corporate finance written assignment #2

Corporate Finance Written Assignment #2 Topic: Value

Member:

IM11Y009 LIU, Jiming (Rachel)

IM12Y011 NILJIANSKUL, Natt (Natt)

Answers to Q1:

(Remark: unit in all calculation in question 1, if not specificed, is in JPY)

Method: identify annual dividend identify market price per share from dividend yield identify market capitalisation

total down to accounting book value by market-to-book ratio

Annual dividend = 2 Semi-annual1 dividend [semi-annual = A semiannual event happens twice a year, typically every six months.]

= 2 30

= 60

Currently, Takao Inc.s stock yield 2% annually; Dividend yield = DIV! P!

2% = 60 P!

Current price per share (P!) = 3,000

With 25 million common shares outstanding;

Market capitalisation of Takao Inc. = Market value per share number of outstanding shares

= 3,000 25 millions

= 75 billions

Under a market-to-book ratio of 1.5, therefore:

1 Investopedia, Semiannual, http://www.investopedia.com/terms/s/semiannual.asp.

Accounting book value of shareholders equity = 75 billions 1.5 = 50 bil l ions

Answers to Q2:

(Remark: unit in all analyses below for question 2, if not specificed, is in JPY millions, with the present value assessment conducted with a discount rate/compound annual interest rate r = 9%.

Payback period calculated from hereon out is a simple payback period with year as the only unit in consderation.)

(a)

Project A

Year 0 Year 1 Year 2 Year 3 FCF C! = 100 C! = 145

PV of FCF PV!"!#$ = 100 PV!"!#$ = !!

(!!!)!

= !"#

(!!!%)!

= 111.97 NPV!"!!"#$% NPV! = 100 NPV! = 100 NPV! = 100 NPV! = 100 +

111.97 = 11.97

PP [] [] [] [+] From the table above, net present value became positive at Year 3; Payback Period = 3 years[Answer to (i)]

and net present value of the project (NPV!"#$%&' ! or NPV!"!!"#$%) = NPV! = 11.97[Answer to (ii)]

For this, we determine the internal rate of return of the project by zeroing NPV;

NPV!"#$%&' ! = PV(FCF!") + PV(FCF!") + PV(FCF!") + PV(FCF!")

0 = !!

(!!!"")!+

!!(!!!"")!

+ !!

(!!!"")!+

!!(!!!"")!

0 = !!""

(!!!"")!+

!"#(!!!"")!

IRR = 13.19%[Answer to (iii)]

And we can determine the profitability index of this project as follow;

PI = !"#

!"#$%&'$"& =

!"#!"#$%&' !!!

= !!.!"!""

= 0.11967 or 11.97%[Answer to (iv)]

Project B

Year 0 Year 1 Year 2 Year 3 FCF C! = 100 C! = 115

PV of FCF PV!"!#$ = 100 PV!"!#$ = !!

(!!!)!

= !!"

(!!!%)!

= 105.50

NPV!"!!"#$% NPV! = 100 NPV! = 100 + 105.50 = 5.50

PP [] [+] From the table above, net present value became positive at Year 1; Payback Period = 1 year[Answer to (i)]



NPV!"#$%&' ! = PV(FCF!") + PV(FCF!")

0 = !!

(!!!"")!+

!!(!!!"")!

0 = !!""

(!!!"")!+

!!"(!!!"")!



PI = !"#

!"#$%&'$"& =

!"#!"#$%&' !!!

= !.!"!""

= 0.05504 or 5.50%[Answer to (iv)]

Project C

Year 0 Year 1 Year 2 Year 3 FCF C! = 100 C! = 230 *C! = 120

(* = this cash flow is a result from operation, not from an investing activity)

PV of FCF PV!"!#$ = 100 PV!"!#$ = !!

(!!!)!

= !"#

(!!!%)!

= 211.01

PV!"!#$ = !!

(!!!)!

= !!"#

(!!!%)!

= 101.00

NPV!"!!"#$% NPV! = 100 NPV! = 100 + 211.01 = 111.01

NPV! = 100 + 105.50 + 101.00 = 10.01

PP [] [+] From the table above, net present value became positive at Year 1; Payback Period = 1 year[Answer to (i)]



NPV!"#$%&' ! = PV(FCF!") + PV(FCF!") + PV(FCF!")

