FRL 367 Project PDF

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This was our Corporate Finance Theory Project that was worth 25% of our overall grade....

Description

“Music Store Project” Question 1 Solutions

Year

2008 2007 2006 2005 2004 2003 2002 Betas Total Risks Systematic Risk Unsystematic Risk

I-Music

Annual returns (%) You-Tunes Songs ‘R S&P 500 US stock index

U.S. Treasury bills

45 -5 -10 -10 22 8 37

-5 0 15 18 -9 0 15

51 20 1 -16 30 0 -15

38 22 5 -13 -3 18 -37

3 3 3 3 3 4 4

0.00 514.29 0.01 1397.9 7

-0.28 119.14 47.17

0.74 610.48 341.50

1.00 615.90 615.90

-0.01 0.24 0.03

323.86

1659.45

1674.20

0.65

Beta Calculations: To arrive at the “Beta” values for all the three securities and S&P 500 and U.S. Treasury Bills, we have used the excel formula “Slope” and have then arrived at the values. Among all the five “Beta” values calculated, we observe that S&P 500 has

the highest Beta Value. While calculating the Beta Values, we have considered the S & P 500 Stock Index Returns as the base to calculate the “Beta” values. Total Risk: “Total Risk” is the sum of systematic and unsystematic risk. It is also the variance of the security returns. Here we have calculated by doing nothing nothing but, by considering the sum of the variances of the last seven year returns. We observe the “S&P 500 stock Index “ has the highest total risk. Systematic Risk – Systematic risk is the risk which cannot be diversified. Here we observe that “S&P 500 stock index” has the highest “Systematic Risk”. We have calculated the the systematic risk for individual items by Squaring the beta values and multiplying them with “S&P 500 Stock Index – Total Risk”. Question 2 Solutions

Beta Risk Free Rate Return From Market

0.16 (Avg "Beta" Of Competitors) 3.29 (Avg U.S. Treasury Bills Returns) 4.29 (Avg S & P 500 Stock Index Returns)

As per Capital Asset Pricing Model (CAPM), Risk Free Rate + Beta * ( Return From Market - Risk Free Required Rate OF Return = Rate) 3.29% + 0.16 * (4.29 % - 3.29%) 3.44%

The minimum annual rate of return on equity that investors require to get is 3.44%. Question 3 Solutions

Year

2008 2007 2006 2005 Betas Total Risks Systematic Risk Unsystematic Risk Beta Risk Free Rate Return From Market

I-Music

YouTunes

Annual returns (%) Songs ‘R S&P 500 US stock index

U.S. Treasury bills

45 -5 -10 -10

-5 0 15 18

51 20 1 -16

38 22 5 -13

3 3 3 3

0.98 716.67 593.96 1948.10

-0.49 126.00 149.75 342.50

1.29 824.67 1022.36 2241.68

1.00 482.00 615.90 1310.21

0.00 0.00 0.00 0.00

0.59 (Avg "Beta" Of Competitors) 3.00 (Avg U.S. Treasury Bills Returns) 13.00 (Avg S & P 500 Stock Index Returns)

As per Capital Asset Pricing Model (CAPM), Required Rate OF Return = Risk Free Rate + Beta * ( Return From Market - Risk Free

Rate) =

3.00% + 0.59 * (13.00 % - 3.00%)

=

8.92 %

Total Number Of Shares Outstanding Each Stock Price Total Capital ( 900,000 +300,000)

= =

Weighted Average Capital (WACC)

=

=

10000 90

1,200,000 8.92 %

(Assumptions: The Music Industry has given a negative return for the year 2002 till 2004 . Hence neglecting those year performances, we have calculated the revised Beta values, Systematic and Unsystematic Risks. Here only common stock is available in the firm’s capital structure and there are no other capitals available.Hence the required rate of return and WACC are one and the same. ) Hence the weighted average cost of capital for the proposed investment project is 8.92%. The Beta of the company is finding out by averaging the Beta values of its competitors , which is 0.59 (Considering year 2005 through 2008). But the Beta for the proposed project is 0.90. As the Beta for the project is 0.90 , which is more than the Beta of the company I,e 0.59, the project is more risky than the company. More the Beta value, higher riskier it is.

