Corporate Finance Written Assignment #2

rd

Topic: Value

<Due date: Monday, 3 December 2012>

Member:
IM11Y009 LIU, Jiming (Rachel)
IM12Y011 NILJIANSKUL, Natt (Natt)

Answers to Q1:

(Remark: unit in all calculation in question 1, if not specificed, is in JPY)

Method: identify annual dividend identify market price per share from dividend yield identify market capitalisation
total down to accounting book value by market-to-book ratio

Annual dividend = 2 Semi-annual1 dividend [semi-annual = A semiannual event happens twice a year, typically every six months.]

= 2 30

= 60

Currently, Takao Inc.s stock yield 2% annually;

Dividend yield = DIV! P!

2% = 60 P!

Current price per share (P! ) = 3,000

With 25 million common shares outstanding;

Market capitalisation of Takao Inc. = Market value per share number of outstanding shares

= 3,000 25 millions

= 75 billions

Under a market-to-book ratio of 1.5, therefore:

1 Investopedia, Semiannual, http://www.investopedia.com/terms/s/semiannual.asp.

Page 1

Accounting book value of shareholders equity = 75 billions 1.5 = 50 billions

Answers to Q2:

(Remark: unit in all analyses below for question 2, if not specificed, is in JPY millions,
with the present value assessment conducted with a discount rate/compound annual interest rate r = 9%.
Payback period calculated from hereon out is a simple payback period with year as the only unit in consderation.)

(a)
Project A

FCF

Year 0
C! = 100

Year 1

Year 2

Year 3
C! = 145

PV of FCF

PV!"!#$ = 100

PV!"!#$ =

NPV!"!!"#$% NPV! = 100

NPV! = 100

NPV! = 100

PP

[]

[]

[]

!!
(!!!)!
!"#

(!!!%)!

= 111.97
NPV! = 100 +

111.97
= 11.97
[+]

From the table above, net present value became positive at Year 3; Payback Period = 3 years [Answer to (i)]
and net present value of the project (NPV!"#$%&' ! or NPV!"!!"#$% ) = NPV! = 11.97 [Answer to (ii)]
For this, we determine the internal rate of return of the project by zeroing NPV;
NPV!"#$%&' ! = PV(FCF!" ) + PV(FCF!" ) + PV(FCF!" ) + PV(FCF!" )
0 =

0 =

!!
(!!!"")!
!!""
(!!!"")!

!!
(!!!"")!
!"#

(!!!"")!

!!
(!!!"")!

!!
(!!!"")!

IRR = 13.19% [Answer to (iii)]

And we can determine the profitability index of this project as follow;
Page 2

PI =

!"#
!"#$%&'$"&

!"#!"#$%&' !
!!

!!.!"

!""

= 0.11967 or 11.97% [Answer to (iv)]

Project B

FCF

Year 0
C! = 100

Year 1
C! = 115

PV of FCF

PV!"!#$ = 100

PV!"!#$ =

(!!!)!
!!"

(!!!%)!

= 105.50
NPV! = 100 +

105.50
= 5.50
[+]

NPV!"!!"#$% NPV! = 100

PP

!!

[]

Year 2

Year 3

From the table above, net present value became positive at Year 1; Payback Period = 1 year [Answer to (i)]
and net present value of the project (NPV!"#$%&' ! or NPV!"!!"#$% ) = NPV! = 5.50 [Answer to (ii)]
For this, we determine the internal rate of return of the project by zeroing NPV;
NPV!"#$%&' ! = PV(FCF!" ) + PV(FCF!" )
0 =

0 =

!!
(!!!"")!
!!""
(!!!"")!

!!
(!!!"")!
!!"

(!!!"")!

IRR = 15.00% [Answer to (iii)]

And we can determine the profitability index of this project as follow;
PI =

!"#
!"#$%&'$"&

!"#!"#$%&' !
!!

!.!"
!""

= 0.05504 or 5.50% [Answer to (iv)]

Project C

FCF

Year 0
C! = 100

Year 1
C! = 230

Year 2
*C

Year 3

! = 120
(* = this cash flow is a
result from operation,
not from an investing
activity)

Page 3

PV of FCF

PV!"!#$ = 100

PV!"!#$ =

(!!!)!

!"#
(!!!%)!

PV!"!#$ =

= 211.01
NPV! = 100 +

211.01
= 111.01

NPV!"!!"#$% NPV! = 100

PP

!!

[]

!!

(!!!)!
!!"#

(!!!%)!

