Maximum payback (years): 3

Required return: 10%

Cum
Cumulative Discounted discounted
t Cash flow cash flow cash flow cash flow
0 -30,000 -30,000 -30,000.00 -30,000
1 8,000 $ (22,000) 7,272.73 $ (22,727)
2 10,000 $ (12,000) 8,264.46 $ (14,463)
3 11,000 $ (1,000) 8,264.46 $ (6,198)
4 17,000 $ 16,000 11,611.23 $ 5,413
5 12,000 $ 28,000 7,451.06 $ 12,864

Payback period for project: 3.06 #NAME?

Accept or reject? Reject #NAME?
Discounted payback period: 3.53 #NAME?
Accept or reject? Reject #NAME?
IRR 24% #NAME?
Accept or reject? Accept #NAME?
NPV 12,863.94 #NAME?
Accept or reject? Accept #NAME?
 SIMPLE CAPITAL BUDGETING EXAMPLE
Discount rate 15%

Year Cash flow

0 -1,000
1 100
2 200
3 300
4 400
5 500
6 600 NPV of Cash Flo

1,200
NPV 172.13
IRR 19.71% 1,000
800

NPV
600
Discount
400
rate NPV
0% 1,100.00 #NAME? 200
3% 849.34 #NAME? 0
6% 637.67 -2% 0% 3% 5% 8% 10% 1
-200
9% 457.83
12% 304.16 -400
15% 172.13 Disco
18% 58.10
21% -40.86
24% -127.14
27% -202.71
30% -269.16
 NPV of Cash Flows

3% 5% 8% 10% 13% 15% 18% 20% 23% 25% 28% 30%

Discount rate
required return = 0.10
Project A
Time CF Cum CF Disc CF
0 -150 -150 -150.00000 -150
1 50 -100 45.45455 -104.5455
2 100 0 82.64463 -21.90083
3 150 150 112.69722 90.79639
Decision
Criteria
PB 2.000
DiscPB 2.194
NPV 90.796
IRR 36.19%
PI 1.605
 Problems with the IRR Approach
Problem 1: Investing or Financing?
Required return: 10%
The use of the IRR decision rule becomes problematic when the cash flows resemble a loan. Consider the following
t Cash flow
0 $ 25,000
1 (10,000)
2 (11,000)
3 (12,000)
The IRR of this project is:
IRR: 14.77%
The IRR decision rule implies that we should accept projects when the IRR is greater than the required return. So, th
than the IRR. However, the NPV profile for the project looks like this:

Return NPV
0% $ (8,000.00)
5% (4,867.18)
10% (2,197.60)
15% 96.57
20% 2,083.33
25% 3,816.00
30% 5,336.82
With loan-type cash flows, the NPV increases as the interest rate increases. The standard IRR decision rule cannot b
Problem 2: Multiple Rates of Return
Excel uses an algorithm to calculate the IRR of a set of cash flows. Because the algorithm always starts at the same p
is not a problem, but with multiple IRRs we may want to find both IRRs. In this case, we can use the guess argument
following set of cash flows:

t Cash flow
0 $ (50,000)
1 25,000
2 29,000
3 41,000
4 32,000
5 (35,000)

We would expect two IRRs. Using the IRR function without using the Guess argument, we find:
IRR:
Now we will use the Guess argument to find what the other IRR is:
IRR:
We can graph the NPV profile for this project as well. The NPV profile will look like this:

Return NPV
-50% $ (164,000.00)
-45% (7,975.42)
-40% 58,847.74
-35% 84,011.95
-30% 89,462.72
-25% 85,720.16
-20% 77,954.10
-15% 68,732.59
-10% 59,321.92
-5% 50,324.30
0% 42,000.00
5% 34,433.78
10% 27,622.31
15% 21,520.38
20% 16,065.46
25% 11,190.40
30% 6,829.92
35% 2,923.56
40% (583.09)
45% (3,738.29)
50% (6,584.36)
55% (9,158.27)
60% (11,492.16)

Mutually Exclusive Investments and Incremental IRR

Even when there is a single IRR, it is not possible to rank projects according to IRR. In other words, the project with t
comparing two mutually exclusive investments, we may want to know the crossover rate, that is, the interest rate th
have the cash flows for two projects:

t Investment A Investment B
0 $ (100,000) $ (110,000)
1 35,000 38,000
2 29,000 36,000
3 29,000 30,000
4 29,000 29,000
5 20,000 21,000
 IRR: 14.07% 13.73%

To find the crossover rate, we calculate the incremental cash flows of the larger project, that is, subtract the cash flo
large project. Notice we used an IF statement to makes sure the cash flows below are always the larger project minu
from the larger project are:

Incremental
t cash flows
0 $ (10,000)
1 3,000
2 7,000
3 1,000
4 -
5 1,000

The crossover rate, or incremental IRR, is the IRR of these incremental cash flows, or:

Crossover rate: 9.36%

We can create a table to show the NPV of each project at different interest rates and graph the NPV profile of each

R Investment A Investment B
0% $ 42,000.00 $ 44,000.00
5% 24,217.37 25,071.09
10% 9,799.07 9,683.70
15% (2,044.70) (2,988.31)
20% (11,889.15) (13,547.45)
emble a loan. Consider the following project.

eater than the required return. So, this project looks acceptable for any required return less

e standard IRR decision rule cannot be used in such cases.

algorithm always starts at the same point, it will always arrive at the same IRR. Generally, this
case, we can use the guess argument to try to find multiple IRRs. Suppose we have the

ument, we find:
ike this:

RR. In other words, the project with the highest IRR is not necessarily the best project. When
sover rate, that is, the interest rate that makes the NPV of the two projects equal. Below we
r project, that is, subtract the cash flows of the smaller project from the cash flows of the
ow are always the larger project minus the smaller project. So, the incremental cash flows

ws, or:

es and graph the NPV profile of each project. Doing so, we get:
The Modified Internal Rate of Return (MIRR)
Excel does have a built-in function to calculate the MIRR, but we work through the MIRR calculation for each metho
manually first. Suppose we have a project with the following cash flows, reinvestment rate, and discount rate:
t Cash flow
0 -12,000
1 5,800
2 6,500
3 6,200
4 5,100
5 (4,300)
Discount rate: 11%
Reinvestment rate: 8%
With the discounting approach, we discount all negative cash flows to the beginning of the project. In order to have
Excel discount only negative cash flows, we can use an IF statement for each cash flow as follows. Notice that the
equation at time 0 is not a nested IF, but simply a series of IF statements that calculates the present value of each ca
flow if the cash flow is negative, otherwise it returns a value of 0 to be added in to the cash flow. Once we get these
modified cash flows, we can simply calculate the IRR of these cash flows.
Discounting approach:
t Cash flow
0 -14,551.84
1 5,800.00
2 6,500.00
3 6,200.00
4 5,100.00
5 -
MIRR: 23.08%
With the reinvestment approach, we simply find the future value of all cash flows except the cash flow at time 0 at t
end of the project and then calculate the IRR of the two remaining cash flows. Doing so, we find that the MIRR using
reinvestment approach is:
Reinvestment approach:
t Cash flow
0 $ (12,000.00)
1 0.00
2 0.00
3 0.00
4 0.00
5 24,518.64
MIRR: 15.36%
We should note that to have Excel accurately calculate the IRR of these modified cash flows, the intermediate cash fl
must be entered as 0, not left blank.

For the combination approach, we need to find the present value of all negative cash flows at time 0, the future valu
all positive cash flows at the end of the project, then find the IRR of the modified cash flows. Again, we can use a ser
of IF statements to test whether each cash flow is negative or positive. So, the MIRR using the combination approac
 Combination approach:
t Cash flow
0 $ (14,551.84)
1 -
2 -
3 -
4 -
5 28,818.64

MIRR: 14.64%

As we mentioned earlier, Excel does have a built-in MIRR function. Using the MIRR function, the MIRR is:

MIRR: 14.64%
What method is Excel using to calculate the MIRR? Of course, remember that Excel was written by computer
programmers, so the method that Excel uses is not necessarily more correct, just the method the programmers
selected.
alculation for each method
, and discount rate:

project. In order to have

ollows. Notice that the
e present value of each cash
h flow. Once we get these

he cash flow at time 0 at the

e find that the MIRR using the

s, the intermediate cash flows

s at time 0, the future value of

s. Again, we can use a series
the combination approach is:
n, the MIRR is:

ritten by computer
od the programmers
 RANKING PROJECTS WITH NPV AND IRR
Discount rate 8%

Year Project A Project B 500

0 -500 -500
1 100 250
2 100 250 400
3 150 200
4 200 100
5 400 50 300

NPV
NPV #NAME? 200
IRR #NAME?

TABLE OF NPVs AND DISCOUNT RATES 100

Project A Project B
NPV NPV 0
0% 450.00 350.00 #NAME? 0% 5%
2% 382.57 311.53 #NAME?
4% 321.69 275.90 -100
6% 266.60 242.84
8% 216.64 212.11
-200
10% 171.22 183.49
12% 129.85 156.79
14% 92.08 131.84
16% 57.53 108.47
18% 25.86 86.57
20% -3.22 66.00
22% -29.96 46.66
24% -54.61 28.45
26% -77.36 11.28
28% -98.39 -4.93
30% -117.87 -20.25

Calculating the crossover point

Year Project A Project B Cashflow(A) - cashflow(B)
0 -500 -500 0 #NAME?
1 100 250 -150 #NAME?
2 100 250 -150
3 150 200 -50
4 200 100 100
5 400 50 350

IRR 8.51% #NAME?

500

400
Project A
NPV
300
Project B
NPV
200

100

0
0% 5% 10% 15% 20% 25% 30%
-100
Discount rate

-200
Qn.1
PB Cutoff 2 years
Discount rate 15%
Disc CF
Year Project A Project B Project A Project B
0 -15000 -18000 -15000 -18000
1 9500 10500 8260.8695652 9130.4347826
2 6000 7000 4536.8620038 5293.0056711
3 2400 6000 1578.0389578 3945.0973946

PB Period 1.916666667 2.083333333

NPV -624.2294732 368.5378483
IRR 11.87% 16.37%

Qn.8
Discount rate 10%
Disc CF
Year Project Alpha Project Beta Project Alpha Project Beta
0 -2300 -3900 -2300 -3900
1 1200 800 1090.9090909 727.27272727
2 1100 2300 909.09090909 1900.8264463
3 900 2900 676.18332081 2178.8129226

NPV 376.1833208 906.91209617

PI 1.163557966 1.2325415631

Qn.10
Year Cashflows
0 7000
1 -3700
2 -2400
3 -1500
4 -1200

IRR 12.40%
NPV (10%) ₹ -293.70
NPV (20%) ₹ 803.24

Qn.11 Discount rate 14%

Year Deepwater Fis New Submarine
Incremental
0 -850000 -1650000 -800000
1 320000 810000 490000
2 470000 750000 280000
3 410000 690000 280000

IRR 18.58% 17.81% 16.84%

NPV 69089.81 103357.31 34267.49

Qn.12 Discount rate 10%

 Year Cashflows1 Cashflows2 Incremental
0 -30000 -12000 -18000
1 18000 7500 10500
2 18000 7500 10500
3 18000 7500 10500

PI 1.49 1.55 1.45

NPV 14763.34 6651.39 8111.95

Qn.13
Year Cashflows
0 -78000000
1 110000000
2 -13000000
IRR 28% -87%

Qn.15 Discount rate 10%

Maximum Investment 20
Year CDMA G4 WI-FI
0 -8 -12 -20
1 11 10 18
2 7.5 25 32
3 2.5 20 20
NPV 10.08 32.78 37.84
PI 2.259579264 3.731530178 2.8918106687
Decision Accept CDMA and G4

Qn.17 Discount rate 12%

Year Project A Project B Project C
0 -150000 -300000 -150000
1 110000 200000 120000
2 110000 200000 90000
NPV 35905.61 38010.20 28890.31
PI 1.239370748 1.12670068 1.1926020408

if independent ; Decision Accept All; as A, B and C are +ve NPV

Mutually exclusive, Decision Accept B; Hgihest NPV
Max Investment 450000, Decsion Accept A& B
Qn.19
Year NP-30 NX-20 Cum NP-30 Cum NX-20
0 -550000 -350000 -550000 -350000
1 185000 100000 -365000 -250000
2 185000 110000 -180000 -140000
3 185000 121000 5000 -19000
4 185000 133100 190000 114100
5 185000 146410 375000 260510
Payback Period 2.973 3.143
IRR 20.27% 20.34%
NPV 70148.69 48583.79
Qn.22
Year Cashflow
0 -1008
1 5724
2 -12140
3 11400
4 -4000
IRR 1 25.00% #NAME?
IRR 2 33.33% #NAME?
IRR 3 42.86% #NAME?
IRR 4 66.67% #NAME?

Qn.27
Year Project Million Project Billion Incremental
0 -1200 -Io -Io+1200
1 Io+160 Io+400 240
2 960 1200 240
3 1200 1600 400

PV of the Increment CFs = -Io+1200+ ₹ 690.32

=-Io+1890.32

If Io is lessr than 1890 accept Project Billion

Q.1
Etonic Inc. is considering an investment of $395,000 in an asset with an economic life of 5 years. The firm 
estimates that the nominal annual cash revenues and expenses at the end of the first year will be $255,000 
and $82,000, respectively. Both revenues and expenses will grow thereafter at the annual inflation rate of 3 
percent. Etonic will use the straight-line method to depreciate its asset to zero over five years. The salvage 
value of the asset is estimated to be $45,000 in nominal terms at that time. The one-time net working 
capital investment of $15,000 is required immediately and will be recovered at the end of the project. All 
corporate cash flows are subject to a 34 percent tax rate.
What is the project’s total nominal cash flow from assets for each year?
Answer 34%
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
Sales 255000 262650 270529.5 278645.4 287004.7
Expenses 82000 84460 86993.8 89603.61 92291.72
Depreciation 79000 79000 79000 79000 79000
EBIT 94000 99190 104535.7 110041.8 115713
EBIT*(1-T) 62040 65465.4 68993.56 72627.57 76370.6
Capital spending 395000 -29700
NWC 15000 -15000
FCF -410000 141040 144465.4 147993.6 151627.6 200070.6
 rs. The firm 
be $255,000 
ation rate of 3 
The salvage 
Q.1
Flatte Restaurant is considering the purchase of a $7,500 soufflé maker.
The soufflé maker has an economic life of five years and will be fully depreciated by the straight-line method.
The machine will produce 1,300 soufflés per year, with each costing $2.15 to make and priced at $5.25.
Assume that the discount rate is 14 percent and the tax rate is 34 percent.
Should the company make the purchase?
Answer
r 14%
0 1 2 3 4 5
Revenue 6825 6825 6825 6825 6825
Expenses 2795 2795 2795 2795 2795
Depreciation 1500 1500 1500 1500 1500
EBIT 0 2530 2530 2530 2530 2530
EBIT*(1-T) 0 1669.8 1669.8 1669.8 1669.8 1669.8
EBIT*(1-T)+Dep 0 3169.8 3169.8 3169.8 3169.8 3169.8
Capex 7500
FCF -7500 3169.8 3169.8 3169.8 3169.8 3169.8
NPV 3382.18005508755 #NAME?

Q.2
The Best Manufacturing Company is considering a new investment. Financial projections for
the investment are tabulated here. The corporate tax rate is 34 percent. Assume all sales
revenue is received in cash, all operating costs and income taxes are paid in cash, and all
cash flows occur at the end of the year. All net working capital is recovered at the end of the project.