Question 4. Solutions:

Total Number of years the store will run Initial Investment Depreciation (Straightline for 5 Yrs) No. of CDs getting Sold Estimated Increase In No. CD selling per year Expected Selling To College Students Discount Offered To Students Avg price of CD to a regular customer Cost of making CD Free CD to each customer Maintance Expenses Etc per annum Beta Of Project Corporate Tax Rate Year 0 No. of CDs Sold Sales (a) Customers without Student (60%) (b) Only to students (40%) Total Sales Less: Cost Of Making Less: Cost of Free CD Less : Maintance Expenses etc Less : Discount Offered To Student Less : Depreciations EBITA

= = = = = = = = = = = = =

$ $

5 years 300000 60000 22000 1000 40% 10% 10 4 0.5 30000 0.9 34%

1 22000

2 23000

3 24000

4 25000

5 26000

$ 1,32,000.0 $ 88,000 $ 2,20,000 $ 88,000 11000 30000 8800 60000 $ 22,200

$1,38,000.0 $ 92,000 $ 2,30,000 $ 92,000 11500 30000 9200 60000 $ 27,300

$1,44,000.0 $ 96,000 $ 2,40,000 $ 96,000 12000 30000 9600 60000 $ 32,400

$ 1,50,000.0 $ 1,00,000 $ 2,50,000 $ 1,00,000 12500 30000 10000 60000 $ 37,500

$ 1,56,000.0 $ 1,04,000 $ 2,60,000 $ 1,04,000 13000 30000 10400 60000 $ 42,600

Less : Tax @34% PAT Add: Depreciations OCF Terminal Cash Flow Net Present Value (NPV)

$

-300000 $

$ $

7548 14,652 60000 74,652 74,652

$ $ $

9282 18,018 60000 78,018 78,018

$ $ $

11016 21,384 60000 81,384 81,384

$ $ $

12750 24,750 60000 84,750 84,750

$ $ $

14484 28,116 60000 88,116 88,116

-291,593

( Assumptions: The Net Present Value (NPV) is arrived at by considering the WACC of 8.92% with the help of Excel "NPV" function.)

As per our calculations for NPV, it is negative by a bigger amount which “-$291,593” . Hence second team of researchers can not “Poly Tunes” company’s managers to accept the new Pasadena project. It has to be rejected.

Question 5. Solutions:

If the project is accepted , there will be a loss of Total capital invested for the company Return ( - Ve) % The revised systematic risk Changed To

291593 1200000 24.30% 216.17

(Assumptions: Here we have calculated the negative return for the company on the total capital after considering the tentative loss by accepting the project. The revised systematic risk has

been calculated to 216.17 .)

Question6. Solutions:

Total Equity Investment (30%) Total Debt Investment (70%) Cost of Debt Tax Rate (a)

= = = =

1200000 2800000 5.00% 34%

As per Adjusted Present Value Approach (APV), current value of the project = NPV of the project considering solely financed by equity plus PV of additional financial benefits (Which is interest tax shield) Interest Tax Shield = 47600 PV of Interest Tax Shield = $ 2,02,082 Current Value of project as per APV

=

$

-89,511

$ $

24,000 -

$ $

$ $

1,44,000 96,000

$ $

(Source - http://www.investopedia.com/terms/a/apv.asp#axzz2LZp4HV7c) (b)

Year No. of CDs Sold Sales (a) Customers without Student (60%) (b) Only to students (40%)

0

1 $ $

22,000 -

$ $

$ $

1,32,000 88,000

$ $

2 23,000 1,38,000 92,000

3

4 25,000 1,50,000 1,00,000

$ $ $ $

5 26,000 1,56,000 1,04,000

Total Sales Less: Cost Of Making Less: Cost of Free CD Less : Maintance Expenses etc Less : Discount Offered To Student Less : Depreciations Less : Interest PBT Less : Tax @34% PAT Add: Depreciations Net Debt Issued / Paid Cash - Flow - To - Equity

(c)

$ $ $ $ $ $ $ $ $ $ $ $ $

2,20,000 88,000 11,000 30,000 8,800 60,000 1,40,000 -1,17,800 -40,052 -1,57,852 60,000 28,00,000 27,02,148

WACC

2,30,000 92,000 11,500 30,000 9,200 60,000 1,40,000 -1,12,700 -38,318 -1,51,018 60,000

$ $ $ $ $ $ $ $ $ $ $

2,40,000 96,000 12,000 30,000 9,600 60,000 1,40,000 -1,07,600 -36,584 -1,44,184 60,000

$

-91,018

$

-84,184

=

Total Equity Investment (30%) Total Debt Investment (70%) Cost of Debt Tax Rate Cost of Equity

Year No. of CDs Sold Sales (a) Customers without Student (60%) (b) Only to students (40%)

$ $ $ $ $ $ $ $ $ $ $

$

-77,350

$ 2,60,000 $ 1,04,000 $ 13,000 $ 30,000 $ 10,400 $ 60,000 $ 1,40,000 $ -97,400 $ -33,116 $ -1,30,516 $ 60,000 $ -28,00,000 $ -28,70,516

