FINANCIAL MANAGEMENT

Financial Management



Financial Management

Question 1(a)

Nominal cost of capital is calculated as a weighted average of the pre-company tax costs of liability and equity, with weights identical to the percentages of liability and equity observed in what are judged to be comparable personal part firms. This weighted average cost of capital is then converted to real terms by subtracting the expected rate of inflation (Lally, 1995). The resulting real cost of capital is:

Nominal cost of capital = cost of financing (vanilla bonds) + country risk premium

=[I (1 - T)/SV] * 100% + 4.7%(real terms)

Annual Interest Payment (coupon rate 8%) = 8% of 2380 million LKR

= 190.4 million LKR

Corporate Tax Rate = 28% = 0.28

Principle at par + premium= 2380 million LKR + 6% of 2380 million LKR

=2380 million LKR + 142.8 million LKR

=2522800000 LKR

Therefore,

Nominal cost of Capital = (190.4 million (1-0.28)/2522800000) × 100% + 4.7%

= 5.4% + 4.7%

Nominal cost of Capital = 10.13% --- (1)

Question 1(b)

Discount Rate

=

10.13%

Taken from(1)

Cash Flows

Year

(in millions LKR)

0

-2380

1

1133.6

2

1134.05344

3

1134.507061

4

1134.960864

5

1135.414849

NPV

=

2,951.99

IRR

=

38%

Assumption: The discount rate is taken from the nominal cost of capital from (1).

The net present value of an earnings stream is the addition of the present values of the one-by-one allowances in the earnings stream. Each future earnings allowance in the stream is discounted, significance that it is split up by a number comprising the opportunity cost of holding capital from now (year 0) until the year when income is obtained or the outgo is spent. The opening cost can either be how much you would have acquired buying into the cash someplace additional, or how much concern you would have had to yield if you scrounged money.

A positive net present value means this investment is better. A negative net present value means your alternative investment, or not borrowing, is better. As mentioned in the above table, the NPV of the above project is 2951 million (which is positive. This implies that the project is worth pursuing.

Question 1 (c)

It does not provide a full cross-classification of so-called adjustment lending with the "poverty spells." It is not mentioned that developing countries have had few or no such loans and developed countries have had a large number.

Whenever we make an expenditure that engenders a cash flow gain for more than one year, this is a capital expenditure. Capital expenditures often include large cash outlays with greatest inferences on the future ideals of the company. Additionally, one time we entrust to establishing a capital expenditure it is at times arduous to back-out. Therefore, we want to very carefully examine and estimate recommended capital expenditures.

Question 1 (d)

One of the major risks involved in this project is that all the amount is financed through bonds and Easterly plc is neglecting other options like taking debts and/or issuing shares. These kind of financing options can be helpful in mitigating the risk of this partiuclar project.

Adjusting for Risk

It is worth noting that indecision and risk is not the matching thing. Uncertainty is where you have no foundation for a ...