Year 0 Year 1 Year 2 Year 3 Year 3

  Investment $27,400
  Sales revenue $12,900 $14,000 $15,200 $11,200
  Operating costs 2700.00 2800.00 2900.00 2100.00
  Depreciation 6850.00 6850.00 6850.00 6850.00
  Net working capital
spending 300.00 200.00 225.00 150.00 ?

a)Compute the incremental net income of the investment for each year.
b)Compute the incremental cash flows of the investment for each year.
c)Suppose the appropriate discount rate is 12 percent. What is the NPV of the project? 

Answer
r 12%
Year 0 Year 1 Year 2 Year 3 Year 4
  Investment 27,400
  Sales revenue 12,900 14,000 15,200 11,200
  Operating costs 2700 2800 2900 2100
  Depreciation 6850 6850 6850 6850
EBIT*(1-T)+DEP 9061 9721 10447 8335
  Net working capital spending 300 200 225 150 -875
FCF -27,700 8,861 9,496 10,297 9,210
NPV 964.08 #NAME?
Q.3
Down Under Boomerang, Inc., is considering a new three-year expansion project that requires an initial fixed asset i
The fixed asset will be depreciated straight-line to zero over its three-year tax life, after which it will be worthless. Th
with costs of $485,000. The tax rate is 35 percent and required return is 12 percent.
What is the project’s NPV?

Answer
r 12%
EBIT*(1-t)+DEP 683250

or
(REV-COST)*(1-T)+DEP*T 683250
Investment 1650000

NPV -8948.79 #NAME?

Q.4
In the previous problem, suppose the project requires an intitial investment in net working capital of 
$285,000 and the fixed asset will have a market value of $225,000 at the end of the project.
What is the project's Year 0 net cash flow? Year 1? Year 2? Year 3? Wht is the new NPV?
Answer
WC 285000
After-tax sale proceeds 146250
Year 0 Year 1 Year 2 Year 3
FCF -1935000 683250 683250 1114500
NPV 13006.45 #NAME?
aight-line method.
ced at $5.25.

#NAME?

#NAME?
res an initial fixed asset investment of $1.65 million.
ch it will be worthless. The project is estimated to generate $1.24 million in annual sales,
Q.6
Your firm is contemplating the purchase of a new $530,000 computer-based order entry system. 
The system will be depreciated straight-line to zero over its five-year life. It will be worth $50,000 
at the end of that time. You will save $186,000 before taxes per year in order processing costs, 
and you will be able to reduce working capital by $85,000 (this is a one-time reduction). If the tax 
rate is 35 percent, what is the IRR for this project? 
Answer
Capex 530000
DEP 106000
After-tax SV 32500
Annual EBIT*(1-t)+DEP 158000
WC Reduction 85000
0 1 2 3
FCF -445000 158000 158000 158000
IRR 20.68% #NAME?

Q.9
Howell Petroleum is considering a new project that complements its existing business.
The machine required for the project cost $3.9 million. The marketing department predicts that sales related to 
the project will be $2.35 million per year for the next four years, after which the market will cease to exist. 
The machine will be depreciated down to zero over its four-year economic life using the straight-line 
method. Cost of goods sold and operating expenses related to the project are predicted to be 25 percent 
of sales. Howell also needs to add net working capital of $150,000 immedietly. The additional net working 
capital will be recovered in full at the end of the project's life. The corporate tax rate is 35 percent. The 
required rate of return for Howell is 13 percent. Should Howell proceed with the project?
Answer
tax 35% r
Year 0 Year 0 Year 1 Year 2 Year 3
Capex 4000000
Sales 2400000 2400000 2400000
Exp (25% of sales) 960000 960000 960000
DEP 1000000 1000000 1000000
Ebit*(1-T)+DEP 1286000 1286000 1286000
WC
FCF -4000000 1286000 1286000 1286000
NPV 76446.9640051899 #NAME?

Q.10
You are evaluating two different silicon wafer milling machines. The Techron I costs $245,000, 
has a three-year life, and has pretax operating costs of $39,000 per year.
The Techron II costs  $315,000, has a five-year life, and has pretax operating costs of $48,000 per year. For both 
milling machines, use straight-line depreciation to zero over the project's life and assume a salvage value of $20,000
If your tax rate is 35 percent and your discount rate is 9 percent
Compute the EAC for both machines. Which do you prefer? Why?
Answer
Techron 1 Techron 2
Capex 245000 315000
Life 3 5
Pretax Cost 39000 48000
After tax SV 13000 13000
DEP 81666.6666666667 63000
EBIT*(1-t)+DEP 3233.33333333333 -9150
PV of Cost -226777.095339178 -342141.20103779
PVIFA 2.53129466598818 3.88965126335172
EAC -89589.3703669809 -87961.9220009369
Techron 2 is better
 4 5
158000 105500

s that sales related to 

l cease to exist. 
traight-line 
o be 25 percent 
onal net working 
percent. The 

10%
Year 4

2400000 0.076447
960000
1000000
1286000

1286000

8,000 per year. For both 

a salvage value of $20,000.
Q.12
Hagar Industrial Systems Company (HISC) is trying to decide between two different conveyor belt systems. 
System A costs $290,000, has a four-year life, and requires $89,000 in pretax annual operating costs. 
System B costs $410,000, has a six-year life, and requires $79,000 in pretax annual operating costs.
Both systems are to be depreciated straight-line to zero over their lives and will have zero salvage value. 
Whichever system is chosen, it will not be replaced when it wears out. The tax rate is 34 percent and the 
discount rate is 7.5 percent.
which system should the firm choose?
Answer
System A System B
Capex 290000 410000
Life 4 6
Pretax Cost 89000 79000
DEP 72500 68333.3333
EBIT*(1-t)+DEP -34090 -28906.6667
PV of Cost -404178.533 -545683.454

Q.14
Vandalay Industries is considering the purchase of a new machine for the production of latex. 
Machine A costs $3,100,000 and will last for 6 years. Variable costs are 35 percent of sales, and fixed costs are $20
Machine B costs $6,100,000 and will last for 9 years. Variable costs for this machine are 30 percent of sales and fixe
The sales for each machine will be $13.5 million per year. The required return is 10 percent and the tax rate is 35 pe
Both machines will be depreciated on a straight-line basis 
If the company plans to replace the machine when it wears out on a perpetual basis, which machine should you cho
Answer
Machine A Machine B
Capex 3100000 6100000
Life 6 9
Sales 13500000 13500000
VC 4725000 4050000
Fixed Coost 204000 165000
Pretax Cost 4929000 4215000
DEP 516666.667 677777.778
EBIT*(1-t)+DEP -3023016.67 -2502527.78
PV of Cost -16266026 -20512117
PVIFA 4.3552607 5.75902382
EAC -3734799.55 -3561735.07
Machine B is better
 eyor belt systems. 
erating costs. 
ating costs.
o salvage value. 
percent and the 

es, and fixed costs are $204,000 per year. 

30 percent of sales and fixed costs are $165,000 per year. 
ent and the tax rate is 35 percent.

ch machine should you choose?

Q.17
Etonic Inc. is considering an investment of $395,000 in an asset with an economic life of 5 years. The firm 
estimates that the nominal annual cash revenues and expenses at the end of the first year will be $255,000 
and $82,000, respectively. Both revenues and expenses will grow thereafter at the annual inflation rate of 3 
percent. Etonic will use the straight-line method to depreciate its asset to zero over five years. The salvage 
value of the asset is estimated to be $45,000 in nominal terms at that time. The one-time net working 
capital investment of $15,000 is required immediately and will be recovered at the end of the project. All 
corporate cash flows are subject to a 34 percent tax rate.
What is the project’s total nominal cash flow from assets for each year?
Answer 34%
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
Sales 255000 262650 270529.5 278645.4 287004.7
Expenses 82000 84460 86993.8 89603.61 92291.72
Depreciation 79000 79000 79000 79000 79000
EBIT 94000 99190 104535.7 110041.8 115713
EBIT*(1-T) 62040 65465.4 68993.56 72627.57 76370.6
Capital spending 395000 -29700
NWC 15000 -15000
FCF -410000 141040 144465.4 147993.6 151627.6 200070.6

Q.19
Bridgton Golf Academy is evaluating different golf practice equipment. The "Dimple-Max" 
equipment costs $64,000, has a 3 year life, and costs $7,500 per year to operate. The relevant 
discount rate is 12 percent. Assume that the straight-line depreciation method is used and that 
the equipment is fully depreciated to zero. Furthermore, assume the equipment has a salvage 
value of $7,500 at the end of the project's life.
the relevant tax rate is 34 percent. All cash flows occur at the end of the year.
Find EAC of this equipment.
Answer
Capex 64000
Life 3
Pretax Cost 7500
After tax SV 4950
DEP 21333.3333333
EBIT*(1-t)+DEP 2303.33333333
PV of Cost -54944.469752
PVIFA 2.40183126822
EAC -22876.073969

Q.20
RightPrice Investors, Inc., is considering the purchase of a $415,000 computer with an economic life of five 
years. The computer will be fully depreciated over five years using the straight-line method.
The market value of the computer will be $50,000 in five years. The computer will replace 4 office employees whose
combined annual salaries are $120,000. The machine will also immediately lower the firm’s required net 
working capital by $80,000. This amount of net working capital will need to be replaced once the machine 
is sold. The corporate tax rate is 34 percent. The appropriate discount rate is 9 percent.
is it worthwhile to buy computer
Answer
T 34%
r 9%
Capex 415000
Life 5
Dep 83000
After tax SV 33000
WC Savings 80000
Cost Savings 120000
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
Capex 415000 -33000
EBIT*(1-T)+DEP 107420 107420 107420 107420 107420
WC -80000 80000
FCF -335000 107420 107420 107420 107420 60420
NPV 52279.56
 rs. The firm 
be $255,000 
ation rate of 3 
The salvage 

mic life of five 

ffice employees whose 

he machine 
Q.32
Your company has been approached to bid on a contract to sell 15,000 voice recognition (VR) computer keyboards a year for f
Due to techonological improvements, beyond that time they will be outdated and no sales will be possible. The equipment nece
be depreciated on a straight-line basis to a zero salvage value. Production will require an investment in net working capital of $
end of the project, and the equipment can be sold for $200,000 at the end of production.
Fixed costs are $700,000 per year, and variable costs are $48 per unit. In addition to the contract, you feel your company can s
additional units to companies in other countries over the next four years, respectively, at a price of $145. This price is fixed. The
required return is 13 percent. Additionally, the president of the company will undertake the project only if it has an NPV of $100
What bid price should you set for contract?
Answer 13% 40%
Year 1 Year 2 Year 3
Q from Contract 15000 15000 15000
Other Sales 4000 12000 14000
R form other sales @ 145 580000 1740000 2030000
VC @ 48 912000 1296000 1392000
FC 700000 700000 700000
Capex 3400000
WC 75000
EBIT**x(1-T)+DEP -279200 186400 302800
FCF -3475000 -279200 186400 302800
NPV all CF other than Contract REV -3310801.50
Required NPV 100000
NPV of Contract Rev 3410801.50
15000*X*(1-40%)*PVIFA = 3410801.50
X *PVIFA= 378.977944679658
X= 127.410185946386
Q.33
Suppose we are thinking about replacing an old computer with a new one. The old one cost us $450,000; the new o
The new machine will be depreciated straight-line to zero over its five year life. It will probably be worth about $130,0
The old computer is being depreciated at a rate of $90,000 per year. It will be completely written off in three years
. If we don’t replace it now, we will have to replace it in two years. We can sell it now for $230,000; in two years, it w
The new machine will save us $85,000 per year in operating costs. The tax rate is 38 percent, and the discount rate
a) Suppose we recognise that if we don't replace the computer now, we will be replacing it in 2 years. Should we rep
(HINT: What we effectively have here is a decision either to "invest" in the old computer-by not selling it-or to invest
notice that the two investments have unequal lives)
b) Suppose we consider only whether we should replace the old computer now without worrying about what's going
What are the relevant cash flows? Should we replace it or not?
(HINT: consider the net change in firms's after tax cash flows if we do the replacement)

(a) New Old

T 38%
r 14%
Capex 580000 245200 Salvage value if selling today (2
Life 5 2
DEP 116000 90000
After Tax SV 80600 71400 Capial loss of 270000-180000-
Saving in cost 85000
CF 96780 34200
NPV -205885.309486477 -133944.229
PVIFA 3.43308096885846 1.646660511
EAC -59971.00 -81342.95
Decision: Replace it today

(a)
Compare NPV and make a decision
New Old Difference
Year 0 -580000.00 -245200.00 -334800.00
Year 1 96780.00 34200.00 62580.00
Year 2 96780.00 105600.00 -8820.00
Year 3 96780.00 96780.00
Year 4 96780.00 96780.00
Year 5 177380.00 177380.00
-71941.08
Decision: Continue with the old one
 computer keyboards a year for four years.
be possible. The equipment necessary for the production will cost $3.4 and will
tment in net working capital of $75,000 to be returned at the

act, you feel your company can sell 4,000, 12,000, 14,000 and 7,000
e of $145. This price is fixed. The tax rate is 40 percent, and the
ect only if it has an NPV of $100,000.

Year 4
15000
7000
1015000
1056000
700000
-120000
-75000
-104600
90400

e cost us $450,000; the new one will cost $580,000.

robably be worth about $130,000 after 5 yrs.
ely written off in three years
or $230,000; in two years, it will probably be worth $60,000.
percent, and the discount rate is 14 percent
ng it in 2 years. Should we replace now or should we wait?
er-by not selling it-or to invest in new one.

t worrying about what's going to happen in two years.

Salvage value if selling today (230000+CL*T)

Capial loss of 270000-180000-60000=30000

Q.32
Your company has been approached to bid on a contract to sell 15,000 voice recognition (VR) computer keyboards a year for f
Due to techonological improvements, beyond that time they will be outdated and no sales will be possible. The equipment nece
be depreciated on a straight-line basis to a zero salvage value. Production will require an investment in net working capital of $
end of the project, and the equipment can be sold for $200,000 at the end of production.
Fixed costs are $700,000 per year, and variable costs are $48 per unit. In addition to the contract, you feel your company can s
additional units to companies in other countries over the next four years, respectively, at a price of $145. This price is fixed. The
required return is 13 percent. Additionally, the president of the company will undertake the project only if it has an NPV of $100
What bid price should you set for contract?
Answer 13% 40%
Year 1 Year 2 Year 3
Q from Contract 5000 5000 5000

VC @ 48 2500000 2500000 2500000

FC 1000000 1000000 1000000
Capex 4000000
WC 75000
EBIT**x(1-T)+DEP -2150000 -2150000 -2150000
FCF -4075000 -2150000 -2150000 -2150000
NPV all CF other than Contract REV -10424114.45
Required NPV 100000
NPV of Contract Rev 10524114.45
15000*X*(1-40%)*PVIFA = 10524114.45 -614.2857
X *PVIFA= 1169.34604948245
X= 393.127356596346
Q.33
Suppose we are thinking about replacing an old computer with a new one. The old one cost us $450,000; the new o
The new machine will be depreciated straight-line to zero over its five year life. It will probably be worth about $130,0
The old computer is being depreciated at a rate of $90,000 per year. It will be completely written off in three years
. If we don’t replace it now, we will have to replace it in two years. We can sell it now for $230,000; in two years, it w
The new machine will save us $85,000 per year in operating costs. The tax rate is 38 percent, and the discount rate
a) Suppose we recognise that if we don't replace the computer now, we will be replacing it in 2 years. Should we rep
(HINT: What we effectively have here is a decision either to "invest" in the old computer-by not selling it-or to invest
notice that the two investments have unequal lives)
b) Suppose we consider only whether we should replace the old computer now without worrying about what's going
What are the relevant cash flows? Should we replace it or not?
(HINT: consider the net change in firms's after tax cash flows if we do the replacement)

(a) New Old

T 38%
r 14%
Capex 580000 245200 Salvage value if selling today (2
Life 5 2
DEP 116000 90000
After Tax SV 80600 71400 Capial loss of 270000-180000-
Saving in cost 85000
CF 96780 34200
NPV -205885.309486477 -133944.229
PVIFA 3.43308096885846 1.646660511
EAC -59971.00 -81342.95
Decision: Replace it today

(a)
Compare NPV and make a decision
New Old Difference
Year 0 -580000.00 -245200.00 -334800.00
Year 1 96780.00 34200.00 62580.00
Year 2 96780.00 105600.00 -8820.00
Year 3 96780.00 96780.00
Year 4 96780.00 96780.00
Year 5 177380.00 177380.00
-71941.08
Decision: Continue with the old one
 computer keyboards a year for four years.
be possible. The equipment necessary for the production will cost $3.4 and will
tment in net working capital of $75,000 to be returned at the

act, you feel your company can sell 4,000, 12,000, 14,000 and 7,000
e of $145. This price is fixed. The tax rate is 40 percent, and the
ect only if it has an NPV of $100,000.