4.99%

= = = = =

0

$ 2,50,000 $ 1,00,000 $ 12,500 $ 30,000 $ 10,000 $ 60,000 $ 1,40,000 $ -1,02,500 $ -34,850 $ -1,37,350 $ 60,000

1200000 2800000 5.00% 0.34 8.92%

1 22000 0

2 23000 0

3 24000 0

4 25000 0

5 26000 0

132000 88000

138000 92000

144000 96000

150000 100000

156000 104000

Total Sales Less: Cost Of Making Less: Cost of Free CD Less : Maintance Expenses etc Less : Discount Offered To Student Less : Depreciations Less : Interest PBT Less : Tax @34% PAT Add: Depreciations Net Debt Issued / Paid Operating Cash flow PV of OCF

$

220000 88000 11000 30000 8800 60000 140000 -117800 -40052 -157852 60000 2800000 2702148 25,73,785

230000 92000 11500 30000 9200 60000 140000 -112700 -38318 -151018 60000 -91018 -82,576

$

240000 96000 12000 30000 9600 60000 140000 -107600 -36584 -144184 60000

$

-84184 -72,748

Question - 7. Solutions:

Total Equity Investment (30%) Total Debt Investment (70%) Cost of Debt Tax Rate Annual Repayment in 5 Years (a)

= = = = =

There won't be any change though there will be annual repayments ]

$

1200000 2800000 0.05 0.34 6,46,729

250000 100000 12500 30000 10000 60000 140000 -102500 -34850 -137350 60000

$

-77350 -63,667

260000 104000 13000 30000 10400 60000 140000 -97400 -33116 -130516 60000 -2800000 -2870516 $ -22,50,483

As per Adjusted Present Value Approach (APV), current value of the project = NPV of the project considering solely financed by equity plus PV of additional finacing benefits (Which is interest tax shield) Interest Tax Shield = $ 47,600 PV of Interest Tax Shield = $ 2,02,082 Current Value of project as per APV

(b)

Year No. of CDs Sold Sales (a) Customers without Student (60%) (b) Only to students (40%) Total Sales Less: Cost Of Making Less: Cost of Free CD Less : Maintance Expenses etc Less : Discount Offered To Student Less : Depreciations Less : Interest PBT Less : Tax @34% PAT Add: Depreciations Net Debt Issued / Paid Cash - Flow - To - Equity

=

0

$ $

$

-89,511.06

1 22000 0

2 23000 0

3 24000 0

4 25000 0

5 26000 0

132000 88000 220000 88000 11000 30000 8800 60000 140000 -117800 -40052 -157852 60000 21,53,271 -22,51,123

138000 92000 230000 92000 11500 30000 9200 60000 140000 -112700 -38318 -151018 60000 6,46,729 -7,37,747

144000 96000 240000 96000 12000 30000 9600 60000 140000 -107600 -36584 -144184 60000 6,46,729 -7,30,913

150000 100000 250000 100000 12500 30000 10000 60000 140000 -102500 -34850 -137350 60000 $ 6,46,729 $ -7,24,079

156000 104000 260000 104000 13000 30000 10400 60000 140000 -97400 -33116 -130516 60000 6,46,729 -7,17,245

$ $

$ $

$ $

(c)

WACC

=

Total Equity Investment (30%) Total Debt Investment (70%) Cost of Debt Tax Rate Cost of Equity

Year No. of CDs Sold Sales (a) Customers without Student (60%) (b) Only to students (40%) Total Sales Less: Cost Of Making Less: Cost of Free CD Less : Maintance Expenses etc Less : Discount Offered To Student Less : Depreciations Less : Interest PBT Less : Tax @34% PAT Add: Depreciations Net Debt Issued / Repaid Paid Operating Cash flow PV of OCF

4.99%

= = = = =

0

$ $ $

1200000 2800000 5% 34% 8.92%

1 22000 0

2 23000 0

3 24000 0

4 25000 0

5 26000 0

132000 88000 220000 88000 11000 30000 8800 60000 140000 -117800 -40052 -157852 60000 21,53,271 -22,51,123 -21,44,185

138000 92000 230000 92000 11500 30000 9200 60000 140000 -112700 -38318 -151018 60000 6,46,729 -7,37,747 -6,69,320

144000 96000 240000 96000 12000 30000 9600 60000 140000 -107600 -36584 -144184 60000 6,46,729 -7,30,913 -6,31,619

150000 100000 250000 100000 12500 30000 10000 60000 140000 -102500 -34850 -137350 60000 $ 6,46,729 $ -7,24,079 $ -5,95,990

156000 104000 260000 104000 13000 30000 10400 60000 140000 -97400 -33116 -130516 60000 6,46,729 -7,17,245 -5,62,320

$ $ $

$ $ $

$ $ $...