FIN301 Principles of Finance
Module 4 Case
CAPITAL BUDGETING AND CAPITAL STRUCTURE
Questions 1 and 2 for this assignment are computational in nature and require the use of Microsoft Excel. Questions 3 and 4 are conceptual in nature and do not require computations. Make sure to thoroughly review the required background readings and work through both the concepts and the computational examples. The videos on computing NPV and IRR using Excel along with the sample spreadsheet should also help. If you are unable to figure out how to make the computations in Excel, then you can get partial credit by computing the answers using a calculator and thoroughly explaining your steps. For conceptual questions, make sure to thoroughly explain the reasoning for your answers and to use references from the required background readings.
Case Assignment
Submit your answers to the following questions in a Word document, and also submit an Excel file with your computations for Questions 1 and 2:
The table below gives the initial investment (the negative numbers at “Year 0”) for two projects. Compute the payback period, the NPV, and the IRR using Excel. Then rank the two projects based on each of these three criteria, and discuss which projects should be funded based on your computations.
Firm Cost of Capital:
11%
Year
Project A
Project B
0
-100,000
-150,000
1
25,000
30,000
2
25,000
30,000
3
25,000
90,000
4
25,000
20,000
5
25,000
20,000
6
25,000
20,000
The ACME Umbrella Company is deciding between two different umbrella factories. Both factories will cost $500,000 to get started. However, the cash flows for each factory will depend on whether the next five years are rainier than average or sunnier than average. Factory A will have cash flows of $130,000 per year for the next five years if the weather is sunnier than average. But if it is rainier than average the cash flows will be $150,000 per year for the next five years. Factory B will have cash flows of $100,000 per year for the next five years if it is sunnier than average, but if it is rainier than average it will have cash flows of $200,000 per year. ACME has a cost of capital of 9%. Based on this information, calculate the following:
Calculate the NPV for both factories and for both scenarios (rainy versus sunny). What is the range of NPV for each factory based on your scenario analysis?
Based on your answer to a) above, do you think ACME should use the same discount rate of 9% for each factory? Or should they use a risk-adjusted discount rate (RADR)? If so, which factory should have a higher RADR? Explain your answer with references to the background readings.
Your neighbor Freewheeling Franklin has a very successful new internet-based technology company. While his company has great cash flow, you see Mr. Franklin has a collection of five expensive sports cars in his newly built garage. You also see him throwing some extravagant parties every weekend where he serves expensive champagne. Based on the required background readings such as Ross, et al. (2013)., explain how you would handle the following situations:
Mr. Franklin asks you for a loan to help expand his business and offers you an interest rate considerably higher than you would get from leaving your money in the bank. As a lender, what measures might you take to make sure you get your money back and Mr. Franklin won’t waste the money?
Mr. Franklin asks you to buy one-third of his company, and wants to use the money from selling this portion of the company to expand his business. As a shareholder, what steps might you take to make sure he spends his profits and the investment money you gave him wisely?
Suppose you own a new business and after a few rough years you now are making a solid profit of $150,000 per year and have built up some savings as well. While your business is successful, you realize that in order to expand and remain competitive you are going to have to raise a lot of money to invest in some new machinery and new stores. You have to decide between using your savings to finance your expansions and machinery upgrades, taking out a bank loan, or selling a portion of your equity to new investors. Explain the pros and cons of each of these three options in this situation, and make references to the required background readings such as Ross, et al. (2013).
Assignment Expectations
Answer the assignment questions directly.
Stay focused on the precise assignment questions. Do not go off on tangents or devote a lot of space to summarizing general background materials.
For computational problems, make sure to show your work and explain your steps.
For short answer/short essay questions, make sure to reference your sources of information with both a bibliography and in-text citations. See the Student Guide to Writing a High-Quality Academic Paper, including pages 11-14 on in-text citations. Another resource is the “Writing Style Guide,” which is found under “My Resources” in the TLC Portal.
FIN301 Principles of Finance
Module 4 SLP
CAPITAL BUDGETING AND CAPITAL STRUCTURE
For your final SLP, you will be doing some research on the capital structure of your four companies. You will also be doing an overall assessment of these four companies based on the research you did for your Module 1-4 SLPs.
Write a two- to three-page paper addressing the following issues:
Go to investing.com or a similar page and find the long-term debt to total equity and the total debt to equity ratios for your four companies. Investing.com should also give you the industry averages for these ratios. Based on these ratios, do your four companies have a greater relative debt load than the average of their industry? Do any of them seem at risk for bankruptcy?
How does the debt ratios align with the credit ratings you found for your Module 2 SLP or the beta that you found for your Module 3 SLP? Do the companies with higher debt ratios have lower credit ratings or larger betas, and do the companies with lower debt ratios have higher credit ratings and lower betas?
Finally, what is your overall assessment of your four companies based on your research for your Modules 1-4 SLPs? Which ones do you think are good investments based on your research? Which companies do you think are bad investments? Rank your four companies from best to worst investment. This part of the assignment should be at least one page.
SLP Assignment Expectations
Answer the assignment questions directly.
Stay focused on the precise assignment questions. Do not go off on tangents or devote a lot of space to summarizing general background materials.
For computational problems, make sure to show your work and explain your steps.
For short answer/short essay questions, make sure to reference your sources of information with both a bibliography and in-text citations. See the Student Guide to Writing a High-Quality Academic Paper, including pages 11-14 on in-text citations. Another resource is the “Writing Style Guide,” which is found under “My Resources” in the TLC Portal.
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