Year 4
5000
0.085714 0.085714

2500000 14.28571
1000000 0.0857 0.0857
0
-75000 -13061 -25900.16
-2150000
-2075000 2.55082 3.933439
200 -5120.308 -6584.609

13.34713

0.085714 0.085714

e cost us $450,000; the new one will cost $580,000.

robably be worth about $130,000 after 5 yrs. 0.0857 0.0857
ely written off in three years
or $230,000; in two years, it will probably be worth $60,000. -13061 -25900.16
percent, and the discount rate is 14 percent
ng it in 2 years. Should we replace now or should we wait? 2.55082 3.933439
er-by not selling it-or to invest in new one. -5120.308 -6584.609

t worrying about what's going to happen in two years.

Salvage value if selling today (230000+CL*T)

Capial loss of 270000-180000-60000=30000

 INFY REL INFT (ADJ)REL(ADJ)
6/30/2005 2358.25 642.55 294.78 321.27 Return
7/29/2005 2268.45 703.35 283.56 351.68
8/31/2005 2376.1 719.4 297.01 359.7
9/30/2005 2515.3 793.55 314.41 396.77
10/31/2005 2521.95 762.5 315.24 381.25
11/30/2005 2684.45 832.7 335.56 416.35
12/30/2005 2996.85 889.3 374.61 444.65
1/31/2006 2880.3 713.9 360.04 356.95
2/28/2006 2828.95 708.85 353.62 354.43
3/31/2006 2981.4 795.35 372.68 397.68
4/29/2006 3177.35 1022.95 397.17 511.48
5/31/2006 2909.85 954.15 363.73 477.07
6/30/2006 3078.95 1059.85 384.87 529.92
7/31/2006 1655.55 978.8 413.89 489.4
8/31/2006 1806.4 1117.35 451.6 558.67
9/29/2006 1849.65 1171.75 462.41 585.88
10/31/2006 2095.5 1226 523.88 613
11/30/2006 2179.7 1244.45 544.92 622.23
12/29/2006 2241.8 1270.15 560.45 635.08
1/31/2007 2247.3 1366.45 561.83 683.23
2/28/2007 2077.55 1352.5 519.39 676.25
3/30/2007 2018.65 1370.3 504.66 685.15
4/30/2007 2050.85 1561.05 512.71 780.52
5/31/2007 1923.5 1758.8 480.88 879.4
6/29/2007 1929.05 1700.55 482.26 850.27
7/31/2007 1975.8 1893.5 493.95 946.75
8/31/2007 1854.55 1960.9 463.64 980.45
9/28/2007 1892.75 2298.05 473.19 1149.03
10/31/2007 1837.45 2783.8 459.36 1391.9
11/30/2007 1602.5 2851.65 400.63 1425.83
12/31/2007 1769.9 2882.7 442.48 1441.35
1/31/2008 1499.05 2478.9 374.76 1239.45
2/29/2008 1548.2 2463.45 387.05 1231.72
3/31/2008 1439.9 2265.8 359.98 1132.9
4/30/2008 1753.1 2614.5 438.27 1307.25
5/30/2008 1962.8 2403.5 490.7 1201.75
6/30/2008 1736.8 2095.15 434.2 1047.58
7/31/2008 1583.45 2207.5 395.86 1103.75
8/29/2008 1749.1 2136.2 437.27 1068.1
9/30/2008 1398.05 1949.35 349.51 974.67
10/31/2008 1388.95 1375.45 347.24 687.73
11/28/2008 1243.85 1134.45 310.96 567.23
12/31/2008 1115.45 1232.75 278.86 616.38
1/30/2009 1306.65 1323.6 326.66 661.8
2/27/2009 1231.25 1266.05 307.81 633.02
3/31/2009 1323.9 1524.75 330.98 762.38
4/29/2009 1509.25 1806.25 377.31 903.13
5/29/2009 1605.1 2271.9 401.27 1135.95
6/30/2009 1776.5 2023.4 444.13 1011.7
7/31/2009 2064.35 1955.4 516.09 977.7
8/31/2009 2131.15 2005.1 532.79 1002.55
 9/30/2009 2306.4 2201.65 576.6 1100.83
10/30/2009 2206.2 1931.15 551.55 965.58
11/30/2009 2379.35 1063.5 594.84 1063.5
12/31/2009 2601.1 1090.55 650.27 1090.55
1/29/2010 2475.5 1046.2 618.88 1046.2
2/26/2010 2601.95 978.95 650.49 978.95
3/31/2010 2615.95 1074.25 653.99 1074.25
4/30/2010 2738.15 1033.6 684.54 1033.6
5/31/2010 2658 1045.6 664.5 1045.6
6/30/2010 2791 1089.85 697.75 1089.85
7/30/2010 2788.4 1009.65 697.1 1009.65
8/31/2010 2713.85 919.2 678.46 919.2
9/30/2010 3050.5 987.25 762.63 987.25
10/29/2010 2971.7 1096.25 742.92 1096.25
11/30/2010 3051 985.6 762.75 985.6
12/31/2010 3442.75 1058.7 860.69 1058.7
1/31/2011 3117.7 919.3 779.42 919.3
2/28/2011 2997.1 964.25 749.27 964.25
3/31/2011 3241.3 1049.1 810.33 1049.1
4/29/2011 2906.25 983.75 726.56 983.75
5/31/2011 2785.65 951.85 696.41 951.85
6/30/2011 2910.45 898.5 727.61 898.5
7/29/2011 2775.9 827.95 693.98 827.95
8/30/2011 2342.95 782.6 585.74 782.6
9/30/2011 2533.05 808.35 633.26 808.35
10/31/2011 2877.55 877.55 719.39 877.55
11/30/2011 2606.85 778.25 651.71 778.25
12/30/2011 2767.65 692.95 691.91 692.95
1/31/2012 2746 817.1 686.5 817.1
2/29/2012 2883.45 820.75 720.86 820.75
3/30/2012 2866.3 750.6 716.58 750.6
4/30/2012 2462.1 745.1 615.52 745.1
5/31/2012 2429.35 705.6 607.34 705.6
6/29/2012 2509.2 737.85 627.3 737.85
7/31/2012 2226.95 743.6 556.74 743.6
8/31/2012 2361.65 766.4 590.41 766.4
9/28/2012 2534.95 837.2 633.74 837.2
10/31/2012 2363 805.5 590.75 805.5
11/30/2012 2436.85 793.7 609.21 793.7
12/31/2012 2318.7 839.55 579.67 839.55
1/31/2013 2789.5 886.65 697.38 886.65
2/28/2013 2907 813.85 726.75 813.85
3/28/2013 2889.35 772.9 722.34 772.9
4/30/2013 2235.45 788.2 558.86 788.2
5/31/2013 2411.7 806.3 602.92 806.3
6/28/2013 2498.85 862.6 624.71 862.6
7/31/2013 2969.65 872.05 742.41 872.05
8/30/2013 3105.85 853.85 776.46 853.85
9/30/2013 3013 822.4 753.25 822.4
10/31/2013 3309.9 914.7 827.48 914.7
11/29/2013 3354.55 853.2 838.64 853.2
12/31/2013 3485.65 895.2 871.41 895.2
 1/31/2014 3701.1 831.15 925.27 831.15
2/28/2014 3824.85 799.95 956.21 799.95
3/31/2014 3282.8 930.75 820.7 930.75
4/30/2014 3180.8 935.8 795.2 935.8
5/30/2014 2939.4 1064.7 734.85 1064.7
6/30/2014 3255.55 1015.4 813.89 1015.4
7/31/2014 3367.65 1006.45 841.91 1006.45
8/28/2014 3598.8 998.7 899.7 998.7
9/30/2014 3747.75 945.7 936.94 945.7
10/31/2014 4051.25 1000.55 1012.81 1000.55
11/28/2014 4359.85 991.6 1089.96 991.6
12/31/2014 1972.55 891.15 986.27 891.15
1/30/2015 2141.9 915.25 1070.95 915.25
2/28/2015 2296.45 865.15 1148.22 865.15
3/31/2015 2218.35 826 1109.18 826
4/30/2015 1942.25 862.35 971.13 862.35
5/29/2015 2023.15 877 1011.58 877
6/30/2015 984.35 1000.1 984.35 1000.1
 INFY RELIND
Mean
SD
VAR
COVAR
CORREL
Sceaniro Probabilty E(R1) E(R2) DR1 DR2 DR1^2 DR2^2
1 0.20 -5.0% -6.0% -6.400% -7.520% 0.409600% 0.565504%
2 0.20 -2.5% -3.0% -3.900% -4.520% 0.152100% 0.204304%
3 0.20 2.0% 2.5% 0.600% 0.980% 0.003600% 0.009604%
4 0.20 5.0% 5.6% 3.600% 4.080% 0.129600% 0.166464%
5 0.20 7.5% 8.5% 6.100% 6.980% 0.372100% 0.487204%

ER 1.40% 1.52% 0.213% 0.287%

SD 4.620% 5.354%
4.620% 5.354%
COV
DR1*DR2
0.4812800%
0.1762800%
0.0058800%
0.1468800%
0.4257800%

0.247%

0.247220%
0.247220%
 Return Return=Pt/pt-1-1
Hero HondaI C I C I Bank Ltd. Hero Honda
I C I C I Bank Ltd. Porfolio
1 Dec-00 174.79 150.55 0.5
2 Jan-01 172.51 152.05
3 Feb-01 162.57 177.4
4 Mar-01 140.35 165.4
5 Apr-01 139.9 158.3 Proportion
6 May-01 138.7 145.8
7 Jun-01 144.55 127.85
8 Jul-01 163.1 125.5
9 Aug-01 182.75 106.1
10 Sep-01 186.25 71.45
11 Oct-01 222.1 101.6
12 Nov-01 245.7 101
13 Dec-01 250.7 88
14 Jan-02 303.3 90.55
15 Feb-02 345.35 125.55
16 Mar-02 333.7 124
17 Apr-02 355.3 112.55
18 May-02 324.95 139.45
19 Jun-02 308.4 137.4
20 Jul-02 267.15 140.75
21 Aug-02 268.95 143.65
22 Sep-02 259.95 140.15
23 Oct-02 237.35 135.15
24 Nov-02 287.65 133.45
25 Dec-02 271.4 140.55
26 Jan-03 254.95 150.05
27 Feb-03 223.2 149.4
28 Mar-03 188.4 133.95
29 Apr-03 203.5 121.4
30 May-03 213.85 137.65
31 Jun-03 253.2 150.2
32 Jul-03 265.8 158.6
33 Aug-03 290.55 179.5
34 Sep-03 309.4 204.35
35 Oct-03 353.45 248.1
36 Nov-03 374.55 249.9
37 Dec-03 448.85 295.7
38 Jan-04 452.25 295.25
39 Feb-04 493.15 271.8
40 Mar-04 490.45 295.9
41 Apr-04 482.8 315.2
42 May-04 446.2 230.35
43 Jun-04 507.5 244.4
44 Jul-04 428.9 266.8
45 Aug-04 442.5 269.45
46 Sep-04 447.9 286.05
47 Oct-04 423.35 299
48 Nov-04 492.65 340.2
49 Dec-04 571.1 370.75
50 Jan-05 536.75 360.6
51 Feb-05 544.25 380.75
52 Mar-05 548.15 393
53 Apr-05 504.1 360.2
54 May-05 553 392.05
55 Jun-05 578.3 421.55
56 Jul-05 613.85 536
57 Aug-05 646.7 481.7
58 Sep-05 742 600.35
59 Oct-05 706.85 497.7
60 Nov-05 832.05 537.15
61 Dec-05 859.7 584.7
62 Jan-06 856.15 609.15
63 Feb-06 886.75 615.1
64 Mar-06 888.3 589.25
65 Apr-06 844.9 590.25
66 May-06 770.8 536.05
67 Jun-06 791.5 487.4
68 Jul-06 705.2 554.05
69 Aug-06 720.3 596.5
70 Sep-06 774.55 699.05
71 Oct-06 756.15 776.85
72 Nov-06 742.65 871.45
73 Dec-06 762.35 890.4
Pt/pt-1-1 Hero HondaI C I C I Bank Ltd.
Mean #DIV/0! #DIV/0!
STDEVP #DIV/0! #DIV/0!
Correl #VALUE!

Data>What-if Analysis>Data table

Proportion Sigma Mean
#DIV/0! #DIV/0!
0
0.05
0.1
Chart Title
0.15 12.024
0.2
0.25 10.024
0.3
0.35 8.024
0.4
0.45 6.024
0.5
0.55 4.024
0.6
0.65 2.024
0.7
0.75 0.024
0.08 2.08 4.08 6.08 8.08 10.08 12.08
0.8
0.85
0.9
0.95
1
10.08 12.08
 Portfolio Mathematics
Hero HondaI C I C I Bank Ltd.
Mean 0.024778 0.032754 Weight Proportion Sigma Mean
STDEVP 0.091898 0.126218 1 Data>What-if Analysis>Data table
Correl 0.327359 0
0.05
0.1
0.15
0.327359 0.2
0.25 Cha
0.3 12.024
0.35
0.4 10.024
0.45
0.5 8.024
0.55
0.6 6.024
0.65
0.7 4.024
0.75
0.8 2.024
0.85
0.9 0.024
0.95 0.08 2.08 4.08
1
if Analysis>Data table

Chart Title

2.08 4.08 6.08 8.08 10.08 12.08

 TIERRA DEL FUEGO STOCK EXCHANGE
market portfolio and risk-free rate
Market portfolio
Expected return 22.00%
Standard deviation of return 19.00%
Risk-free rate 7.00%

XR XM mean sigma

• A portfolio composed of 35%

risk free asset and 65% market
portfolio. 35% 65% 16.7500% 12.3500%

• A portfolio composed of 120%

market portfolio.
• A portfolio that yields a return
of 15%.
• A portfolio that yields a return
of 23%.
• A portfolio with standard
deviation of 35%.
• A portfolio with standard
deviation of 5%.
Question 1
Formula and Dormula are two stocks listed on the Chitango stock market. Their βs are 1.8
and 2.6 respectively. What is the beta of a portfolio invested 20% in Formula and 80% in
Dormula?

