# Solution of Financial Management

Solution: Week 6

a). The current price of the bond = ∑(n→1)20\$100/(1+12/100)n + (\$ 1000)/(1+12/100)20

= (\$ 100)/(1+12/100)1 …………….. (\$ 100)/(1+12/100)20 + (\$ 1000)/(1+12/100)20

= \$ 100 x (PVAF)(12%,20) + \$ 1000x (PVF)(12%,20)

= \$ 100 x 4.870 + \$ 1,000 x 0.026

= \$ 487 + \$ 26 = \$ 513

Current price of the bond should be = \$ 513.

b). Current price of the ordinary shares if average return of the industry is 9%.

Return of equity on the basis of growth model.

= + growth rate

= 8.84 + 4 = 12.84 % .

Current price of the equity shares = = \$ 142.66 per ordinary shares

c). Current price of Preference Shares

= = \$ 120

Week 7 :

1. Solution :
 Project 1 Project 2 PV @ 9% PV PV @ 9% Year 0 \$ -1,75,000.00 1.00 \$ -1,75,000.00 \$ -1,85,000.00 1.00 \$ -1,85,000.00 year 1 \$ 76,000.00 0.917 \$ 69,692.00 \$ 87,000.00 0.917 \$ 79,779.00 year 2 \$ 83,000.00 0.842 \$ 69,886.00 \$ 78,000.00 0.842 \$ 65,676.00 Year 3 \$ 67,000.00 0.772 \$ 51,724.00 \$ 69,000.00 0.772 \$ 53,268.00 year 4 \$ 65,000.00 0.708 \$ 46,020.00 \$ 65,000.00 0.708 \$ 46,020.00 Year 5 \$ 55,000.00 0.650 \$ 35,750.00 \$ 57,000.00 0.650 \$ 37,050.00 Net Present Value (NPV) \$ 98,072.00 \$ 96,793.00

As per the Net Present Value (NPV ), we should accept Project 1 as it has the highest NPV values.

b ).

 Project 1 Project 2 CFAT Cumulative CFAT CFAT Cumulative CFAT Year 0 \$ -1,75,000.00 \$ -1,85,000.00 year 1 \$ 76,000.00 \$ 76,000.00 \$ 87,000.00 \$ 87,000.00 year 2 \$ 83,000.00 \$ 1,59,000.00 \$ 78,000.00 \$ 1,65,000.00 Year 3 \$ 67,000.00 \$ 16,000.00 \$ 69,000.00 \$ 20,000.00 year 4 \$ 65,000.00 \$ 65,000.00 Year 5 \$ 55,000.00 \$ 57,000.00 Pay Back Period Pay Back Period 2.238806 Years 2.289855072 Years 2 years & 3 months 2 years & 4months

Based on the Payback period we should select project 1 as it has the lowest Pay Back Period.

But as the condition of the question has been given that it should be a maximum of 2 years than both the project will be rejected on this ground.

c).

The project will be chosen by the Giant Machinery if two methods in conflict.

As we know that in the country where we are having inflations in this situation the NPV is a tool where the discounted tech. has been adopted. A country where we are having no inflation normally in those types of the country normally we follow the non-discounting tech like payback periods, as we know that the payback period does not consider the post payback period cash flows. Hence if there are conflicts between these two methods then we will follow the NPV method for selection of the projects as it takes into consideration all the CFAT of the project while evaluating for the decision making.

Week 8 :

Solution:

The pre-tax cost of bonds when the WACC has been given.

WACC = WD x KD (1-tax ) + WE x KE

13.5% = +

13.5% = 0.31 x 0.65 Kd + 0.6896 x 17.6%

13.5% = 0.2015 Kd + 12.13 %

13.5% - 12.13% = 0.2015 Kd

1.37 % = 0.2015 Kd

Kd = 1.37% / 0.2015 = 6.8 %

Hence the pre tax Cost of Debt = 6.8 %

Week 9 :

Solution:

a). Calculate the Market value of the firms

Market value of the firm = Ordinary shares in the circulation x Shares prices

= 35,000 x \$ 47 = \$ 1,645,000 is total market value of the firm .

b). The capital structure of the Firms :

 Particulars Units Units Market Price of securities Total MV of securities Ordinary Shares 35000 \$ 47.00 \$ 16,45,000.00 Preference Shares 5000 \$ 58.00 \$ 2,90,000.00 Bond 4500 \$ 102.00 \$ 4,59,000.00 Capital Structure \$ 23,94,000.00

C ). Calculation of WACC

Cost of Equity Shares = 13.5 %

Cost of Preference shares =( = 12.068 %

Cost of the Bonds = Pre tax yield maturituty yield = 8.49 %

Post Tax Yield of Cost of Bonds = 8.49% ( 1 – 0.30 ) = 5.943 %

 Calculation of WACC Particulars Units Units Market Price of securities Total MV of securities Weighted Cost of Securities WACC Ordinary Shares 35000 \$ 47.00 \$ 16,45,000.00 0.6871345 13.50% 9.28% Preference Shares 5000 \$ 58.00 \$ 2,90,000.00 0.12113617 12.07% 1.46% Bond 4500 \$ 102.00 \$ 4,59,000.00 0.19172932 5.94% 1.14% Capital Structure \$ 23,94,000.00 WACC 11.88%

Week 10 :

Solution 10:

Amount of dividend payout ratio as per Residual Dividend policy.

Firms needed \$ 175,000 for next year.

Currently capital structure ratio is 65% equity & 35% debt.

Amount financed by the Debt = \$ 175,000 x 35% = \$ 61,250

Amount financed by the Equity = \$ 175,000x 65 % = \$ 113,750

Hence Amount Paid as dividend = NI – Equity Finance

= \$ 250,000 - \$ 113,750 = \$ 136,250

Dividend Payout Ratio = = 54.50 % .

b). When company is paying a dividend of \$ 2.50 per share and the

Tax on dividend is 15%

Then the share price of the company ex-dividend would reduce by = \$ 2.5 ( 1- 0.15)

= \$ 2.125 per shares.

Hence the Company ex-dividend shares price tomorrow morning probably

= \$ 25 – \$ 2.125 = \$ 22.875

c).

 Valuation of the company as it goes for liquidation Dividend Payout DV @ 12% Present Value Year 0 \$ 25,00,000 1 \$ 25,00,000 year 1 \$ 75,00,000 0.8928 \$ 66,96,000 Current Value of the Firm \$ 91,96,000 Total no of outstanding equity shares 15,00,000 Value per share \$ 6.131