100,000 per year for 3 years starting in 2 years. That is, in 2 years you will need $100,000, another $100,000 in 3 years and another $100,000 in 4 years. If the interest you can achieve is 10% compounded annually which option requires less money if you invest today to cover these educational expenses? Answer Place only your final answer in the box. Question Your Answer Harvard or Europe? Harvard To compare two investment options for educational expenses, I calculate their present values using the formula: PV= FV/ (1+r) Harvard: PV = 500000/ (1+0.1) 5 = 310460.662 (the total amount of money) Europe musical conservatory school : 2 years: PV = 100000/ (1+0.1) 2 = 82644.628 3 years: PV = 100000/ (1+0.1) 3 = 75131.480 4 years: PV = 100000/ (1+0.1) 4 = 68301.346 Add the numbers: $82644.628 + $75131.480 + $68301.346 + $100000 = 326077.454 Page 4 of 10

Corporate Finance BFIN350 Question 3 Joe’s Tree Service bought new machines 3 years ago for $600,000. The machines can be sold today to his brother’s company Sam’s Tree Service for $430,000. Joe’s current statement of financial position show net fixed assets of $380,000, current liabilities of $720,000, and net working capital of $250,000. If all Joe’s assets were liquidated today, he would receive $1M. a. What is the book value of Joe’s company? b. What is the market value of Joe’s company? c. Explain the difference between book and market value. d. Why is it important to know these the book and market values of an asset? e. What is the implication of depreciation on book and market values? f. How do non-cash expenses impact a company’s profitability? Answer Place only your final answer in the box. a) $1350000 b) $280000 c) Book value and market value are two ways to evaluate an asset or a company. Book value is the cost minus depreciation, while market value reflects current supply and demand. Book value is used for accounting purposes, while market value is used for investment and financing decisions. d) Asset values are crucial for valuation, investment, and financing decisions. Book value is used for accounting and tax purposes, while market value is used for investment and financing decisions. Both values help to evaluate performance and manage risk. e) Depreciation reduces an asset's book value over time due to wear and tear, which can affect financial ratios and performance metrics. Although depreciation doesn't directly affect market value, heavily depreciated assets can be perceived as less valuable, leading to a reduced market value. f) Non-cash expenses reduce a company's reported earnings. Examples include depreciation, stock-based compensation, and asset impairments. Adjusted earnings exclude such charges, making it tough for investors to assess true financial figures. Show your work below (you must show all calculations used to derive you answers): A) Calculate the book value using this formula: Book Value = Fixed Assets + Liabilities + Working Capital Page 5 of 10

Corporate Finance BFIN350 Book Value = $380000 +$720000 + $250000 = $1350000 A) Calculate the market value using this formula: Market Value = Liquid Assets – Current Liabilities Market Value: $1000000 – $720000 = $280000 Page 6 of 10

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Corporate Finance BFIN350 Question 4 The NewLife Insurance Company is offering an insurance policy that will give you and your offspring $18,000 per year forever. a. If you require 6% return on investment the how much would you have to pay for the policy? b. If in part a. above, the cost of the policy was $360,000, what would you expect the interest rate to be for this to be a fair deal? c. You’re considering getting a loan. Bank A charges 15% annually and Bank B charges 15.25% accrued semi-annually. Which bank has the lower effective rate of interest? d. Payments are made on a 15-year annuity of $1500 at the end of each month. Calculate the present value if the interest rate is 11% compounded monthly for the first 7 years and 7 percent compounded monthly thereafter. Answer Place only your final answer in the box. a) $300000 b) 5% c) Bank A d) $138724.68 Show your work below (you must show all calculations used to derive you answers): A) Calculate the present value using this formula: PV = C/r (where C- periodical cash flow, r – required rate of return) PV = 18000/ 0.06 = 300000 B) Calculate the interest rate using this formula: Interest rate (r) = C/P R= 18000/ 360000 = 0.05 or 5%. C) Calculate the effective annual rate using this formula: EAR (Effective Annual Rate) = (1+r/t) t-1 (where t - number of times compounded a year) Bank A: 15% Page 7 of 10

Corporate Finance BFIN350 Bank B: (1+15.25%/ 2) 2-1 = 0.1583 or 15.83% Page 8 of 10

Corporate Finance BFIN350 D) Financial calculator: Value of first 7 years: 1) N = 84 (7*12 = 84 payments) 2) I/Y = 11/ 12 = 0.92 3) PMT = -1500 4) FV = 0 5) PV = 87604.36 PV 7 years from today: 1) PMT = - 1500 2) I/Y = 7 / 12 = 0.58 3) N = 96 (8*12 = 96 payments) 4) FV= 0 5) PV = 110021.35 Value today: 1) FV = 110021.35 2) PMT = 0 3) N =84 4) I/Y = 11/ 12 = 0.92 5) PV = 51120.33 So, PV = PV for first 7 years + PV after those 7 years = 87604.36 +51120.33 = 138724.69 Page 9 of 10

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Corporate Finance BFIN350 Question 5 If the first Thor Marvel comic book was issued in 1949 and in 2016 it was sold for $533,500, at a return of 25.9% per year then how much would the comic book have originally sold for? Answer Place only your final answer in the box. Selling Price? $0.11 Show your work below (you must show all calculations used to derive you answers): Calculate the present value using this formula: PV = FV/(1+r) n ( where r – required rate of return, n - number of years). N = 2016 – 1949 = 67 years r = 25.9%/100 = 0.259 PV = 533500/ (1+0.259) 67 = 0.1060  0.11 Page 10 of 10