Question 2
Consider the data below. Compute the expected return and standard deviation of returns
for a portfolio composed of 75% stock A and 25% stock B.
Asset A Asset B
Mean return 30% 13%
Return sigma σ 40% 10%
Correlation ρAB 0.5
Date S & P Cnx N
H D F C BaInfosys LtdState Bank Of India
Apr-03 934.05 49.27 348.83 262.82 NIFTY H D F C BaInfosys LtdState Bank
May-03 1006.8 49.01 334.05 332.4 0.077887 -0.005277 -0.04237 0.264744
Jun-03 1134.15 51.79 408.11 362.5 0.12649 0.056723 0.221703 0.090554
Jul-03 1185.85 53.31 449.16 398.02 0.045585 0.029349 0.100586 0.097986
Aug-03 1356.55 55.09 488.8 414.44 0.143947 0.03339 0.088254 0.041254
Sep-03 1417.1 55.03 565.52 426.09 0.044635 -0.001089 0.156956 0.02811
Oct-03 1555.9 63.27 592.68 456.85 0.097947 0.149737 0.048027 0.072191
Nov-03 1615.25 60.49 615.56 444.16 0.038145 -0.043939 0.038604 -0.027777
Dec-03 1879.75 73.33 695.46 508.09 0.163752 0.212266 0.129801 0.143935
Jan-04 1809.75 68.94 649.39 562.15 -0.037239 -0.059866 -0.066244 0.106398
Feb-04 1800.3 74.91 633.99 552.24 -0.005222 0.086597 -0.023715 -0.017629
Mar-04 1771.9 75.67 617.27 571.49 -0.015775 0.010146 -0.026373 0.034858
Apr-04 1796.1 75.18 643.37 606.31 0.013658 -0.006475 0.042283 0.060928
May-04 1483.6 70.51 651.11 438.74 -0.173988 -0.062118 0.01203 -0.276377
Jun-04 1505.6 73.94 690.36 406.33 0.014829 0.048646 0.060282 -0.073871
Jul-04 1632.3 74.96 776.88 416.99 0.084152 0.013795 0.125326 0.026235
Aug-04 1631.75 73.48 787.45 417.84 -0.000337 -0.019744 0.013606 0.002038
Sep-04 1745.5 80.57 847.6 441.76 0.06971 0.096489 0.076386 0.057247
Oct-04 1786.9 82.87 953.2 422.08 0.023718 0.028547 0.124587 -0.044549
Nov-04 1958.8 99.06 1074.18 499.78 0.0962 0.195366 0.12692 0.184088
Dec-04 2080.5 103.77 1044.5 615.6 0.06213 0.047547 -0.02763 0.231742
Jan-05 2057.6 112.88 1033.63 606.49 -0.011007 0.08779 -0.010407 -0.014799
Feb-05 2103.25 117.38 1118.58 674.05 0.022186 0.039865 0.082186 0.111395
Mar-05 2035.65 108.85 1126.28 619.85 -0.032141 -0.07267 0.006884 -0.080409
Apr-05 1902.5 107.44 943.67 551.77 -0.065409 -0.012954 -0.162136 -0.109833
May-05 2087.55 108.01 1125.35 632.82 0.097267 0.005305 0.192525 0.146891
Jun-05 2220.6 126.82 1178.83 643.06 0.063735 0.174151 0.047523 0.016182
Jul-05 2312.3 137.1 1134.6 755.57 0.041295 0.08106 -0.03752 0.17496
Aug-05 2384.65 128.03 1188.13 751.66 0.031289 -0.066156 0.04718 -0.005175
Sep-05 2601.4 137.51 1258.5 885.59 0.090894 0.074045 0.059228 0.178179
Oct-05 2370.95 121.2 1261.95 790.91 -0.088587 -0.11861 0.002741 -0.106912
Nov-05 2652.25 137.51 1342.05 845.63 0.118644 0.134571 0.063473 0.069186
Dec-05 2836.55 141.49 1498.38 856.2 0.069488 0.028943 0.116486 0.0125
Jan-06 3001.1 152.51 1439.85 836.71 0.058011 0.077885 -0.039062 -0.022763
Feb-06 3074.7 147.21 1414.3 827.66 0.024524 -0.034752 -0.017745 -0.010816
Mar-06 3402.55 154.7 1490.43 913.37 0.106628 0.05088 0.053829 0.103557
Apr-06 3557.6 165.32 1588.75 862.05 0.045569 0.068649 0.065968 -0.056188
May-06 3071.05 148.04 1454.03 784.07 -0.136764 -0.104525 -0.084796 -0.090459
Jun-06 3128.2 158.23 1538.78 686.32 0.018609 0.068833 0.058286 -0.12467
Jul-06 3143.2 159.01 1653.9 764.3 0.004795 0.00493 0.074813 0.11362
Aug-06 3413.9 170.63 1808.8 877.47 0.086122 0.073077 0.093657 0.14807
Sep-06 3588.4 185.2 1847.9 970.22 0.051115 0.085389 0.021617 0.105702
Oct-06 3744.1 200.81 2094.8 1033.63 0.04339 0.084287 0.133611 0.065356
Nov-06 3954.5 223.68 2180.45 1239.79 0.056195 0.113889 0.040887 0.199452
Dec-06 3966.4 213.95 2240.5 1175.53 0.003009 -0.0435 0.02754 -0.051831
Jan-07 4082.7 215.63 2244.45 1073.77 0.029321 0.007852 0.001763 -0.086565
Feb-07 3745.3 186.52 2078.35 980.46 -0.082641 -0.135 -0.074005 -0.086899
Mar-07 3821.55 189.88 2012.6 936.82 0.020359 0.018014 -0.031636 -0.04451
Apr-07 4087.9 205.23 2049.35 1042.83 0.069697 0.080841 0.01826 0.113159
May-07 4295.8 227.95 1920.25 1276.02 0.050857 0.110705 -0.062996 0.223613
Jun-07 4318.3 228.82 1929.2 1439.15 0.005238 0.003817 0.004661 0.127843
 Jul-07 4528.85 239.73 1977.25 1532.75 0.048758 0.047679 0.024907 0.065038
Aug-07 4464 234.26 1855.05 1509.16 -0.014319 -0.022817 -0.061803 -0.015391
Sep-07 5021.35 287.81 1896.75 1840.53 0.124854 0.228592 0.022479 0.219572
Oct-07 5900.65 330.62 1839.1 1951.34 0.175112 0.148744 -0.030394 0.060205
Nov-07 5762.75 343.8 1604.05 2170.38 -0.02337 0.039864 -0.127807 0.112251
Dec-07 6138.6 345.56 1768.4 2237.09 0.065221 0.005119 0.102459 0.030737
Jan-08 5137.45 313.6 1503.9 2162.25 -0.163091 -0.092488 -0.14957 -0.033454
Feb-08 5223.5 290.69 1546.85 2109.7 0.01675 -0.073055 0.028559 -0.024303
Mar-08 4734.5 263.99 1430.15 1598.85 -0.093615 -0.09185 -0.075444 -0.242143
Apr-08 5165.9 302.97 1753.75 1776.35 0.091118 0.147657 0.22627 0.111017
May-08 4870.1 271.57 1957.55 1443.35 -0.05726 -0.103641 0.116208 -0.187463
Jun-08 4040.55 200.46 1734.75 1111.45 -0.170335 -0.261848 -0.113816 -0.229951
Jul-08 4332.95 219.05 1583.3 1414.75 0.072366 0.092737 -0.087304 0.272887
Aug-08 4360 255.45 1748.5 1403.6 0.006243 0.166172 0.104339 -0.007881
Sep-08 3921.2 245.8 1397.55 1465.65 -0.100642 -0.037776 -0.200715 0.044208
Oct-08 2885.6 204.73 1381.65 1109.5 -0.264103 -0.167087 -0.011377 -0.242998
Nov-08 2755.1 184.08 1240.6 1086.85 -0.045225 -0.100865 -0.102088 -0.020415
Dec-08 2959.15 199.52 1117.85 1288.25 0.074063 0.083877 -0.098944 0.185306
Jan-09 2874.8 184.92 1305.5 1152.2 -0.028505 -0.073176 0.167867 -0.105608
Feb-09 2763.65 176.97 1231.3 1027.1 -0.038664 -0.042992 -0.056836 -0.108575
Mar-09 3020.95 193.57 1324.1 1066.55 0.093102 0.093801 0.075367 0.038409
Apr-09 3473.95 220.14 1507.3 1277.7 0.149953 0.137263 0.138358 0.197975
May-09 4448.95 288.47 1602 1869.1 0.28066 0.310393 0.062828 0.462863
Jun-09 4291.1 298.35 1776.9 1742.05 -0.03548 0.03425 0.109176 -0.067974
Jul-09 4636.45 299.92 2063.9 1814 0.080481 0.005262 0.161517 0.041302
Aug-09 4662.1 293.87 2132.3 1743.05 0.005532 -0.020172 0.033141 -0.039112
Sep-09 5083.95 328.45 2308.4 2195.7 0.090485 0.117671 0.082587 0.259688
Oct-09 4711.7 324.26 2205.4 2191 -0.073221 -0.012757 -0.04462 -0.002141
Nov-09 5032.7 354.51 2383.95 2238.15 0.068128 0.093289 0.08096 0.02152
Dec-09 5201.05 340.08 2605.25 2269.45 0.033451 -0.040704 0.092829 0.013985
Jan-10 4882.05 326.17 2476.7 2058 -0.061334 -0.040902 -0.049343 -0.093172
Feb-10 4922.3 340.93 2601.6 1975.85 0.008244 0.045252 0.05043 -0.039917
Mar-10 5249.1 386.5 2615.1 2079 0.066392 0.133664 0.005189 0.052205
Apr-10 5278 398.32 2736.15 2297.95 0.005506 0.030582 0.046289 0.105315
May-10 5086.3 377.08 2657.65 2268.35 -0.036321 -0.053324 -0.02869 -0.012881
Jun-10 5312.5 382.93 2788.55 2302.1 0.044472 0.015514 0.049254 0.014879
Jul-10 5367.6 425.49 2788.85 2503.8 0.010372 0.111143 0.000108 0.087616
Aug-10 5402.4 426.49 2707.1 2764.85 0.006483 0.00235 -0.029313 0.104262
Sep-10 6029.95 496.16 3041 3233.2 0.116161 0.163357 0.123342 0.169394
Oct-10 6017.7 455.62 2969.6 3151.2 -0.002032 -0.081708 -0.023479 -0.025362
Nov-10 5862.7 457.84 3049.45 2994.1 -0.025757 0.004872 0.026889 -0.049854
Dec-10 6134.5 469.3 3445 2811.05 0.046361 0.025031 0.129712 -0.061137
Jan-11 5505.9 408.57 3116.3 2641.05 -0.10247 -0.129405 -0.095414 -0.060476
Feb-11 5333.25 409.94 3003.05 2632 -0.031357 0.003353 -0.036341 -0.003427
Mar-11 5833.75 468.59 3236.75 2767.9 0.093845 0.14307 0.077821 0.051634
Apr-11 5749.5 458.5 2905.95 2805.6 -0.014442 -0.021533 -0.102201 0.01362
May-11 5560.15 477.66 2791.85 2297.8 -0.032933 0.041788 -0.039264 -0.180995
Jun-11 5647.4 500.52 2907.4 2405.95 0.015692 0.047858 0.041388 0.047067
Jul-11 5482 487.4 2766.8 2342 -0.029288 -0.026213 -0.048359 -0.02658
Aug-11 5001 472.2 2342.8 1974.5 -0.087742 -0.031186 -0.153246 -0.156917
Sep-11 4943.25 467.25 2533.8 1911.1 -0.011548 -0.010483 0.081526 -0.032109
Oct-11 5326.6 489.05 2875.2 1906.7 0.07755 0.046656 0.134738 -0.002302
Portfolio NIFTY H D F C BaInfosys LtdState BankPortfolio
0.072366 VARP 0.006379633 0.008107 0.007333 0.014666 0.006127
0.122993 COVAR 0.006379633 0.005742 0.003779 0.007133 0.005551
0.075974 Beta 1.000 0.900 0.592 1.118 0.870
0.054299 Beta 1.0000 0.9000 0.5923 1.1181 0.8702
0.061326 Intercept 0.00000 0.00833 0.01241 0.00390 0.00822
0.089985
-0.011037
0.162001
-0.006571
0.015085
0.00621
0.032245
-0.108821
0.011686
0.055119
-0.001367
0.076707
0.036195
0.168791
0.083886
0.020862
0.077816
-0.048732
-0.094974
0.114907
0.079285
0.072833
-0.00805
0.103817
-0.07426
0.089077
0.052643
0.005353
-0.021104
0.069422
0.026143
-0.09326
0.000816
0.064454
0.104935
0.070903
0.094418
0.118076
-0.022597
-0.02565
-0.098635
-0.019377
0.070753
0.090441
0.04544
 0.045875
-0.033337
0.156881
0.059518
0.008103
0.046105
-0.091837
-0.022933
-0.136479
0.161648
-0.058299
-0.201872
0.092773
0.087543
-0.064761
-0.140487
-0.074456
0.056746
-0.003639
-0.069468
0.069193
0.157865
0.278695
0.025151
0.06936
-0.008714
0.153315
-0.019839
0.065257
0.022037
-0.061139
0.018588
0.063686
0.060729
-0.031632
0.026549
0.066289
0.025766
0.152031
-0.043516
-0.006031
0.031202
-0.095098
-0.012138
0.090841
-0.036705
-0.05949
0.045438
-0.033717
-0.113783
0.012978
0.059697
Question 1
Formula and Dormula are two stocks listed on the Chitango stock market. Their βs are 1.8
and 2.6 respectively. What is the beta of a portfolio invested 20% in Formula and 80% in
Dormula?
F D
Beta 1.8 2.6
Weight 20% 80%
Portfolio Beta 2.44

Question 2
Consider the following data, concerning ASAP Company:
D 500,000
E 300,000
rD 6%
TC 25%
rE 11%
Find the company WACC.

V=D+E 800,000 =B15+B16

Wd 0.6250 =B15/B22
We 0.3750 =B16/B22
WACC 6.94% =B23*B17*(1-B18)+B24*B19

Question 3
Consider the following data, concerning Elizabeth company
E(rM) 21%
rD 8%
TC 25%
β 0.70
D 1,000,000
rf 4%
E 1,000,000
Find the company WACC.