0 = !!

(!!!"")!+

!!(!!!"")!

+!!

(!!!"")!

0 = !!""

(!!!"")!+

!"#(!!!"")!

+!!"#

(!!!"")!



PI = !"#

!"#$%&'$"& =

!"#!"#$%&' !!!

= !".!"!""

= 0.10008 or 10.01%[Answer to (iv)]

Project D

Year 0 Year 1 Year 2 Year 3 FCF C! = 45 C! = 20 C! = 20 C! = 20

PV of FCF PV!"!#$ = 45 PV!"!#$ = !!

(!!!)!

= !"

(!!!%)!

= 18.35

PV!"!#$ = !!

(!!!)!

= !"

(!!!%)!

= 16.83

PV!"!#$ = !!

(!!!)!

= !"

(!!!%)!

= 15.44 NPV!"!!"#$% NPV! = 45 NPV! = 45 +

18.35 = 26.65

NPV! = 45 + 18.35 + 16.83 = 9.82

NPV! = 45 + 18.35 + 16.83 + 15.44 = ~5.63

PP [] [] [] [+]

From the table above, net present value became positive at Year 3; Payback Period = 3 years[Answer to (i)]




0 = !!

(!!!"")!+

!!(!!!"")!

+!!

(!!!"")!+

!!(!!!"")!

0 = !!"

(!!!"")!+

!"(!!!"")!

+!"

(!!!"")!+

!"(!!!"")!



PI = !"#

!"#$%&'$"& =

!"#!"#$%&' !!!

= !.!"!"

= 0.12502 or 12.50%[Answer to (iv)]

Project E

Year 0 Year 1 Year 2 Year 3 FCF C! = 40 **C! = 60

(** = this cash flow is a result from initial investment, not from an operating activity)

C! = 75 C! = 70

PV of FCF PV!"!#$ = 40 PV!"!#$ = !!

(!!!)!

= !!"

(!!!%)!

= 55.05

PV!"!#$ = !!

(!!!)!

= !"

(!!!%)!

= 63.13

PV!"!#$ = !!

(!!!)!

= !"

(!!!%)!

= 54.05 NPV!"!!"#$% NPV! = 40 NPV! = 40 +

55.05 = 95.05

NPV! = 40 + 55.05 + 63.13 = 31.92

NPV! = 40 + 55.05 + 63.13 + 54.05 = 22.13

PP [] [] [] [+] From the table above, net present value became positive at Year 3; Payback Period = 3 years[Answer to (i)]




0 = !!

(!!!"")!+

!!(!!!"")!

+!!

(!!!"")!+

!!(!!!"")!

0 = !!"

(!!!"")!+

!!"(!!!"")!

+!"

(!!!"")!+

!"(!!!"")!



PI = !"#

!"#$%&'$"&() =

!"#!"#$%&' !!!!!"(!!)

= !!.!"

!"!!!.!" = 0.23287 or 23.29%Answer to (iv)]

(*) = The Investment component for calculating PI has to take into account all the initial outlay which in this case consist of cash outflow in year 0 and

year 1.

(b) According to (a), we summarise the result and rank from different vaulation methods in the table below:

Project (**) Simple payback period (simple PP)

Net present value (NPV)

Internal rate of return (IRR)

Profitability index (PI)

Profitability index in % (PI in %)

A 3 [3 (4)] 11.97 [2] 13.19% [5] 0.11967 [3] 11.97% B 1 [1 (2)] 5.50 [5] 15.00% [4] 0.05505 [5] 5.50% C 1 [1 (1)] 10.01 [3] 50.00% [1] 0.10008 [4] 10.01% D 3 [3 (3)] 5.63 [4] 15.89% [3] 0.12502 [2] 12.50% E 3 [3 (5)] 22.13 [1] 21.82% [2] 0.23287 [1] 23.29%

(**) = For the purpose of disambiguity, we give the ranking of 1-2-3-4-5 in the parenthesis inside the bracket as the exact payback period can be

determined by accruing monthly cash flow.