= 101.00
NPV! = 100 +

105.50 +

101.00
= 10.01

[+]

From the table above, net present value became positive at Year 1; Payback Period = 1 year [Answer to (i)]
and net present value of the project (NPV!"#$%&' ! or NPV!"!!"#$% ) = NPV! = 10.01 [Answer to (ii)]
For this, we determine the internal rate of return of the project by zeroing NPV;
NPV!"#$%&' ! = PV(FCF!" ) + PV(FCF!" ) + PV(FCF!" )
0 =

0 =

!!
(!!!"")!
!!""
(!!!"")!

!!
(!!!"")!
!"#
(!!!"")!

!!
(!!!"")!
!!"#
(!!!"")!

IRR = 50.00% [Answer to (iii)]

And we can determine the profitability index of this project as follow;
PI =

!"#
!"#$%&'$"&

!"#!"#$%&' !
!!

!".!"
!""

= 0.10008 or 10.01% [Answer to (iv)]

Project D

FCF

Year 0
C! = 45

Year 1
C! = 20

PV of FCF

PV!"!#$ = 45

PP

[]

Year 3
C! = 20

PV!"!#$ =

NPV!"!!"#$% NPV! = 45

Year 2
C! = 20

!!
(!!!)!

!"
(!!!%)!

PV!"!#$ =

!!
(!!!)!

!"
(!!!%)!

= 18.35
NPV! = 45 +

18.35
= 26.65

= 16.83
NPV! = 45 +

18.35 +

16.83
= 9.82

[]

[]

PV!"!#$ =

!!
(!!!)!
!"

(!!!%)!

= 15.44
NPV! = 45 +

18.35 +

16.83 +

15.44
= ~5.63
[+]

Page 4

From the table above, net present value became positive at Year 3; Payback Period = 3 years [Answer to (i)]
and net present value of the project (NPV!"#$%&' ! or NPV!"!!"#$% ) = NPV! = 5.63 [Answer to (ii)]
For this, we determine the internal rate of return of the project by zeroing NPV;
NPV!"#$%&' ! = PV(FCF!" ) + PV(FCF!" ) + PV(FCF!" ) + PV(FCF!" )
0 =

0 =

!!
(!!!"")!
!!"
(!!!"")!

!!
(!!!"")!
!"
(!!!"")!

!!
(!!!"")!
!"
(!!!"")!

!!
(!!!"")!
!"
(!!!"")!

IRR = 15.89% [Answer to (iii)]

And we can determine the profitability index of this project as follow;
PI =

!"#
!"#$%&'$"&

!"#!"#$%&' !
!!

!.!"
!"

= 0.12502 or 12.50% [Answer to (iv)]

Project E

FCF

Year 0
C! = 40

Year 1

Year 2
C! = 75

**C = 60
!

Year 3
C! = 70

(** = this cash flow is

a result from initial
investment, not from
an operating activity)

PV of FCF

PV!"!#$ = 40

PV!"!#$ =

NPV!"!!"#$% NPV! = 40

PP

[]

!!
(!!!)!
!!"

(!!!%)!

PV!"!#$ =

!!
(!!!)!
!"

(!!!%)!

= 55.05
NPV! = 40 +

55.05
= 95.05

= 63.13
NPV! = 40 +

55.05 +

63.13
= 31.92

[]

[]

PV!"!#$ =

!!
(!!!)!
!"

(!!!%)!

= 54.05
NPV! = 40 +

55.05 +

63.13 +

54.05
= 22.13
[+]

From the table above, net present value became positive at Year 3; Payback Period = 3 years [Answer to (i)]
and net present value of the project (NPV!"#$%&' ! or NPV!"!!"#$% ) = NPV! = 22.13 [Answer to (ii)]
For this, we determine the internal rate of return of the project by zeroing NPV;
NPV!"#$%&' ! = PV(FCF!" ) + PV(FCF!" ) + PV(FCF!" ) + PV(FCF!" )
Page 5

 0 =

0 =

!!
(!!!"")!
!!"
(!!!"")!

!!
(!!!"")!
!!"
(!!!"")!

!!
(!!!"")!
!"
(!!!"")!

!!
(!!!"")!
!"
(!!!"")!

IRR = 21.82% [Answer to (iii)]

And we can determine the profitability index of this project as follow;
PI =
(*)

!"#
!"#$%&'$"&()

!"#!"#$%&' !
!! !!"(!! )

!!.!"
!"!!!.!"

= 0.23287 or 23.29% Answer to (iv)]

= The Investment component for calculating PI has to take into account all the initial outlay which in this case consist of cash outflow in year 0 and

year 1.

