Finance Project

Accounting and Finance Assignment

Name of Student

Name of the institution.

Solution 2

The net present value is the difference of the present values of the cash inflows and cash outflows undertaken by the project. This method is one of the best techniques to analyze the projects from the viewpoint of capital budgeting. The reason for this is that it takes into account the time value of money concepts. The formula used to calculate the present value of any given value is given as:

PV = FV/(1+i)^n

If we calculate the present values of the given in flows, we will come up with the following table.

Inflows

PV factor

PV

1

6500

1.120

5803.57

2

3000

1.254

2391.58

3

3000

1.405

2135.34

4

1000

1.574

635.518

10966

The above table shows the calculation of the net present value for the first project. The present value of the outflows is 1000. Thus the net present value of the project is given as

10966-10000= 966

This shows the first project will save $ 966 to the company when the net present value method is applied.

Inflows

PV factor

PV

1

3500

1.120

3125

2

3500

1.254

2790.18

3

3500

1.405

2491.23

4

3500

1.574

2224.31

10630.7

The above table shows the calculation of the net present value for the second project. The present value of the outflows is $ 10000 while the present value of the inflows is calculated as $ 10630.7 as above. Thus the net present value of the second project is given as follows:

10630.7-10000= 630.7

Internal Rate of Return:

The internal rate of return is the rate at which the net present value is equal to zero. In other words, this is the rate at which the present value of the outflows is equal to the present value of the inflows. This rate is calculated by using the hit and trial method or interpolation. However we will use the built in function of Excel to calculate the return. When we run the function of the internal rate of return for both the projects, we see that the first project gives us the internal rate of return @ 18% and the second project gives us the internal rate of return @ 15%.

The payback Period

This is the time taken in the project to cover the initial outflow in terms of money. The major benefit of this method is that it is simple and quick however the major drawback is that this does not take into account the time value of money aspects. In case of both the projects, the payback period is positive. Due to the disadvantage related to the time value of money, this method is seldom used in the practical aspects.

Part b

In case of the independence assumption, we will take on both projects. The reason is that this projects have an internal rate of return that is higher than the cost of capital for the company.

Part c

The assumption of exclusiveness will force the company to select only one project at time. In this case the company will choose the first project. The reason is that it is better than the other project on both the criteria. The net present value and the internal rate of return.

Answer 1

The cost of Capital

The formula for the cost of capital is given by

CE = {Dividend (next Year)/Stock price} + growth rate of Dividends

We have to first calculate the dividend for the next year which is

D1= D0(1+g)

With this formula, we calculate D1 as 3.924

Putting this value and other data in the equation, we have

Cost of Equity = (3.924/54) + 0.09

= 16.26%

Cost of Preferred Stock

This value is calculated by the formula

D/P0

D is the dividend and P is the price, if we calculate from the given data,

11/95

=11.57%

The cost of Debt is given at 12%.

The WACC will be as under:

=0.25*0.12+0.15*0.1157+0.6*0.1626

= 0.03+0.0173+0.0975

= 0.14486 or 14.48%

Part c

We assume that the company will use the debt preferred stock equally to finance.

WACC=05*0.12+0.15*0.5

= 13.5%

The company can take on any of the projects that have higher expected return than the weighted average cost of capital.