A. Finding the company cost of equity.

rE =Rf+Beta*MRP
16% =B34+B32*(B29-B34)

B. Finding the company WACC.

We 0.500
Wd 0.500
WACC 10.95% =B44*B30*(1-B31)+B43*B40

Question 4
Consider the following data, concerning Abby Company. Abby’s stock is not currently listed
on a stock exchange.
E(rM) 20%
rD 10%
TC 30%
Cov(rAbby,rM) 0.13 Estimate
D 1,500,000
Var(rM) 0.11
rF 7%
E 3,000,000

A. Finding the company cost of equity.

β 1.18 =B53/B55
rE 22.36% =B56+B60*(B50-B56)
B. Finding the company WACC.
We 66.667% =B57/(B57+B54)
Wd 33.333% =B54/(B57+B54)

WACC 17.242% =B63*B61+B64*B51*(1-B52)

Question 11
Given the following information for Huntington Power CO., find the WACC. Assume the company's tax rate 35%
DEBT: 10,000 5.6 percent coupond bonds outstanding, $1,000 par value, 25 years to maturity, selling for 97 
percent of par; the bonds make semiannual payments.
Common Stock: 425,000 shares outstanding selling for $61 per share; the beta is .95.
Market: 7 percent market risk permium and 3.8 percent risk free-rate.
Tc 35%
D 9700000
Coupon rate 5.60%
T 25 yrs
SA yield 2.915% =RATE(25*2,1000*5.6%/2,-970,1000)
Rd 5.829% ( following text book, we used BEY for calculation, the correct yield to
E 25925000
Re 10.45%

WACC 8.6364% =B8/(B8+B13)*B12*(1-B7)+B13/(B13+B8)*B14

Question 12
Titan Mining Corporation has 8.7million shares of common stock outstanding and 230,000 6.4 percent
semiannual bonds outstanding, par value $1,000 each. The common stock currently sells for $37 per share 
and has a beta of 1.2, and the bonds have 20 years to maturity and sell for 104 percent of par. The market 
risk premium is 7 percent, T-bills are yielding 3.5 percent, and Titan Mining's tax rate is 35 percent.
a.what is firms market value capital structure
b. If the company is evaluating a new investment projecr that has the same risk as the firm's typical project, what rat
should the firm use to discount the project's cash flows?
a.
E 321900000 =8.7*37*10^6
D 239200000 =230000*1000*1.04
We 0.573694528604527 =B26/(B26+B27)
Wd 0.426305471395473 =1-B28
b.
Ke = Rf+Beta*E(MRP)
0.119
Rd 6.052433% =2*RATE(20*2,6.4%*1000/2,-1040,1000)
WACC 8.5041% =B28*B32+B29*B33*(1-35%)
Question 13
An all-equity firm is considering the projects shown as follows. The T-bill rate is 3.5 percent and
the expected return on the market is 11%
Project Beta IRR Required R Decision
W 0.8 9.4% 9.50% Reject
X 0.95 10.9% 10.63% Accept
Y 1.15 13.0% 12.13% Accept
Z 1.45 14.2% 14.38% Reject
a. Which projects have a higher expected return than the firm's 11% cost of capital?
b.Which project should be accepted?
c. Which projects would be incorrectly accepted or rejected if the firm's overall cost of capital
was used as a hurdle rate?

a.
Y, Z
b. Please see the calculations and text in colm D and F highlighted with yellow
c.
incorrectly accepted Z
incorrectly rejected X

Question 17
The Saunders Investment Bank has the following financing outstanding
What is the WACC for the company? 
Debt 50,000 bonds with a coupon rate of 5.7 percent and a current price quote of 
106.5; the bonds have 20 years to maturity. 200,000 zero coupon bonds with a 
price quote of 17.5 and 30 years until maturity.
Prefferred Stock: 125,000 shares of 4 percent preferred stock with a current price of $79, and a 
par value of $100.
Common Stock: 2,300,000 shares of common stock; the current price is $65, and the beta of 
the stock is 1.20.
Market: The corporate tax rate is 40 percent, the market risk premium is 7 percent, and 
the risk-free rate is 4 percent.
Rd1 5.174% =2*RATE(40,1000*5.7%/2,-1065,1000)
Rd2 5.8951% =2*((1000/175)^(1/60)-1) =((FV/PV)^(1/T))-1
Kps 5.06%
Ke 12.400%

Security MV Weight
D1 53250000 0.215043
D2 35000000 0.141343
PS 9875000 0.039879
Equity 149500000 0.603735
247625000
WACC 8.856%
Question 19
Floyd Industries stock has a beta of 1.15. The company just paid a dividend of $.85, and the dividends are
expected to grow at 4.5 percent per year. The expected return on the market is 11 percent, and Treasury 
bills are yielding 3.9 percent. The most recent stock price for the company is $76
A.Calculate the cost of equity using the DDM method.
B.Calculate the cost of equity using the SML method.
C.Why do you think your estimate in (a) and (b) are so different?

A.
D1 0.88825 =0.85*(1+4.5%)
P0 76
g 4.50%
Ke as per DDM 5.67% =B89/B90+B91
B.
Ke as per CAPM 12.07%
C.
Assumptions of DDM may not applicable
g may not be correctly estimated
beta, E(MRP) is not estimated correctly
he company's tax rate 35%
maturity, selling for 97 

calculation, the correct yield to use is Effective annual yield) 5.914%

0,000 6.4 percent

sells for $37 per share 
nt of par. The market 
is 35 percent.

e firm's typical project, what rate

( following text book, we used BEY for calculation, the correct yield to use is Effective annual yield)
ce quote of 
n bonds with a 

of $79, and a 

the beta of 

7 percent, and 

=((FV/PV)^(1/T))-1

and the dividends are

rcent, and Treasury 
Jay, CEO of NewVenture, Inc., seeks to raise Rs 5 million in equity for his early stage venture.
VC1 conservatively projects sales revenue of Rs 5 million in year five
and knows that comparable companies trade at a price sales ratio of 20X.
Trailing Price to Sales at IPO
Source: CB Insights

a) VC1 Fund is considering an investment. What share of the compny will she
require today if her required rate of return is 50% per year?  If 30% Per year
50% 30%
Value of the company in 5 years 100 100
Investment 5 5
Required FV of Investment 37.96875 18.56465
% Ownership Required 37.97% 18.56%
or
PV of TV 13.1687242798 26.93291
% Ownership Required 37.97% 18.56%

b)If the company has 1,000,000 shares outstanding before the investment, how many new shares should VC1 purchas
What will be the share price of the new shares? 
(Assume investment is in standard preferred stock with no dividends and a conversion rate to common of 1:1) 
50% 30%
% Ownership Required 37.97% 18.56%
No Existing Shares 1000000 1000000
No New Shares 612091 227968
Price per Share 8.17 21.93

c)What is the pre-money value of the firm?

What is the post-money value of the firm?
50% 30%
Pre-money value 8168724.27984 21932907
Post-Money value 13168724.2798 26932907

d) Jay feels that he may need as much as $12 million in total outside financing to launch his new product.
If he sought to raise the full amount in this round, how much of his company would he have to give up?
What price per share would the venture capitalist be willing to pay if her required rate of return was 50%?, 30% ?
 50% 30%
Value of the company in 5 years 100 100
Investment 12 12
Required FV of Investment 91.125 44.55516
% Ownership Required 91.13% 44.56%
or
PV of TV 13.1687242798 26.93291
% Ownership Required 91.13% 44.56%
% Ownership Required
No Existing Shares 1000000 1000000
No New Shares 10267605.6338 803594.3
Price per Share 1.16872427984 14.93291
Pre-money value
Post-Money value

e) VC felt that the company would have to grant generous stock options in addition to the salaries projected in his bus
From past experience, she felt management should have the ability to own at least a 15% share of the company by the
Given her beliefs, what share of the company should Benedicta insist on today if her required rate of return is 50%? 3

% Ownership Management 15% 15%

Value of firm 100 100
Net Value 85 85
Investment 5 5
Future Value 37.96875 18.56465
% 44.7% 21.8%
 0.405405
0.266667

w shares should VC1 purchase? 

te to common of 1:1) 

his new product.

ave to give up?
return was 50%?, 30% ?
 salaries projected in his business plan.
share of the company by the end of year 5.
ired rate of return is 50%? 30%?
•The entrepreneur started the business last year with an initial investment of $1 million, and now needs an additional $2 milli
To raise the funds, the entrepreneur approaches Longhorn Partners, a hypothetical venture capital firm located in Austin, Texa
•Longhorn Partners believes the opportunity is good and is willing to provide the $2 million, in exchange for a share of the com
will the entrepreneur have to give up to acquire the needed funds?” This is first-stage financing, so LPs’ required (i.e., hoped-f
Valuation Assumptions
•Forecast of EBITDA for Bear-Builders in year 5: $6million
•Comparable companies EV/EBITDA 5.0x
•Bear-Builder’s projected Balance Sheet at year 5 includes $300,000 in cash and $3million in interest-bearing debt.
•Calculate Ownership Interests based on this VC financing, also consider impact of staged investing.
Solution
BITDA at 5 6 million
Multiple 5
TV of Entr 30 million
Cash 0.3 million
Debt 3 million
TV of Equity 27.3 million
RoR 50%
E value today 3.595062
Investment 2
% ownership 55.63%
Post Money 3.595062
Pre Money 1.595062

•Now assume VC invests $1 million initially (still requiring a 50% ROR) but invests the second $1 million two years later, on the
Because the second-stage investment is less risky than the first, we assume that the VC requires only a 30% return on this sec

Solution
Owership in R1 0.278159 (Post dilution in R2)
E value at time 2 with ROR 30% 12.42604
Owership in R2 0.080476
Total 0.358636

E value at time 2 with ROR 30% 12.42604

Owership in R2 0.080476
Owership in R1 0.302504 (Pre dilution in R2)
Total Ownership 0.358636
now needs an additional $2 million to finance the expansion of its already profitable operations.
apital firm located in Austin, Texas.
n exchange for a share of the common equity in the company. Now the key question is, “How much stock
ng, so LPs’ required (i.e., hoped-for) rate of return is 50% per year based on a 5 year investment horizon.

nterest-bearing debt.

$1 million two years later, on the condition that the firm has achieved certain performance benchmarks.
res only a 30% return on this second infusion of capital.
On further analysis and discussion, VC1 and E agreed that the company will probably need another round of financin
VC1 believes that NewVenture will need an additional $3 million in equity at the beginning of year 3.
While VC1 will require a 50% return,round 2 investorswill probably have a hurdle rate of only 30%, and will invest i
As before, the management option pool (created after VC1 Series A investment but before the Rs 3M Series B invest
should have the ability to own a 15% share of the company by the end of year 5.
a)Based on this new information, what share of the company should VC1 seek today? What price per share should sh
b)What share of the company will the Round 2 investors seek? What price per share will they be willing to pay?
c)Create a capitalization table to depict the pre-money and post-money valuation, the number of shares and the share
other round of financing in addition to the current Rs.5 million.

y 30%, and will invest in simple convertible preferred.

e Rs 3M Series B investment)

rice per share should she be willing to pay?
be willing to pay?
of shares and the share price:
 Series --> Series A (Rs 5 M) Series B ( 3 M)
Share price --> ₹ 5.33 $18.41
Pre-Money --> ₹ 5,325,460 ₹ 35,688,960
Post-Money --> ₹ 10,325,460 ₹ 38,688,960
Number of
Number of shares Ownership Value shares Ownership
Entrepreneur 1,000,000 51.6% ₹ 5,325,460 1,000,000 47.58%
Series A1 Investors
VC1 938,886 48.4% ₹ 5,000,000 938,886 44.67%
Series B Investors
VC2 162,982 7.75%
ESOP Pool
Employees
Total Shares Outstanding 1,938,886 100.0% $10,325,460 2,101,868 100%

TV 100,000,000
Less ESOP 85,000,000 VC1
VC2 Share 7.75% 162981.26 VC2
Less VC2 78,409,000
Required Value 37,968,750
VC1Share 48.4240%
No of Exisiting Shares 1,000,000
New Shares 938885.1454
ries B ( 3 M) ESOP (0)
$18.41 $40.44
35,688,960
38,688,960 ₹ 100,000,000
Number of
Value shares Ownership Value
₹ 18,406,941 1,000,000 40.4% $40,440,218

₹ 17,282,019 938,886 38.0% $37,968,754

₹ 3,000,000 162,982 6.6% $6,591,028

370,918 15.0% $15,000,000

$38,688,960 2,472,786 100% $100,000,000

$40.44
$40.44
 1. EBIT-EPS Analysis Money, Inc., has no debt outstanding and a total market value of $275,000. Earnings before interest a
conditions are normal. If there is strong expansion in the economy, then EBIT will be 25 percent higher. If there is a recessio
considering a $99,000 debt issue with an interest rate of 8 percent. The proceeds will be used to repurchase shares of stock
taxes for this problem.
a. Calculate earnings per share, EPS, under each of the three economic scenarios before any debt is issued. Also calculate th
or enters a recession.
b. Repeat part (a) assuming that Money goes through with recapitalization. What do you observe?
c. Repeat parts (a) and (b) assuming that Money has a tax rate of 35%?

a
A table outlining the income statement for the three possible states of the economy is shown below. The EPS
the net income divided by the 5,000 shares outstanding. The last row shows the percentage change in EPS th
company will experience in a recession or an expansion economy.

N 5000 5000 5000

Recession Normal Expansion
EBIT 12600.00 21000.00 26250.00
Interest
NI
EPS 0 0 0
DEPS #DIV/0! -- #DIV/0!

b If the company undergoes the proposed recapitalization, it will repurchase:

Share price = Equity / Shares outstanding 55
Shares repurchased = Debt issued / Share price 1800
No of shares 3200
The interest payment each year under all three scenarios will be:
Interest payment = $99,000(.08) 7920
Recession Normal Expansion
EBIT 12600.00 21000.00 26250.00
Interest
NI
EPS
DEPS

c N 5000
T 35%
N 5000 5000 5000
Recession Normal Expansion
EBIT 12600.00 21000.00 26250.00
Interest
PBT
Taxes
NI 0 0 0
EPS 0 0 0
DEPS #DIV/0! -- #DIV/0!

N 0 0 0
Recession Normal Expansion
EBIT 12600.00 21000.00 26250.00
Interest 7920.00 7920.00 7920.00
PBT
Taxes
NI
EPS
DEPS #DIV/0! -- #DIV/0!
arnings before interest and taxes, EBIT, are projected to be $21,000 if economic
her. If there is a recession, then EBIT will be 40 percent lower. Money is
purchase shares of stock. There are currently 5,000 shares outstanding. Ignore

issued. Also calculate the percentage changes in EPS when the economy expands

shown below. The EPS is

ntage change in EPS the
 ROE and Leverage Suppose the company in Problem 1 has a market-to-book ratio of 1.0.
a. Calculate return on equity (ROE) under each of the three economic scenarios before any debt is issued. Also calculate th
percentage changes in ROE for economic expansion and recession, assuming no taxes.
b. Repeat part (a) assuming the firm goes through with the proposed recapitalization.
c. Repeat parts (a) and (b) of this problem assuming the firm has a tax rate of 35 percent.

a
Since the company has a market-to-book ratio of 1.0, t
he total equity of the firm is equal to the market value of equity.
BV of Equity = 275000
Recession Normal Expansion
ROE
%DROE #DIV/0! ––– #DIV/0!
b New BV of Equity
Recession Normal Expansion
ROE
%DROE
c BV of Equity =
ROE
%DROE

New BV of Equity

ROE
%DROE
y debt is issued. Also calculate the
 3. Break-Even EBIT. Rolston Corporation is comparing two different capital structures: an all-equity plan (Plan I) and a leve
II). Under Plan I, the company would have 265,000 shares of stock outstanding. Under Plan II, there would be 185,000 sha
outstanding and $2.8 million in debt outstanding. The interest rate on the debt is 10 percent, and there are no taxes.
a. If EBIT is $750,000, which plan will result in the higher EPS?
b. If EBIT is $1,500,000, which plan will result in the higher EPS?
c. What is the break-even EBIT?