(b)

According to (a), we summarise the result and rank from different vaulation methods in the table below:

Project
A
B
C
D
E

(**)

(**) Simple payback

period (simple PP)

3
[3 (4)]
1
[1 (2)]
1
[1 (1)]
3
[3 (3)]
3
[3 (5)]

Net present
value (NPV)
11.97 [2]
5.50 [5]
10.01 [3]
5.63 [4]
22.13 [1]

Internal rate of
return (IRR)
13.19%
[5]
15.00%
[4]
50.00%
[1]
15.89%
[3]
21.82%
[2]

Profitability index Profitability index

(PI)
in % (PI in %)
0.11967
[3]
11.97%
0.05505
[5]
5.50%
0.10008
[4]
10.01%
0.12502
[2]
12.50%
0.23287
[1]
23.29%

= For the purpose of disambiguity, we give the ranking of 1-2-3-4-5 in the parenthesis inside the bracket as the exact payback period can be

determined by accruing monthly cash flow.

NB numbers in brackets behind each result denote the rank in the respective valuation methods. We shaded
the cells to emphasise the top 1 & 2 ranks and also by bolding + double-underlining for top rank, and single-
underlining for rank 2, respectively. The rest remain with normal formatting.

Answers to Q3:

(Remark: unit in all analyses below for question 3, if not specificed, is in RMB million)

(a)

Constant stream of cash flow of 4.3 for 12 years (12 years annuity inflow) in-which such point, the
facility does not generate any further cash flow from an initial outlay of 21.2 with a discount rate of 14%
based on the project cost of capital; C! = 21.2, C! to C!" = 4.3, r = 14%
Page 6

NPV of this project (calculate to termination at year 12)

= PV(FCF!" ) + PV(FCF!" ) + PV(FCF!" ) + PV(FCF!" ) + + PV(FCF!" )
=

!!
!!!

!!".!
!!!"%

!!
!!!

!!
!!!

!.!
!!!"%

!!
!!!

!.!
!!!"%

+ +

C12
(1+)

!.!
!!!"%

12

+ +

4.3
(1+14%)

12

= RMB 3,139,256.14

(b)

The 10% fixed rate loan from the bank is not the project cost of capital.

Reason/explanation: First of all, it is the company that owns the project while the bank is only the lender not
the owner of the project. Therefore, the 10% rate cannot be the cost of capital for this project as this financing
option was granted to the company instead of the project. Next, the company existing cost of capital of 14% has
to be re-evaluate to reflect the investment activity making in this facility expansion project as the capital
structure has changed by taking the loan. As a result of taking this on to the project i.e. investing and executing
the project, the re-evaluation affect the project cost of capital as risk is altered both in the big picture (the
company) and the small picture (the project.) Also, in our opinion, it is very risky for the company to consider
this 10% as a cost of capital of the project and it will even be more risky if the company adopt this risk attitude
to take loan to finance the future project instead of considering other financing option that can bring down the
overall big picture risk as well as the small picture risk, had they presume that the bank loan interest rate will
eventually become the project cost of capital.

(c)

At year 8, the built facility is only going to generate cash flows at the end of that year towards the end of
year 12. However, cash flow generating in year 8 will belong to the company per the point of time
assumed by the question (please see the note below for further explanation.) To determinine net
present value of this project at year 8, we only take into account cash flow from the end of year 9 to
year 12 with all the parameters the same as (a), neglecting cash flow generate in year 8, and therefore
we start to discount the cash flow from at the end of year 9 (at year 8, n = 0); C! (year 9) to C! (year 12)
= 4.3, r = 14%

NPV of this project (calculate at the end of year 8)

= PV(FCF!" ) + PV(FCF!"# ) + PV(FCF!"" ) + PV(FCF!" )
=

!!
!!!

!.!
!!!"%

!!
!!!

!!
!!!

!.!
!!!"%

!!
(!!!)!
!.!

!!!"%

!.!
(!!!"%)!

= RM B 12,528,962.91

Page 7

NB per the assumption given by the question (It is now eight years later), prior investments and/or prior
cash flows generated are already sunk, whereas cash flow generate in year 8 belongs to the company and does
not serve the purpose for asset valuation if the facility is to be put on sale.

