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Financial management (final exam) - Essay Example

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Financial management (final exam)

Therefore, the results of both techniques will be different because of the differences between the assumptions of both techniques. Question 2 Part A a) Project A Years 0 1 2 3 4 Initial Investment (20,000,000) Cash Flows 3,000,000 7,000,000 9,000,000 15,000,000 Discount Factor (8%) 1.0000 0.9259 0.8573 0.7938 0.7350 Discounted Cash Flows (20,000,000) 2,777,778 6,001,372 7,144,490 11,025,448 Net Present Value 6,949,087 Project B Years 0 1 2 3 4 Initial Investment (20,000,000) Cash Flows 10,000,000 8,000,000 5,000,000 5,000,000 Discount Factor (8%) 1.0000 0.9259 0.8573 0.7938 0.7350 Discounted Cash Flows (20,000,000) 9,259,259 6,858,711 3,969,161 3,675,149 Net Present Value 3,762,280 Based on the above results it can be clearly observed that Project A has generated higher NPV therefore, it should be accepted. b) Project A Profitability Index = PV of Future Cash Flows   Initial Investment   = 26949087/20000000   = 1.35 Project B Profitability Index = PV of Future Cash Flows   Initial Investment   = 14503021/20000000   = 0.73 Since the Profitability Index of Project A is greater than 1, therefore this project should be accepted. c) IRR based on Trial & Error Method Years 0 1 2 3 4 Initial Investment (20,000,000) Cash Flows 3,000,000 7,000,000 9,000,000 15,000,000 Discount Factor (17.5%) 1.0000 0.8511 0.7243 0.6164 0.5246 Discounted Cash Flows (20,000,000) 2,553,191 5,070,167 5,547,904 7,869,367 Net Present Value 1,040,630     Years 0 1 2 3 4 Initial Investment (20,000,000) Cash Flows 3,000,000 7,000,000 9,000,000 15,000,000 Discount Factor (18.5%) 1.0000 0.8439 0.7121 0.6010 0.5071 Discounted Cash Flows (20,000,000) 2,531,646 4,984,956 5,408,632 7,607,078 Net Present Value 532,312     Years 0 1 2 3 4 Initial Investment (20,000,000) Cash Flows 3,000,000 7,000,000 9,000,000 15,000,000 Discount Factor (19.5%) 1.0000 0.8368 0.7003 0.5860 0.4904 Discounted Cash Flows (20,000,000) 2,510,460 4,901,875 5,273,984 7,355,626 Net Present Value 41,945     Years 0 1 2 3 4 Initial Investment (20,000,000) Cash Flows 3,000,000 7,000,000 9,000,000 15,000,000 Discount Factor (19.58%) 1.0000 0.8362 0.6992 0.5847 0.4889 Discounted Cash Flows (20,000,000) 2,508,629 4,894,727 5,262,453 7,334,191 Net Present Value 0 d) Since the IRR of is 19.58% therefore it should be accepted because it is earning more than the double of the cost of capital of the company. e) Advantages of NPV NPV provides the total benefit in the form of currency amount. NPV is easy to calculate and understand. NPV is an absolute measure and provides the results of the project in isolation. Advantages of IRR IRR provides the answer in percentage form. IRR provides the net excess percentage over cost of capital. IRR is relative measure, which makes it comparable to other projects. Part B Steps in Capital Budgeting Typical steps in the process of capital budgeting are: 1. Brainstorming: the most important step in capital budgeting process is to generate good ideas for investments, which comes from brainstorming. 2. Capital Budget Planning: In this step, the company ...Show more

Summary

Part I Question 1 a) Cost of Equity Re = Rf + Beta (Market Risk Premium)   = 2% + 1.16 (3.5%) Re = 6.06% b) Weighted Average Cost of Capital WACC = [Wd x Rd(1-Tax Rate) + We x Re ]   = [0.30 x 0.07 x 0.6] + [0.7 x 0.0606]    = 5.50% c) Enterprise Value using Discounted Cash Flow Technique Years 0 1 2 3 Terminal Value Growth Rate 5.00% 3.00% 1.00% Cash Flows 65.00 30.00 31.50 32.45 819.24 Discount Factor (5.50%) 1.0000 0.9524 0.9070 0.8638 0.8227 Discounted Free Cash Flows 65.00 28.57 28.57 28.03 673.99 Enterprise Value 824.16         d) Enterprise Value using M&A Multiple Technique e) The difference between the two approaches of enterprise valuation exists because of several factors…
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Financial management (final exam) essay example
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