PLAN 1 PLAN2
N 265000 185000
Debt 2800000
Interest @10% 0 280000

a EBIT 750000 750000

EPS
Plan 1 is better

b EBIT 1500000 1500000

EPS

c Let the break even EBIT be E^

E^/265,000 = [E^ – 280000)]/185,000

Break Even EBIT

 y plan (Plan I) and a levered plan (Plan
re would be 185,000 shares of stock
there are no taxes.
4. Homemade Leverage Star, Inc., a prominent consumer products firm, is debating whether or not to convert its all-equity ca
there are 6,000 shares outstanding and the price per share is $58. EBIT is expected to remain at $33,000 per year forever. The
taxes.
a. Ms. Brown, a shareholder of the firm, owns 100 shares of stock. What is her cash flow under the current capital structure, a
b. What will Ms. Brown’s cash flow be under the proposed capital structure of the firm? Assume that she keeps all 100 of her
c. Suppose Star does convert, but Ms. Brown prefers the current all-equity capital structure. Show how she could unlever her
d. Using your answer to part (c), explain why Star’s choice of capital structure is irrelevant

Current Plan Proposed Plan

N 6000
price per share 58
Mkt Cap 348000
Proposed Debt 121800
Interest Cost @8% 9744
New N 3900
a
EBIT/PAT 33000
EPS 5.5
Cashflow for 100 shares (100*EPS) 550
b
EBIT 33000
PAT
EPS
Cashflow for 100 shares (100*EPS)
c
He should sell 35 (100*35 %) shares and lend the proceed at 8%
Sale proceeds @ 58
Interest Income
Dividend Income for 65 shares
Total Income 0

The capital structure is irrelevant because shareholders can create their own
leverage or unlever the stock to create the payoff they desire, regardless of the
capital structure the firm actually chooses.
or not to convert its all-equity capital structure to one that is 35 percent debt. Currently
at $33,000 per year forever. The interest rate on new debt is 8 percent, and there are no

er the current capital structure, assuming the firm has a dividend payout rate of 100 %?
me that she keeps all 100 of her shares.
how how she could unlever her shares of stock to recreate the original capital structure.
 5. Leverage and the cost of capital Weston Industries has a debt–equity ratio of 1.5. Its WACC is 11 percent, and its cost
corporate tax rate is 35 percent.
a. What is the company’s cost of equity capital?
b. What is the company’s unlevered cost of equity capital?
c. What would the cost of equity be if the debt–equity ratio were 2? What if it were 1.0? What if it were zero?

a With the information provided, the equation for WACC is:

WACC = (S/V)RS + (B/V)RB(1 – tC)
The company has a debt-equity ratio of 1.5, which implies the weight of debt is 1.5/2.5, and the weight of equity is 1/2.
 WACC = .11 = (1/2.5)RS + (1.5/2.5)(.07)(1 – .35)
Rs =  

b To find the unlevered cost of equity we need to use M&M Proposition II with taxes, so:
RS = R0 + (R0 – RB)(B/S)(1 – tC)
.2068 = R0 + (R0 – .07)(1.5)(1 – .35)
R0 =

c To find the cost of equity under different capital structures, we can again use M&M Proposition II with taxes. With a D/e
RS = R0 + (R0 – RB)(B/S)(1 – tC)
RS = .1392 + (.1392 – .07)(2)(1 – .35)
RS =
With a debt-equity ratio of 1.0, the cost of equity is:
 RS = .1392 + (.1392 – .07)(1)(1 – .35)
RS =  
And with a debt-equity ratio of 0, the cost of equity is:
RS = .1392 + (.1392 – .07)(0)(1 – .35)
RS = R0 =
s WACC is 11 percent, and its cost of debt is 7 percent. The

0? What if it were zero?

5, and the weight of equity is 1/2.5, so

oposition II with taxes. With a D/e of 2, the cost of equity is:

6. Calculating WACC Shadow Corp. has no debt but can borrow at 8percent. The firm’s WACC is currently 11 percent, and
a. What is the company’s cost of equity?
b. If the firm converts to 25 percent debt, what will its cost of equity be?
c. If the firm converts to 50 percent debt, what will its cost of equity be?
d. What is the company’s WACC in part (b)? In part (c)?

a.For an all-equity financed company:  WACC = R0 = RS = .11 or 11%

 b.To find the cost of equity for the company with leverage, we need to use M&M Proposition II with taxes, so:
 RS = R0 + (R0 – RB)(B/S)(1 – tC)
RS =  
c.Using M&M Proposition II with taxes again, we get:
 RS = R0 + (R0 – RB)(B/S)(1 – tC)
RS =
d.The WACC with 25 percent debt is:
WACC = (S/V)RS + (B/V)RB(1 – tC)
WACC = .75(.1165) + .25(.08)(1 – .35)
WACC =

And the WACC with 50 percent debt is:

WACC = (S/V)RS + (B/V)RD(1 – tC)
WACC = .50(.1295) + .50(.08)(1 – .35)
WACC =
is currently 11 percent, and the tax rate is 35 percent.

I with taxes, so:

7. MM With Taxes Williamson, Inc., has a debt-to-equity ratio of 2.5. The firm’s weighted average cost of capital (r wacc) is 1
and its pre-tax cost of debt is 6%. Williamson is subject to a corporate tax rate of 35%.
a. What is Williamson’s cost of equity capital (r S)?
b. What is Williamson’s unlevered cost of equity capital (r 0)?
c. What would Williamson’s weighted average cost of capital (r wacc) be if the firm’s debt-to-equity ratio were 0.75? What if
were 1.5?
age cost of capital (r wacc) is 10%,

ity ratio were 0.75? What if it

8. Leverage and the cost of capital
Archimedes Levers is financed by a mixture of debt and equity. Complete the following, assume 0 taxes:
rE =…………. % rD =12% rA =…………%
βE =1.5 βD =………………. βA =……………
rf =10% rm =18% D/V =.5
me 0 taxes:
9. Agency Costs
Tom Scott is the owner, president, and primary salesperson for Scott Manufacturing. Because of this, the company’s profits
does. If he works 40 hours each week, the company’s EBIT will be $550,000 per year; if he works a 50-hour week, the comp
company is currently worth $3.2 million. The company needs a cash infusion of $1.3 million, and it can issue equity or issue
Assume there are no corporate taxes.
a. What are the cash flows to Tom under each scenario?
b. Under which form of financing is Tom likely to work harder?
c. What specific new costs will occur with each form of financing?

40 hour week 50 hour week

EBIT 550,000 625,000
DEBT PLAN
DEBT 1,300,000 1,300,000
Interest @8% 104000 104000
CF 446,000 521,000
Diiference 75,000
EQUITY PLAN
CURRENT EQUITY 3,200,000 3,200,000
NEW EQUITY 1,300,000 1,300,000
TOTAL EQUITY 4,500,000 4,500,000
TOM's share 0.71111111111 0.71111111111
CFs 391111.111111 444444.444444
53,333
of this, the company’s profits are driven by the amount of work Tom
rks a 50-hour week, the company’s EBIT will be $625,000 per year. The
nd it can issue equity or issue debt with an interest rate of 8 percent.
10. Agency Costs Fountain Corporation’s economists estimate that a good business environment and a bad business envir
The managers of Fountain must choose between two mutually exclusive projects. Assume that the project Fountain choos
firm will close one year from today. Fountain is obligated to make a $3,500 payment to bondholders at the end of the year
but different volatilities. Consider the following information pertaining to the two projects:
Economy Probability Low-Volatility High-Volatility
Project Payoff Project Payoff
Bad .50 $3,500 $2,900
Good .50 3,700 4,300
a. What is the expected value of the firm if the low-volatility project is undertaken? What if the high-volatility project is un
maximizes the expected value of the firm?
b. What is the expected value of the firm’s equity if the low-volatility project is undertaken? What is it if the high-volatility
c. Which project would Fountain’s stockholders prefer? Explain.
d. Suppose bondholders are fully aware that stockholders might choose to maximize equity value rather than total firm va
minimize this agency cost, the firm’s bondholders decide to use a bond covenant to stipulate that the bondholders can de
take on the high-volatility project. What payment to bondholders would make stockholders indifferent between the two p
 ent and a bad business environment are equally likely for the coming year.
t the project Fountain chooses will be the firm’s only activity and that the
olders at the end of the year. The projects have the same systematic risk

e high-volatility project is undertaken? Which of the two strategies

What is it if the high-volatility project is undertaken?

alue rather than total firm value and opt for the high-volatility project. To
hat the bondholders can demand a higher payment if Fountain chooses to
different between the two projects?
11. Firm Value Janetta Corp. has an EBIT rate of $975,000 per year that is expected to continue in perpetuity. The unlevered c
equity for the company is 14 percent, and the corporate tax rate is 35 percent. The company also has a perpetual bond issue
with a market value of $1.9 million.
a. What is the value of the company?
b. The CFO of the company informs the company president that the value of the company is $4.8 million. Is the CFO correct?
perpetuity. The unlevered cost of
has a perpetual bond issue outstanding

million. Is the CFO correct?

12 Tax shield Compute the present value of interest tax shields generated by these three debt issues. Consider corporate t
marginal tax rate is Tc = 0.35.
a. A $1,000, one-year loan at 8%.
b. A five-year loan of $1,000 at 8%. Assume no principal is repaid until maturity.
c. A $1,000 perpetuity at 7%.
issues. Consider corporate taxes only. The
Here are book and market value balance sheets of the United Frypan Company (UF):
Book Market Book Market
Net Working Capital $ 20 $ 20 Debt $ 40 $ 40
Long-term assets 80 140 Equity 60 120
$100 $160 $100 $160
Assume that MM's theory holds with taxes. There is no growth, and the $40 of debt is expected to be permanen
a. How much of the firm's value is accounted for by the debt-generated tax shield?
b. How much better off will UF's shareholders be if the firm borrows $20 more and uses it to repurchase stock?
s expected to be permanent. Assume a 40% corporate tax rate.

ses it to repurchase stock?

14. 18-12 Tax shields
Compute the present value of interest tax shields generated by these three debt issues. Consider corporate taxes on
a. A $1,000, one-year loan at 8%.
b. A five-year loan of $1,000 at 8%. Assume no principal is repaid until maturity.
c. A $1,000 perpetuity at 7%.
onsider corporate taxes only. The marginal tax rate is T c = 0.35.
1. EBIT-EPS Analysis
Vermont Mining wants to raise $150 million in new capital. The company can sell equity at $10 per share, or sell bonds at
Vermont Mining currently has an interest expense of $50 million. The company has 80 million common shares outstandin
you calculate the cross over EBIT at which EPS from issuing new debt or equity is the same?
2. 17-1 Homemade leverage
Ms. Kraft owns 50,000 shares of the common stock of Copperhead Corporation with a market value of $2 per share, or $1
financed as follows:
  Market Value
Common stock (8 million shares) $16 million
Short-term loans $ 2 million
Copperhead now announces that it is replacing $1 million of short-term debt with an issue of common stock. What action
entitled to exactly the same proportion of profits as before?

3. 17-3 Leverage and Cost of capital

The common stock and debt of Northern Sludge are valued at $50 million and $30 million, respectively. Investors current
stock and an 8% return on the debt. If Northern Sludge issues an additional $10 million of common stock and uses this m
expected return on the stock? Assume that the change in capital structure does not affect the risk of the debt and that th

4. 17-5 MM’s propositions True/false Indicate whether the following statements are true or false.
a. MM’s propositions assume perfect financial markets, with no distorting taxes or other imperfections.
b. MM’s proposition 1 says that corporate borrowing increases earnings per share but reduces the price–earnings ratio.
c. MM’s proposition 2 says that the cost of equity increases with borrowing and that the increase is proportional to D/V, t
d. MM’s proposition 2 assumes that increased borrowing does not affect the interest rate on the firm’s debt.
e. Borrowing does not increase financial risk and the cost of equity if there is no risk of bankruptcy.
f. Borrowing increases firm value if there is a clientele of investors with a reason to prefer debt.

5. 17-9 Homemade leverage

Companies A and B differ only in their capital structure. A is financed 30% debt and 70% equity; B is financed 10% debt an
is risk-free.
a. Rosencrantz owns 1% of the common stock of A. What other investment package would produce identical cash flows f
b. Guildenstern owns 2% of the common stock of B. What other investment package would produce identical cash flows
c. Show that neither Rosencrantz nor Guildenstern would invest in the common stock of B if the total value of company A

6. 17-11 MM proposition 1
Executive Chalk is financed solely by common stock and has outstanding 25 million shares with a market price of $10 a sh
issue $160 million of debt and to use the proceeds to buy back common stock.
a. How is the market price of the stock affected by the announcement?
b. How many shares can the company buy back with the $160 million of new debt that it issues?
c. What is the market value of the firm (equity plus debt) after the change in capital structure?
d. What is the debt ratio after the change in structure?
e. Who (if anyone) gains or loses?
 
7. 17-21 Leverage and the cost of capital
Omega Corporation has 10 million shares outstanding, now trading at $55 per share. The firm has estimated the expecte
12%. It has also issued long-term bonds at an interest rate of 7%. It pays tax at a marginal rate of 35%. Assume a $200 mi
a. What is Omega’s after-tax WACC?
b. How much higher would WACC be if Omega used no debt at all? (Hint: For this problem you can assume that the firm’s
capital structure or by the taxes saved because debt interest is tax-deductible.)

8. 18-3 Tax shields

a. What is the relative tax advantage of corporate debt if the corporate tax rate is T c = 0.35, the personal tax rate is Tp = 0.
capital gains and escapes tax entirely (T pE = 0)?
b. How does the relative tax advantage change if the company decides to pay out all equity income as cash dividends tha
10 per share, or sell bonds at par with a 14 percent coupon rate.
n common shares outstanding and is in the 34 percent tax bracket. Can

t value of $2 per share, or $100,000 overall. The company is currently

f common stock. What action can Ms. Kraft take to ensure that she is

spectively. Investors currently require a 16% return on the common

mmon stock and uses this money to retire debt, what happens to the
e risk of the debt and that there are no taxes.

false.
erfections.
es the price–earnings ratio.
ease is proportional to D/V, the ratio of debt to firm value.
the firm’s debt.
uptcy.
bt.

ty; B is financed 10% debt and 90% equity. The debt of both companies

roduce identical cash flows for Rosencrantz?

roduce identical cash flows for Guildenstern?
the total value of company A were less than that of B.

th a market price of $10 a share. It now announces that it intends to

es?
e?

m has estimated the expected rate of return to shareholders at about

e of 35%. Assume a $200 million debt issuance.

u can assume that the firm’s overall beta [β A] is not affected by its

he personal tax rate is Tp = 0.35, but all equity income is received as

ncome as cash dividends that are taxed at 15%?

19.3
Calculate the weighted-average cost of capital (WACC) for Federated Junkyards of America, using the following information:
Debt: $75,000,000 book value outstanding. The debt is trading at 90% of book value. The yield to maturity is 9%
Equity: 2,500,000 shares selling at $42 per share. Assume the expected rate of return on Federated’s stock is 18%. ∙
Taxes: Federated’s marginal tax rate is Tc = .21

Answer
E 105000000 =2500000*42
D 67500000 =75000000*0.9
We 0.60869565 =B8/(B8+B9)
Wd 0.39130435 =1-B10
ytm 0.09 =9%
Tc 21%
Kd 0.0711 =B12*(1-B13)
Ke 18%
WACC 13.74% =B10*B15+B11*B14
e following information:
aturity is 9%
s stock is 18%. ∙
 19.14

Consider a project lasting one year only. The initial outlay is $1,000, and the expected inflow is $1,200. The opportunity cost o
The borrowing rate is rD = .10, and the tax shield per dollar of interest is Tc = .21.
a. What is the project’s base-case NPV?
b. What is its APV if the firm borrows 30% of the project’s required investment?