Answers to Q4:

(Remark: unit in all calculation in question 4, if not specificed, is in JPY million)

(a)

Project
L
O
S
E
R
Z

To determine the attractiveness of each project the Kittens should invest in, we will advise them with
our criteria based on profitability index. For this purpose, we have prepared a summary table for them
with ranking of attractiveness below:
Investment
(C! )
(100)
(400)
(300)
(200)
(200)
(200)

Net present value

(NPV)
8
43
25
23
21
19

Internal rate of return

!"#
Profitability index (PI =
)
(IRR)
!"#$%&'$"&
13.9
0.08000 or 8.00%
[6]
14.4
0.10750 or 10.75% [2]
16.0
0.08333 or 8.33%
[5]
14.1
0.11500 or 11.50% [1]
16.1
0.10500 or 10.50% [3]
15.7
0.09500 or 9.50%
[4]

NB numbers in brackets behind profitability index denote the attractiveness ranking. We shaded the cells to
remark to the Kittens that their fund should be distributed in those projects only.
With respect to the rankings above, we would like suggest the Kittens distribute their investment (900 million)
by the following;
- [1] Project E: invest 200 million 100% of maximum allowed amount by project E (700 million
remained in the Kittens fund after making this investment)

- [2] Project O: 400 million 100% of maximum allowed amount by project O (300 million remained
in the Kittens fund after making this investment)

- [3] Project R: 200 million 100% of maximum allowed amount by project R (100 million remained
in the Kittens fund after making this investment)

- [4] Project Z: 100 million 50% of maximum allowed amount by project Z (The Kittens fund
depletes after making this investment)

(b)

Under the new circumstance; payout rate = 75%

Page 8

Expected NPV
(if investing 100%
to the project)
23
43
21
19

Project
E
O
R
Z

Amount to be Allowed amount by the project;

Expected NPV for the
invested by
in [], % of the allowed amount
Kittens investment
the Kittens
to be invested by the Kittens
200
200 [100%]
100% 23 = 23.00
400
400 [100%]
100% 43 = 43.00
200
200 [100%]
100% 21 = 21.00
100
200 [50%]
50% 19 = 9.50
Total NPV for the chosen projects = 96.5

Answers to Q5:

(Remark: unit in all calculation in question 5, if not specificed, is in $ million

with the present value assessment conducted with a discount rate/compound annual interest rate
r = 8% according to MSD, Inc.s weighted average cost of capital, under a corporate tax rate of 35%)

First, determining free cash flow from year 1 to year 4;

(*)

Free cash flow = EBIT 1 tax + Depreciation CAPEX change in working capital

FCF!" = 37.50 (1 35%) + 3.00 3.75 1.00(*) = 22.63

FCF!" = 48.81 (1 35%) + 3.00 5.74 2.65(*) = 26.34

FCF!" = 58.30 (1 35%) + 3.50 2.30 1.44(*) = 37.66

FCF!" = 62.10 (1 35%) + 3.05 3.35 + 2.10(**) = 40.17

= Positively increased in working capital means decreased in cash and therefore have negative impact to FCF as denoted by the negative sign.

(**)

= Negatively increased in working capital means decreased in cash and therefore have negative impact to FCF as denoted by the negative sign.

Second, determine free cash flow in year 5 given that the cash flow in year 5 grows over cash flow in year 4
under the same percentage of growth back from year 3 to year 4;

FCF!" = FCF!" (1 + g !"!!"!!" ) = 40.17 (1 +

!".!" ! !".!!
!".!!

) = 42.84

Third, determine free cash flow in year 6 given that the cash flow in year 6 will growsover cash flow in year 5
by only 2%;

FCF!" = FCF!" (1 + g) = 42.84 (1 + 2%) = 43.70
Fourth, determine valuation of MSD, Inc., the company, by DCF methodology;

NPV or P0 = PV(FCF!" ) + PV(FCF!" ) + PV(FCF!" ) + PV(FCF!" ) + PV(FCF!" ) + PV(horizon value)

=

!!
(!!!)!

!!
(!!!)!

!!
(!!!)!

!!
(!!!)!

!!
(!!!)!

!!
(!!!)!

!!
(!!!)!

!"!
(!!!)!

Page 9

!
(!!!%)!

!!.!"
(!!!%)!

CH
(rg)(1+r)

!".!"
(!!!%)!

!".!!
(!!!%)!

!".!"
(!!!%)!

!".!"
(!!!%)!

!".!"
(!!!%)!

= 0 + 20.95 + 22.58 + 29.89 + 29.52 + 29.04 + 27.43 +

43.70(1+2%)
(8%2%)(1+8%)

= 627.78
However, since the company is having a net debt of $25 million (not debt-free), valuation of equity has to be
adjusted for the debt portion i.e. in this case equal to adjusted net asset or in other words, asset that adjusted
out net debt.

Therefore, MSD, Inc.s estimated value of equity P(equity) = Adjusted net asset
= P0 Net debt
= 627.78 25.00
= 602.78

Page 10