NB numbers in brackets behind each result denote the rank in the respective valuation methods. We shaded the cells to emphasise the top 1 & 2 ranks and also by bolding + double-underlining for top rank, and single-underlining for rank 2, respectively. The rest remain with normal formatting.

Answers to Q3:

(Remark: unit in all analyses below for question 3, if not specificed, is in RMB million)

(a) Constant stream of cash flow of 4.3 for 12 years (12 years annuity inflow) in-which such point, the facility does not generate any further cash flow from an initial outlay of 21.2 with a discount rate of 14% based on the project cost of capital; C! = 21.2, C! to C!" = 4.3, r = 14%

NPV of this project (calculate to termination at year 12)

= PV(FCF!") + PV(FCF!") + PV(FCF!") + PV(FCF!") + + PV(FCF!")

= !!!!! !

+ !!!!! !

+ !!!!! !

+ !!!!! !

+ + C12(1+)12

= !!".!!!!"% !

+ !.!

!!!"% !+

!.!!!!"% !

+ !.!

!!!"% !+ + 4.3

(1+14%)12

= RMB 3,139,256.14

(b) The 10% fixed rate loan from the bank is not the project cost of capital.

Reason/explanation: First of all, it is the company that owns the project while the bank is only the lender not the owner of the project. Therefore, the 10% rate cannot be the cost of capital for this project as this financing option was granted to the company instead of the project. Next, the company existing cost of capital of 14% has to be re-evaluate to reflect the investment activity making in this facility expansion project as the capital structure has changed by taking the loan. As a result of taking this on to the project i.e. investing and executing the project, the re-evaluation affect the project cost of capital as risk is altered both in the big picture (the company) and the small picture (the project.) Also, in our opinion, it is very risky for the company to consider this 10% as a cost of capital of the project and it will even be more risky if the company adopt this risk attitude to take loan to finance the future project instead of considering other financing option that can bring down the overall big picture risk as well as the small picture risk, had they presume that the bank loan interest rate will eventually become the project cost of capital.

(c) At year 8, the built facility is only going to generate cash flows at the end of that year towards the end of year 12. However, cash flow generating in year 8 will belong to the company per the point of time assumed by the question (please see the note below for further explanation.) To determinine net present value of this project at year 8, we only take into account cash flow from the end of year 9 to year 12 with all the parameters the same as (a), neglecting cash flow generate in year 8, and therefore we start to discount the cash flow from at the end of year 9 (at year 8, n = 0); C! (year 9) to C! (year 12) = 4.3, r = 14%

NPV of this project (calculate at the end of year 8)

= PV(FCF!") + PV(FCF!"#) + PV(FCF!"") + PV(FCF!")

= !!!!! !

+ !!!!! !

+ !!!!! !

+! !

(!!!)!

= !.!

!!!"% !+

!.!!!!"% !

+ !.!

!!!"% !+

!.!(!!!"%)!

= RMB 12,528,962.91

NB per the assumption given by the question (It is now eight years later), prior investments and/or prior cash flows generated are already sunk, whereas cash flow generate in year 8 belongs to the company and does not serve the purpose for asset valuation if the facility is to be put on sale.

Answers to Q4:

(Remark: unit in all calculation in question 4, if not specificed, is in JPY million)

(a) To determine the attractiveness of each project the Kittens should invest in, we will advise them with our criteria based on profitability index. For this purpose, we have prepared a summary table for them with ranking of attractiveness below:

Project Investment

(C!) Net present value

(NPV) Internal rate of return

(IRR) Profitability index (PI = !"#

!"#$%&$"&)

L (100) 8 13.9 0.08000 or 8.00% [6] O (400) 43 14.4 0.10750 or 10.75% [2] S (300) 25 16.0 0.08333 or 8.33% [5] E (200) 23 14.1 0.11500 or 11.50% [1] R (200) 21 16.1 0.10500 or 10.50% [3] Z (200) 19 15.7 0.09500 or 9.50% [4]

NB numbers in brackets behind profitability index denote the attractiveness ranking. We shaded the cells to remark to the Kittens that their fund should be distributed in those projects only.