APV=NPV with zero debt+PVFS

FCFF at t=0 -1000 =-1000

FCFF at t=1 1200 #N/A
Ku or Ro 0.2 =20%
Base-case NPV 0 =B10+B11/(1+B12)

PVFS =PVITS
ITS at t=1 =Debt at time 0* interest rate * Tc
Borrowing 300 =30%*1000
Rb 10%
Tc 21%
ITS 6.3 =B17*B18*B19
PVITS 5.727273 =B20/(1+B18)

APV = Base-case NPV +PVFS

5.727273 =B13+B21
s $1,200. The opportunity cost of capital is r = .20.
RWJ 3
Pompeii Pizza Club owns three identical restaurants popular for their specialty pizzas. Each restaurant has a debt-equity ratio o
interest payments of $42,000 at the end of each year. The cost of the firm’s levered equity is 19 percent. Each store estimates
be $1.275 million; annual cost of goods sold will be $745,000; and annual general and administrative costs will be $405,000.
These cash flows are expected to remain the same forever. The corporate tax rate is 22 percent.
a. Use the flow to equity approach to determine the value of the company’s equity.
b. What is the total value of the company?

Sales Revenue 1275000 =1275000

COGS 745000 =745000
SGA 405000 =405000
EBIT 125000 =B9-B10-B11
Interest 42000 =42000
PBT 83000 =B12-B13
Tax 18260 =B14*0.22
PAT 64740 =B14-B15
FTE aka FCFE or Lev CF 64740 Assuming not debt reapyament and (Cpex+WC requirement is same as De
Ke,Rs 19% Levered Cost of Equity
E 340736.8 =B17/B18 Assuming that FTE is perpetual
D 136294.7 =B19*0.4
VF 477031.6 =B19+B20
aurant has a debt-equity ratio of 40 percent and makes
9 percent. Each store estimates that annual sales will
rative costs will be $405,000.

WC requirement is same as Dep)

19.5
Whispering Pines Inc. is all-equity-financed. The expected rate of return on the company’s shares is 12%.
a. What is the opportunity cost of capital for an average-risk Whispering Pines investment?
b. Suppose the company issues debt, repurchases shares, and moves to a 30% debt-to-value ratio (D/V = .30).
What will be the company’s weighted-average cost of capital at the new capital structure? The borrowing rate is 7.5% and the

Answer
a 12% same as unlevered cost of equity as D/E ratio is zero
b
Ru 12%
Rd 7.50%
Tc 21%
D/V 30%
Re 13.93%
WACC =We*Ke+Wd*Rd*(1-Tc)
11.528%
(D/V = .30).
rrowing rate is 7.5% and the tax rate is 21%.
19-12
Indicate whether the following statements are true or false by using the APV method.
a. Starts with a base-case value for the project.
1
0
b. Calculates the base-case value by discounting project cash flows, forecasted assuming all-equity financing, at the
1
0
c. Is especially useful when debt is to be paid down on a fixed schedule.
1
0
all-equity financing, at the WACC for the project.
 19.19
Consider a project to produce solar water heaters. It requires a $10 million investment and offers a level after-tax cash flow of
The opportunity cost of capital is 12%, which reflects the project’s business risk.
a. Suppose the project is financed with $5 million of debt and $5 million of equity. The interest rate is 8% and the marginal tax
An equal amount of the debt will be repaid in each year of the project’s life. Calculate APV.
b. How does APV change if the firm incurs issue costs of $400,000 to raise the $5 million of required equity?
Time
a 1
Investment 10 2
FCFF 1.75 3
Ku 12% 4
Tc 21% 5
Interest Rate 8% 6
Base Case NPV ₹ -0.112110 =PV(B11,10,-B10,0)-B9 7
₹ -0.112110 =B10/B11*(1-1/(1+B11)^10)-B9 8
APV ₹ 0.233332 =B14+I18 9
10
b PVITS
Base case NPV ₹ -0.112110 =B14
PVFS =PVITS -issue costs
₹ -0.05456 =I18-0.4
APV ₹ -0.166668
offers a level after-tax cash flow of $1.75 million per year for 10 years.

est rate is 8% and the marginal tax rate is 21%.

equired equity?
Debt at Beg Interest Ex ITS PVITS
5.000 0.4 0.084 0.077778
4.500 0.36 0.0756 0.064815
4.000 0.32 0.0672 0.053346
3.500 0.28 0.0588 0.04322
3.000 0.24 0.0504 0.034301
2.500 0.2 0.042 0.026467
2.000 0.16 0.0336 0.019605
1.500 0.12 0.0252 0.013615
1.000 0.08 0.0168 0.008404
0.500 0.04 0.0084 0.003891
₹ 0.34544 ₹ 0.34544

=NPV(B13,I8:I17) =SUM(J8:J17)
19-24
Company valuation Chiara Company’s management has made the projections shown in Table below.
Use this table as a starting point to value the company as a whole. The WACC for Chiara is 12%, and the forecast long-run grow
The company, which is located in South Africa, has ZAR 5 million of debt and 865,000 shares outstanding. What is the value pe

Latest
Year Forecast
(in 1,000's) 0 1 2 3 4
1 Sales 40,123.00 36,351.00 30,155.00 28,345.00 29,982.00
2 Cost of Goods Sold 22,879.00 21,678.00 17,560.00 16,459.00 15,631.00
3 Other Costs 8,025.00 6,797.00 5,078.00 4,678.00 4,987.00
4 EBITDA (1 – 2 – 3) 9,219.00 7,876.00 7,517.00 7,208.00 9,364.00
5 Depreciation and Amortization 5,678.00 5,890.00 5,670.00 5,908.00 6,107.00
6 EBIT (pretax profit) (4 – 5) 3,541.00 1,986.00 1,847.00 1,300.00 3,257.00
7 Tax at 28% 991.48 556.08 517.16 364.00 911.96
8 Profit after Tax (6 – 7) 2,549.52 1,429.92 1,329.84 936.00 2,345.04
9 Change in Working Capital 784.00 -54.00 -342.00 -245.00 127.00
10 Investment (change in gross PP&E) 6,547.00 7,345.00 5,398.00 5,470.00 6,420.00

FCFF (NOPAT+Dep-Ch in WC-Capex) 28.92 1,943.84 1,619.00 1,905.04

TV at time 5
Total CF 28.92 1,943.84 1,619.00 1,905.04
Value ₹ 21,876.95
Debt Value 5000
Equity Value ₹ 16,876.95
Number of shares (in '000s) 865
PPS (est) ₹ 19.51
g 4%
WACC 12%
the forecast long-run growth rate after year 5 is 4%.
ding. What is the value per share

5
30,450.00
14,987.00
5,134.00
10,329.00
5,908.00
4,421.00
1,237.88
3,183.12
235.00
6,598.00

2,258.12 =H17+H14-H18-H19
29355.56 =H21*(1+C29)/(C30-C29)
31,613.68
RWJ 15
APV, FTE, and WACC 
Summers, Inc., is an unlevered firm with expected annual earnings before taxes of $23.5 million in perpetuity.
The current required return on the firm’s equity is 11 percent and the firm distributes all of its earnings as dividends at the end
The company has 1.9 million shares of common stock outstanding and is subject to a corporate tax rate of 21 percent.
The firm is planning a recapitalization under which it will issue $35 million of perpetual 6 percent debt and use the proceeds to
a. Calculate the value of the company before the recapitalization plan is announced. What is the value of equity before the an
b. Use the APV method to calculate the company value after the recapitalization plan is announced. What is the value of equi
c. How many shares will be repurchased? What is the value of equity after the repur_x0002_chase has been completed? Wha
d. Use the flow to equity method to calculate the value of the company’s equity after the recapitalization.

EBIT 23.5
Ku or Ro 11%
N 1.9
Tc 21%
a
FCFF 18.565 =B12*(1-B15)
V of the unlevered firm 168.7727 =B17/B13
PPS 88.82775 =B18/B14
b
The value of the firm includes the expected PVITS
Debt 35
Kd 6%
PVITS 7.35 =B22*B15
V of the levered firm / V of the firm after annoucement 176.1227 =B18+B24
PPS 92.69617 =B25/B14
c
Number of shared repurchased 0.377578 m =B22/B26
Number after repurchase 1.522422 =B14-B28
V of Equity after repurchase =V before -Debt 141.1227 =B25-B22
PPS after repurchase 92.69617 =B30/B29
d
FCFE or FTE or ECF or Levered CF =(EBIT-INT)*(1-T)
FTE 16.906 =(B12-B22*B23)*(1-B15)
Ke or Rs =Ku+D/E*(Ku-Kd)*(1-T) 0.119796 =B13+B22/B30*(B13-B23)*(1-B1
V of Equity after repurchase =FCFE/Ke 141.1227
 ion in perpetuity.
ts earnings as dividends at the end of each year.
ate tax rate of 21 percent.
cent debt and use the proceeds to buy back shares.
the value of equity before the announcement? What is the price per share?
ounced. What is the value of equity after the announcement? What is the price per share?
_chase has been completed? What is the price per share?
capitalization.

=B12*(1-B15)

=(B12-B22*B23)*(1-B15)
=B13+B22/B30*(B13-B23)*(1-B15)
19.17. APV
Consider a perpetual project with initial investment of $1,000,000, and the expected cash inflow is $95,000 a year in perpetu
The opportunity cost of capital with all-equity financing is 10%, and the project allows the firm to borrow at 7%. The tax rate is
Use APV to calculate the project’s value.
a. Assume first that the project will be partly financed with $400,000 of debt and that the debt amount is to be fixed and perp
b. Then assume that the initial borrowing will be increased or reduced in proportion to changes in the market value of this pro
Explain the difference between your answers to (a) and (b)

CF at 0 -1000000 Tc 21%
CF 1 to infy 95000 Debt in case a 400000
Ku 10% D/E ratio in case b 40%
Kd 7%
a
APV = NPV with zero debt + PVFS
NPV with zero debt -50000 =B11/B12+B10
PVFS 84000 =E11*B13*E10/B13
APV 34000 =B16+B17
b D/V 38.68%
APV = NPV with zero debt + PVFS E/V 61.32%
NPV with zero debt -50000 =B11/B12+B10 Kd 7%
PVFS 58800 =E11*B13*E10/B12 Ke 0.114952681
APV Approx 8800 =B21+B22 WACC 9.18762%
VF 34000
w is $95,000 a year in perpetuity.
o borrow at 7%. The tax rate is 21%.

mount is to be fixed and perpetual.

n the market value of this project.

=400000/1034000
=1-F19
=B13
=B12+F19/F20*(B12-B13)*(1-E10)
=F19*B13*(1-E10)+F20*F22
=B10+B11/F23
Question 1
Estimate CCC
}Net sales = 1,150,000
}Cost of Goods sold = 820,000
}Inventory:
Beginning = 200000, Ending = 300000, Average= 250,000
}Accounts Receivable: Beginning = 160,000, Ending = 200,000, Average= 180,000
}Accounts Payable: Beginning = 75,000, Ending = 100,000, Average= 87,500
}Inventory turnover = 820,000 / 250,000 = 3.28 times
}Inventory period = 365 / 3.28 = 111.3 days
}Receivables turnover = 1,150,000 / 180,000 = 6.39 times
}Receivables period = 365 / 6.39 = 57.1 days
}Operating cycle = 111.3 + 57.1 = 168.4 days
}Payables turnover = 820,000 / 87,500 = 9.37 times
}Payables period = 365 / 9.37 = 38.9 days
}Cash Cycle = 168.4 – 38.9 = 129.5 days
3.28 times
111.3 days
6.39 times

168.4 days
9.37 times

129.5 days
Question 2 a Question 2b
Calculate the cash conversion cycle for Hyundai Motor. Calculate the cash conversion cycle
Hyundai Motor
Selected financial data Hindustan Unilever Limited
2016 (₩ billions) Selected financial data (2020 (Rs Cro
Sales 93,649 Sales
Cost of goods sold 75,960 Cost of goods sol
Accounts receivabl 8,030 Accounts receivab
Inventory 10,524 Inventory
Accounts payable 6,986 Accounts payable

DIO= 51 Days DIO

Coll. Pd.= 31 Days Coll. Pd.
Pay. Pd.= 34 Days Pay. Pd.
CCC= 48 Days CCC
ate the cash conversion cycle

tan Unilever Limited

ed financial data (2020 (Rs Crores))
38,785
17,793
1,046
2,636
7,399

=2636/(17,793/365)
= 1046 /( =54 days
= 7399 /( =10 days
=54+10-1=151 days
=-87 Days
Question 3
Cash conversion cycle
In fiscal 2010 and 2011 Caterpillar’s financial statements included the following items.
$ Millions
2010 2011 Cash conversion cycle = (inventory period
Inventory $ 9,587 $14,544 Inventory period = [(9,587 + 14,544)/2]/[4
Receivables 16,899 18,149 Receivables period = [(16,899 + 18,149)/2
Payables 5,856 8,161 Payables period = [(5,856 + 8,161)/2]/[40
Sales 42,588 60,138 Cash conversion cycle = 107.86 + 106.36
Cost of goods sold 28,779 40,831
What was Caterpillar’s cash conversion cycle?

What effect will each of the following have on the cash conversion cycle?
a. The inventory hodling period falls from 80 to 60 days.
b. Customers are given a larger discount for cash transactions.
c. The firm adopts a policy of reducing accounts payable.
d. The firm starts producing more goods in response to customers’ advance orders instead of producing ahead of de
e. A temporary glut in the commodity market induces the firm to stock up on raw materials while prices are low.
a.    A lower nventory period, decreasing the cash conversion cycle.
b.    A higher discount for cash lowers the receivable period, decreasing the cash conversion cycle.
c.     Reducing accounts payable decreases the accounts payable period, increasing the cash conversion cycle.
d.    Producing according to customer orders reduces inventory and the inventory period, decreasing the cash conversion cycle
e.    An increase in raw materials increases inventory and the inventory period, increasing the cash conversion cycle.
cycle = (inventory period + receivables period) − accounts payable period.
= [(9,587 + 14,544)/2]/[40,831/365] = 107.86 days.
d = [(16,899 + 18,149)/2]/[60,138/365] = 106.36 days.
= [(5,856 + 8,161)/2]/[40,831/365] = 62.65 days.
cycle = 107.86 + 106.36 – 62.65 = 151.57 days.

d of producing ahead of demand.

s while prices are low.

ersion cycle.
g the cash conversion cycle.
conversion cycle.
4. Cash conversion cycle
What effect will each of the following have on the cash conversion cycle?
a. The inventory turnover falls from 80 to 60 days.
b. Customers are given a larger discount for cash transactions.
c. The firm adopts a policy of reducing accounts payable.
d. The firm starts producing more goods in response to customers’ advance orders instead of producing ahead of de
e. A temporary glut in the commodity market induces the firm to stock up on raw materials while prices are low.

a. A decrease in the inventory turnover increases the inventory period which increases the cash cycle. (Note

b. An increase in the cash discount reduces the accounts receivable period which reduces the cash cycle.

c. Assuming the reduction in accounts payable is the result of paying suppliers sooner, the accounts payable
increases the cash cycle.

d. By producing for orders rather than for inventory, decreases the inventory period which decreases the cas

e. An increase in the inventory level, increases the inventory period which increases the cash cycle.
 of producing ahead of demand.
s while prices are low.

ses the cash cycle. (Note: The decrease is from 80 to 60 times.)

duces the cash cycle.

er, the accounts payable period will decrease which

which decreases the cash cycle.

the cash cycle.

