3. Suppose you have the following investment opportunities, but only $90,000 ava
ID: 2617251 • Letter: 3
Question
3.Suppose you have the following investment opportunities, but only $90,000 available
for investment. Which projects should you take?
Project NPV Investment
1 5,000 10,000
2 5,000 5,000
3 10,000 90,000
4 15,000 60,000
5 15,000 75,000
6 3,000 15,000
4.Calculate WACC.
Source of capital
Cost
Sum
Loan 1
12%
14000
Loan 2
15%
6000
Equity
20000
Estimate the cost of equity through CAPM. Company’s beta is 1.2, market portfolio rate of return is 15%, risk-free rate of return is 7%.
5.What is VaR? How it can be calculated?
6.Construct after-tax cash flows.Working capital is estimated as 20% of sales.
1
2
3
4
5
Revenues
3000000
3 600000
4200000
4500000
5000000
Operating Expenses
Salaries
300000
330000
360000
390000
400000
Raw Material
1500000
1900000
2200000
2500000
2800000
Depreciation
200000
200000
200000
200000
200000
Operating Income
Taxes (20%)
Operating Income After Taxes
0
1
2
3
4
5
Capital Expenditure
-10000000
After tax operating Income
Depreciation
Change in Working Capital
After-tax Cash Flows
7. A piece of land produces an income that grows by 5 percent per annum. If the first
year’s flow is $10,000, what is the value of the land? The interest rate is 10 percent.
Source of capital
Cost
Sum
Loan 1
12%
14000
Loan 2
15%
6000
Equity
20000
Explanation / Answer
3 A B C Project NPV Investment NPV/Investment 1 5000 10000 0.5 2 5000 5000 1 3 10000 90000 0.111111111 4 15000 60000 0.25 5 15000 75000 0.2 6 3000 15000 0.2 We need to maximize NPV within the constraint of investment of$90000 Hence we select projects with highest NPV/Investment Projects Selected NPV/Investment Investment Cumulative investment NPV 2 1 5000 5000 5000 1 0.5 10000 15000 5000 4 0.25 60000 75000 15000 6 0.2 15000 90000 3000 Projects Selected:1,.2,4,.6 SUM 28000 Total Investment=$90,000 4 Cost of Equity=Rf+Beta*(Rm-Rf) Rf=Risk free return=7% Beta=1.2 Rm=Market portfolio return=15% Cost of Equity=7+1.2*(15-7) Cost of Equity 16.60% A Weight of loan1=14000/(14000+6000+20000) 0.35 B Weight of loan2=6000/(14000+6000+20000) 0.15 C Weight of loan1=20000/(14000+6000+20000) 0.5 D Cost of Loan 1 12% E Cost of Loan 2 15% F Cost of Equity 16.60% WACC=A*D+B*E+C*F WACC(Weighted Average Cost of Capital) 14.75% 0 1 2 3 4 5 A Revenues 3,000,000 3,600,000 4,200,000 4,500,000 5,000,000 Operating Expenses B Salaries 300,000 330,000 360,000 390,000 400,000 C Raw Material 1,500,000 1,900,000 2,200,000 2,500,000 2,800,000 D Depreciation 200,000 200,000 200,000 200,000 200,000 E=B+C+D Total Operating Expenses 2,000,000 2,430,000 2,760,000 3,090,000 3,400,000 F=A-E Operating Income 1,000,000 1,170,000 1,440,000 1,410,000 1,600,000 G=F*0.2 Taxes (20%) 200,000 234,000 288,000 282,000 320,000 H=F-G Operating Income After Taxes 800,000 936,000 1,152,000 1,128,000 1,280,000 I=0.2*A Working Capital 600,000 720,000 840,000 900,000 1,000,000 Change in Working Capital (600,000) (120,000) (120,000) (60,000) (100,000) 1,000,000 Year 0 1 2 3 4 5 J Capital Expenditure (10,000,000) K After tax operating Income 800,000 936,000 1,152,000 1,128,000 1,280,000 L Depreciation 200,000 200,000 200,000 200,000 200,000 M Change in Working Capital (600,000) (120,000) (120,000) (60,000) (100,000) 1,000,000 N=J+K+L+M After-tax Cash Flows (10,600,000) 880,000 1,016,000 1,292,000 1,228,000 2,480,000 Cash Flow in the first year $10,000 Growth rate =g=5%= 0.05 Interest rate=R=10%= 0.1 Value of Land=Present Value of Cash Flows: 10000/(R-g)=10000/(0.1-0.05)= $200,000
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