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Cash Flow Estimation

Question No-1

Mr. A has been appointed as a financial consultant to develop the financial strategies of M/s ABC & Co. The Co. is in the process of replacement of its some old machines with the new technological advanced machines. As a test case, one of the machine feasibility has been assigned to Mr. A with the following facts and figures.

Existing machine was bought 03 years back for Rs 500,000 with 2% installation & 3% transportation cost with an expected life of 7 years and expected residual value of Rs 5000 and fall under 3 years property class. The machine can produce 10000 units per annum. Each unit is being sold for Rs 20/unit with the 25% COGS and 15% cash operating expenses.

The new machine can be bought for Rs 950000 with 3% installation & 2% transportation cost. The maximum capacity of the machine is 25,000 units with an expected life of 7 years & also falls in 3 years property class. It is expected that in the current year, demand would be 12,500 units in the first year which would increase @ 10% every year. The residual value of the machine is expected to be Rs 15000.

The new machine acquirer Rs 7,000 less working capital than the old machine. Currently, old machine can be sold in the market for Rs 75000. Company pays 40% tax.

You are required to help Mr. A in calculating initial cash outlays, interim CFs & terminal CFs. MACRS rate for 3 years property class are given below;

YEARS

MACRS 01 02 03 04

33.33% 44.45% 14.8% 7.41%

(b) Let’s assume that machine was bought 4 years back and expected inflation each year is 5 % and the life of both of the machines are 5 years. Now calculate all of the three types of CFs.

Cash Flow Estimation

Question No-2

Mr. A is evaluating the replacement of existing machines with technological more advanced machines. Recently, he got an option to replace two existing machines that is machine A and B with the new technological more advanced machine.

Machine A was bought 5 years back for Rs 450,000 inclusive of 2% transportation & 3% installation cost with an expected life of 9 years and fall under 7 years property class. Expected residual value of the machine was Rs 30,000. This machine was producing 15,000 units/annum.

Machine B was bought 3 years back for Rs 500,000 with 5% installation & 7% transportation cost with an expected life of 7 years and fall under 5 years property class with an expected residual value of Rs 45,000. This machine was producing 21,000 units/annum.

Machine A can be sold today on 15% loss while machine B can be sold on 22% premium.

The new machine can be purchased from the market for Rs 1150,000 which would be required Rs 100,000 as the training cost to the employees, 50000 as an installation cost & Rs 25,000 transportation cost. Rs 75,000 as already been spent as R & D on this machine. Expected life of the machine is 9 years an fall under 7 years property class with Rs 30,000 residual value.

This machine is technological very advanced machine that is it can produce 55,000 units/annum. Current demand in the market is 35,000 units/annum which is expected to increase @ of 7% per annum. Expected inflation would be 9 % per annum which is expected to impact on the sale price @ 6% and on the cost price 4%.

Currently, each unit is being sold in the market for Rs 38/unit with 25% COGS and 13% cash operating expenses. Interest rate is expected to be 11% which would alos increase @ 2% every year. Company pays 50% tax.

You are required to prepare Initial Cash Outlay, Interim CFs & Terminal CFs.

Cost of Capital

Question-3

Mr. A is interested to calculate required rate of return by the project which he is going to evaluate for near future investment. Estimated cost of the project is 5 million and he is expecting to finance 2 million through debentures. Currently, company’s debentures are being sold in the market for Rs 1120/debenture with 7% coupon rate and 15 years to maturity.

Remaining 1 million would be financed through 8% preferred shares which would be callable after 10 years. Currently preferred shares are being sold in the market for Rs 110 and would be callable @ Rs 125.

Remaining amount would be through common share for which he has decided to calculate cost of equity through dividend discount model.

Each unit is being sold in the market for Rs 42/share and company paid Rs 2.5 dividend recently.

You are required to calculate market based cost of capital of the company. Keeping in view

(i) There would be zero growth of dividends in future(ii) Company would grow @ 5% foreover(iii) Company would grow @ 5% for next two years, then @ 3% for next 3 years & then 5%

thereafter

Question-4 (Assignment)

Mr. A is calculating the cost of capital for the new project for which they have decided to take loan from HBL amounting R.s. 1.5 million @ 13% would issue 100,000 debentures for 15 years @ 9% at 40% premium.

Perpetual bonds would also be issued. The coupon rate would be 8%. 50,000 debentures with 40% discount.

200,000 preferred shares would be issued with 11% dividends, 60% of them would be callable after 7 years @ 109 and the issuance price would be 20% premium.

1 million ordinary shares @ 300% premium would also be issued with the expectation of 4% growth in the first three years, 3% growth in next 4 years, 2% growth in the next 3 years and 5% thereafter. Currently the company has paid Rs 2 dividend. You are required to calculate

(i) Book based cost of capital(ii) Market based cost of capital(iii) Mixed based cost of capital

Cost Of Equity Calculation

Q-5

Messers ABC & Co. are in the process of calculation of cost of equity and discounting method was selected as an appropriate method for the calculation of C.O.E. The basic benchmark selected was dividend and it has also been assumed that after investing in new project company would be in the volatile/variable growth. For the purpose of calculation of growth pattern, the consultant calculated the patches in which company grow when last time such investment was done and those were the patch of 2 years, 3 years, then 2 years and the constant growth.

For the purpose of calculation of growth rate for future, following last years of data of dividends has been gathered. The share is being traded in the market for Rs 35 and recently company has announced Rs 3.5 dividend.

Required:

(i) Cost of Equity

(b) Assignment

Now let suppose the consultant want to evaluate/calculate the cost of equity (C.O.E) on the basis of FCFs when company earned operating profit of Rs 650,000 which was 30% of sales of that year when F.A. turnover ratio was 1.25 and F.A. represents 60% of total assets with the C.R. of 2. F.A. are depreciated @ 10% and these F.A.s were 10% more than the last year. F.A. and working capital was 5% less than last year working capital. Total outstanding shares of the company are 100,000. If growth patterns remains same, what would be the cost of equity of its company using phase growth model.