5a. Credit policy
Your company is evaluating a switch from a cash only policy to a net 30 policy. The price per unit is Rs.100, and the
The company currently sells 1,000 units per month. Under the proposed policy, the company expects to sell 1,050 u
What is the NPV of the switch? Should the company offer credit terms of net 30?

Cost of switching CF0=100(1,000) + 40(1,050 – 1,000) = 102,000

Incr cash inflow From 1 to ..=(100 – 40)(1,050 – 1,000) = 3,000
Present value of incremental cash inflow=3,000/.015 = 200,000
NPV of switching= 200,000 – 102,000 = 98,000
}Yes, the company should switch

5b. Credit policy

Company X sells on a 1/30, net 60 basis. Customer Y buys goods invoiced at $1,000.
a. How much can Y deduct from the bill if Y pays on day 30?
b. What is the effective annual rate of interest if Y pays on the due date rather than on day 30?
c. How would you expect payment terms to change if
(i) The goods are perishable.
(ii) The goods are not rapidly resold.
(iii) The goods are sold to high-risk firms.
a. Discount amount = discount rate × invoice amount
Discount amount = .01 × $1,000 = $10
Rate = (full price – discount price) / discount price
Rate = (100 – 99) / 99 = .010101
EAR = (1 + rate)365/days in loan period
EAR = (1 + .010101)365/30 – 1 = .1301, or 13.01%
c. (i) Shorter; (ii) longer; (iii) shorter

5c. Cash Management

How would you expect a firm’s cash balance to respond to the following changes?
a. Interest rates increase.
b. The volatility of daily cash flow decreases.
c. The transaction cost of buying or selling marketable securities goes up.
e per unit is Rs.100, and the variable cost per unit is Rs .40.
pany expects to sell 1,050 units per month. The required monthly return is 1.5%.
6a. Credit policy
The Branding Iron Company sells its irons for $50 apiece wholesale. Production cost is $40 per iron.
There is a 25% chance that wholesaler Q will go bankrupt within the next year.
Q orders 1,000 irons and asks for six months’ credit. Assume that the discount rate is 10% per year, there is no cha
a. Calculate the NPV of the order
b. Should you accept the order?
Reject because PV of Q’s order = (.75 x 50)/1.101/2 − 40 = -$4.25 per iron, or −$4,250 in total

6b. Credit policy

Cast Iron Company, on each nondelinquent sale, receives revenues with a present value of $1,200 and incurs costs with a valu
Cast Iron has been asked to extend credit to a new customer.
You can find little information on the firm, and you believe that the probability of payment is no better than 0.8. Calculate the
a. Expected profit = p(1,200 − 1,050) − 1,050(1 − p) = 0.
Solving, p = .875.
Therefore, grant credit if probability of payment exceeds 87.5%.
b.             Expected profit from selling to slow payer: .8(150) − .2(1,050) = −90.

6c . Credit policy
How should your willingness to grant credit be affected by differences in
(a) the profit margin,
(b) the interest rate,
(c) the probability of repeat orders?
In each case illustrate your answer with a simple example
If variable increases (a) more willing; (b) less willing; (c) more willing
% per year, there is no chance of a repeat order, and Q will pay either in full or not at all.

00 and incurs costs with a value of $1,050.

better than 0.8. Calculate the minimum probability at which credit can be extended.
Question 7
}Cost=1000, Rev=1200.
Category Number of Exp no of dProb of default
Prompt Payers 950 19 0.02
Slow Payers 50 10 0.2
All customers 1,000 29 0.029

}If the customer is a slow player, then expected profit= Rs -40 rupees
Profit -40

}If it cost Rs.10 to identify customer category each time. The benefit is -8 Rs.
Benefit -8
Question 8
As treasurer of the Universal Bed Corporation, Aristotle Procrustes is worried about his bad debt ratio, which is currently runn
He believes that imposing a more stringent credit policy might reduce sales by 5% and reduce the bad debt ratio to 4%. Assum
a. If the cost of goods sold is 80% of the selling price, calculate the profit under current policy and proposed policy.
b. Should Mr. Procrustes adopt the more stringent policy?

The more stringent policy should be adopted because profit will increase. For every $100 of current sales:
More
Current
Stringent
Policy
Policy
Sales $100.0 $95.0
Less: Bad Debts* 6 3.8
Less: Cost of Goods** 80 76
Profit $14.0 $15.2
* 6% of sales under current policy; 4% under proposed policy
** 80% of sales
tio, which is currently running at 6%.
ad debt ratio to 4%. Assume currents sales of $100.
roposed policy.

100 of current sales:

Question 9
Until recently, Augean Cleaning Products sold its products on terms of net 60, with an average collection period of 7

Percent of Sales with Average Collection Periods, Days

Cash Discount Cash Discount Net
60 30* 80
*Some customers deduct the cash discount even though they pay after the specified date.
a. Calculate the NPV on original terms. (Use 365 days in a year.)
b. Assume that sales volume is unchanged, there are no defaults and cost of goods sold is 80% of sales. Calculate the

Original terms:
NPV per $100 of sales = –$80 + $100 / 1.1275/360
NPV per $100 of sales = $17.67

Revised terms:
NPV per $100 of sales = – $80 + [.60 × (1 – .02) × $100] / 1.1230/360 + (.40 ×
$100) / 1.1280/360
NPV per $100 of sales = $17.25
verage collection period of 75 days. In an attempt to induce customers to pay more promptly, it has changed its terms to 2/10,

s 80% of sales. Calculate the NPV on changed terms.

hanged its terms to 2/10, EOM, net 60. Assume a current sales of 100 and the interest rate is 12%. The initial effect of the chan
e initial effect of the changed terms is as follows:
Question 10
Jim Khana, the credit manager of Velcro Saddles, is reappraising the company’s credit policy. Velcro sells on terms of net 30. C
ost of goods sold is 85% of sales, and fixed costs are a further 5% of sales. Velcro classifies customers on a scale of 1 to 4.
During the past five years, the collection experience was as follows:

Av. Collection Period

Defaults
Classificati in Days for
as % of
on Nondefaulting
Sales
Accounts

1 0 45
2 2 42
3 10 40
4 20 80
The average interest rate was 15%.
(i) What conclusions (if any) can you draw about Velcro’s credit policy? What other factors should be taken into account befor
(ii) Suppose (a) that it costs $95 to classify each new credit applicant and
(b) that an almost equal proportion of new applicants falls into each of the four categories.
In what circumstances should Mr. Khana not bother to undertake a credit check?

Consider the NPV (per $100 of sales) for selling to each of the four groups:
Classific
NPV per $100 Sales
ation
1 −85+(100×(1−0))/(1.15^(45/365) )=$13.29

−85+(100×(1−0.02))/(1.15^(42/365) )=$11.44
2

3 −85+(100×(1−0.10))/(1.15^(40/365) )=$3.63

4 −85+(100×(1−0.20))/(1.15^(80/365) )=−$7.41

If customers can be classified without cost, then Velcro should sell only to Groups 1, 2, and 3.
The exception would be if nondefaulting Group 4 accounts subsequently became regular and reliable customers (i.e., members
In that case, extending credit to new Group 4 customers might be profitable, depending on the probability of repeat business.
By making a credit check, Velcro Saddles avoids a $7.41 loss per $100 sale 25% of the time (assuming equal customers under e
0.25 ´ $7.41 = $1.85 per $100 of sales, or 1.85%
A credit check is not justified if the value of the sale is less than x, where:
0.0185x = $95
x = $5,135
 sells on terms of net 30. C
rs on a scale of 1 to 4.

e taken into account before changing this policy?

e customers (i.e., members of Group 1, 2, or 3).

ability of repeat business.
ng equal customers under each category). Thus, the expected benefit (loss avoided) from a credit check is:
   Numerator
Activity Ratios
Working capital turnover Revenue
Receivables turnover Revenue*
Inventory turnover Cost of goods sold
Payables turnover Purchases or COGS
Days of sales outstanding (DSO) Accounts Receivable
Days Sales in Inventory (DSI) (DIO) Inventory
Days Payable Outstanding (DPO) Accounts Payable
*or Credit Sales
** or One day credit purchase
Liquidity Ratios
Current ratio Current assets
Quick ratio Current assets-Inventory
Cash ratio Cash & CE*
* May include marketable secutities also
Denominator

Average working capital

Average receivables
Average inventory
Average trade payables
One-Day Revenue
One-Day COGS
One-Day COGS**

Current liabilities
Current liabilities
Current liabilities
 MEN'S WEARHOUSE INC.
BALANCE SHEET ($ millions)
2006 2007 2008 2009 2010
ASSETS
Cash & Short-Term Investments 263.001 179.694 99.367 104.533 186.018
Net Receivables 19.276 17.018 24.872 40.662 16.745
Inventories 416.603 448.586 492.423 440.099 431.492
Prepaid Expenses 0.000 0.000 27.179 26.603 0.000
Other Current Assets 30.732 35.531 27.154 19.718 74.075
Total Current Assets 729.612 680.829 670.995 631.615 708.330

Gross Plant, Property & Equipment 611.957 669.340 865.084 885.981 866.005
Accumulated Depreciation 342.371 379.700 454.917 498.509 521.259
Net Plant, Property & Equipment 269.586 289.640 410.167 387.472 344.746
Intangibles 63.073 61.765 75.609 65.268 59.414
Other Assets 61.003 64.718 99.696 103.375 119.616
TOTAL ASSETS 1,123.274 1,096.952 1,256.467 1,187.730 1,232.106

LIABILITIES
Long Term Debt Due In One Year 0.000 0.000 0.000 0.000 0.000
Accounts Payable 125.064 111.213 146.713 108.800 83.052
Taxes Payable 21.086 19.676 5.590 0.019 23.936
Accrued Expenses 72.531 75.458 70.222 66.542 0.000
Other Current Liabilities 19.404 19.791 54.730 44.862 117.047
Total Current Liabilities 238.085 226.138 277.255 220.223 224.035

Long Term Debt 207.750 72.967 92.399 62.916 43.491

Deferred Taxes 24.400 12.200 4.000 2.700 0.000
Other Liabilities 25.506 31.875 66.876 59.743 62.236
TOTAL LIABILITIES 495.741 343.180 440.530 345.582 329.762

EQUITY
Common Stock 0.671 0.691 0.696 0.700 0.705
Capital Surplus 255.214 286.120 305.209 315.404 327.742
Retained Earnings 641.558 775.857 923.713 938.580 986.523
Less: Treasury Stock 269.910 308.896 413.681 412.536 412.626
TOTAL EQUITY 627.533 753.772 815.937 842.148 902.344
TOTAL LIABILITIES & EQUITY 1,123.274 1,096.952 1,256.467 1,187.730 1,232.106

Common Shares Outstanding 53.069 53.919 51.479 51.918 52.288

INCOME STATEMENT ($ millions, except per share)

2006 2007 2008 2009 2010

Sales 1,724.898 1,882.064 2,112.558 1,972.418 1,909.575

Cost of Goods Sold 965.889 1,004.972 1,062.205 1,031.241 1,025.759
Gross Profit 759.009 877.092 1,050.353 941.177 883.816
Selling, General, & Administrative Exp. 531.839 591.767 741.405 757.073 732.722
Operating Income Before Deprec. 227.170 285.325 308.948 184.104 151.094
Depreciation, Depletion, & Amortization 61.874 61.387 80.296 90.665 86.090
Example 2
1. Forecast growth rate
Bio-Plasma Corp. is growing at 30% per year. It is all-equity-financed and has total assets of $1 million. Its return on
a. What is the internal growth rate?
b. What is the firm’s need for external financing this year?
c. By how much would the firm increase its internal growth rate if it reduced its payout rate to zero?
d. What is the firm's revised need for external financing this year?

a. Internal growth rate = retained earnings / net assets

Internal growth rate = plowback ratio × ROE × (equity / net assets)
Internal growth rate = .40 × .20 × 1= .080, or 8.0%
b. External financing need = change in assets – addition to retained earnings
External financing need = (.30 × $1,000,000) – (.20 × $1,000,000 × .40)
External financing need = $220,000
c. With no dividends, the plowback ratio becomes 1.0 and:
Internal growth rate = plowback ratio × ROE × (equity / net assets)
Internal growth rate = 1 × .20 × 1= .20, or 20%
d. External financing need = change in assets – addition to retained earnings
External financing need = (.30 × $1,000,000) – (.20 × $1,000,000 × 1)
External financing need = $100,000
ts of $1 million. Its return on equity is 20%. Its plowback ratio is 40%.

te to zero?
Example 2
}Pet Treats Inc. Sales estimates (in millions); Q1 = 500; Q2 = 600; Q3 = 650; Q4 = 800; Q1 next year = 550
}Accounts receivable: Beginning = $250; Av. collection period = 30 days
}Accounts payable: Purchases = 50% of next quarter’s sales, Beginning = 125; Accounts payable period is 45 days
}Wages, taxes and other expense are 30% of sales, Interest and dividend payments are $50, A major capital expen
}The initial cash balance is $80 and the company maintains a minimum balance of $50
ACP = 30 days, this implies that 2/3 of sales are collected in the quarter made, and the remaining 1/3 are collected t

Q1 Q2 Q3 Q4
Beginning Receivables 250 167 200 217
Sales 500 600 650 800
Cash Collections 583 567 633 750
Ending Receivables 167 200 217 267

Payables period is 45 days, so half of the purchases will be paid for each quarter, and the remaining in the following
Payment of accounts: Q1: 125 +.5(600)/2 = 275 ; Q2:150 +.5(650)/2 = 313; Q3:162 +.5(800)/2 = 362; Q4:200+.5(55

Payment of accounts 275 313 362 338

Wages, taxes and other ex 150 180 195 240
Capital expenditures 200
Interest and dividend paym 50 50 50 50
Total cash disbursements 475 743 607 628

Q1 Q2 Q3 Q4
Total cash collections 583 567 633 750
Total cash disbursements 475 743 607 628
Net cash inflow 108 -176 26 122
Beginning Cash Balance 80 188 12 38
Net cash inflow 108 -176 26 122
Ending cash balance 188 12 38 160
Minimum cash balance -50 -50 -50 -50
Cumulative surplus (deficit) 138 -39 -12 110

}The company will need to access a line of credit or borrow short-term to pay for the short-fall in quarter 2, but shoul
You could also use 50 as the beginning cash balance in quarters following deficits. This would assume funds were b
0; Q1 next year = 550

unts payable period is 45 days

are $50, A major capital expenditure of $200 is expected in the second quarter

e remaining 1/3 are collected the following quarter. Beginning receivables of $250 will be collected in the first quarter.

the remaining in the following quarter. Beg payables = $125

.5(800)/2 = 362; Q4:200+.5(550)/2 = 338

hort-fall in quarter 2, but should be able to clear up the line of credit in quarter 4.
is would assume funds were borrowed to achieve the target cash balance.
n the first quarter.