With respect to the rankings above, we would like suggest the Kittens distribute their investment (900 million) by the following;

- [1] Project E: invest 200 million 100% of maximum allowed amount by project E (700 million remained in the Kittens fund after making this investment) - [2] Project O: 400 million 100% of maximum allowed amount by project O (300 million remained in the Kittens fund after making this investment) - [3] Project R: 200 million 100% of maximum allowed amount by project R (100 million remained in the Kittens fund after making this investment) - [4] Project Z: 100 million 50% of maximum allowed amount by project Z (The Kittens fund depletes after making this investment)

(b) Under the new circumstance; payout rate = 75%

Project Expected NPV

(if investing 100% to the project)

Amount to be invested by the Kittens

Allowed amount by the project; in [], % of the allowed amount to be invested by the Kittens

Expected NPV for the Kittens investment

E 23 200 200 [100%] 100% 23 = 23.00 O 43 400 400 [100%] 100% 43 = 43.00 R 21 200 200 [100%] 100% 21 = 21.00 Z 19 100 200 [50%] 50% 19 = 9.50

Total NPV for the chosen projects = 96.5

Answers to Q5:

(Remark: unit in all calculation in question 5, if not specificed, is in $ million with the present value assessment conducted with a discount rate/compound annual interest rate

r = 8% according to MSD, Inc.s weighted average cost of capital, under a corporate tax rate of 35%)

First, determining free cash flow from year 1 to year 4;

Free cash !"#$ ! !!"#$ ! 1 ! !"# ! !"#$"%&(&)* ! !"#$% ! !"#$%&!!" !"#$%&!!"#$%"&

!"! !" = 37.50 ! (1 35%) + 3.00 3.75 1.00(*) = 22.63 FCF!" = 48.81 (1 35%) + 3.00 5.74 2.65(*) = 26.34 FCF!" = 58.30 (1 35%) + 3.50 2.30 1.44(*) = 37.66 FCF!" = 62.10 (1 35%) + 3.05 3.35 + 2.10(**) = 40.17

(*) = Positively increased in working capital means decreased in cash and therefore have negative impact to FCF as denoted by the negative sign. (**) = Negatively increased in working capital means decreased in cash and therefore have negative impact to FCF as denoted by the negative sign.

Second, determine free cash flow in year 5 given that the cash flow in year 5 grows over cash flow in year 4 under the same percentage of growth back from year 3 to year 4;

FCF!" = FCF!" ! (1 + ! !" ! !" ! !" ) = 40.17 ! (1 + !" !!" !! !!" !!!

!" !!!) = 42.84

Third, determine free cash flow in year 6 given that the cash flow in year 6 will growsover cash flow in year 5 by only 2%;

!"! !" = !"! !" ! (1 + g) = 42.84 ! (1 + 2%) = 43.70

Fourth, determine valuation of MSD, Inc., the company, by DCF methodology;

! NPV or P0 = !" ! !"! !" ! + !" ! !"! !" ! + !" ! !"! !" ! + !" ! !"! !" ! + !" ! !"! !" ! + PV(horizon value)

= ! !

! ! ! ! ! !! !

! !! ! ! ! )!

+ !!

(!!!)!+

!!(! !! ! !

! !! !

! ! ! ! ! !!

! !(!!!)!

+!!

(!!!)!+

!"!(!! ! ! !

= !

(!!!%)!+

!!!!"! ! ! !" ! !

+ !!" !!"

! ! ! !" ! !! !

!" !!!

(!! !" ! !+

!".!"(! ! !" )!

+!" !!"

! ! ! !" ! !!

!" !!"

! ! ! !" ! !

+ CH(rg)(1+r)H

= 0 + 20.95 + 22.58 + 29.89 + 29.52 + 29.04 + 27.43 + 43.70(1+2%!(8%! !" )! ! ! !" ! !

= 627.78

However, since the company is having a net debt of $25 million (not debt-free), valuation of equity has to be adjusted for the debt portion i.e. in this case equal to adjusted net asset or in other words, asset that adjusted out net debt.

! Therefore, MSD, Inc.s estimated value of equity P(equity) = Adjusted net asset

= P0 Net debt

= 627.78 25.00

= 602.78

corporate finance written assignment #2

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