INTERNATIONAL FINANCE ASSESSMENT

International Finance Assessment

International Finance Assessment

Question # 1(a)

Thunderbolt Plc

Cash Flows (Amount in 000's)

Year

Revenue

Costs

Gross Profit

Interest

Net Cash Flow

Jan 2011

 

 

 

 

(2,000,000)

2011

1,200,000

650,000

550,000

33,000 517,000

2012

1,400,000

730,000

670,000

40,200 629,800

2013

2,400,000

1,130,000

1,270,000

76,200 1,193,800

2014

900,000

530,000

370,000

22,200 347,800

2015

1,400,000

730,000

670,000

40,200 629,800

2016

2,120,000

1,018,000

1,102,000

66,120 1,035,880

2017-2020

1,440,000

746,000

694,000

41,640 652,360

Totals

10,860,000

5,534,000

5,326,000

319,560

3,006,440

 

Discount rate

6%

NPV

1,849,828

IRR

28%

Thunderbolt Plc

WACC Calculation

 

Amount

Weights

Share

1,000,000

0.5

Debenture

500,000

0.25

Loan Stock

500,000

0.25

Total

2,000,000.00

 

Cost of Equity

Ke=D1/(P+g)

Ke

7.00%

Cost of Debentures

Kn

3.00%

Cost of Loan Stock

Kl

7.00%

Formula:

WACC

6.00%

Capital budgeting is one of the most important decisions that face a financial manager. Capital budgeting is the process of evaluating and selecting long-term investments that are consistent with the firm's goal of maximizing owner wealth.

Using NPV as the criteria by which to select projects assumes efficient capital markets so that the firm has access to whatever capital is needed to pursue the positive NPV projects. In situations where this is not the case, there may be capital rationing and the capital budgeting process becomes more complex. The NPV of a project measures the difference between the present value of the project's future cash flows and the present value of its costs.

According to the website Value Based Management, it is defined as “the difference between sums of discounted cash flows which are expected from the investment and the amount initially invested.” (Investopedia, 2007) If the value of NVP is equal to zero then the project is at a break-even point, if it shows a positive number then the shareholders value is the recipient of this increase. The one major advantage of NPV is that one can compare two mutually exclusively project or add projects together to evaluate many different options that the firm is considering. The NPV method has several other advantages going for it such as recognizing the time value of money and choices are decided based on being value maximizing to the firm and shareholders. The major disadvantage for NPV is that it does not account for flexibility or uncertainty in a project after the decision was concluded.

NVP is the best method for evaluating projects or investments for a firm. NPV values where shown in most of the example to demonstrate why it is superior over the other methods. In the case for table one; a great opportunity would be missed if the firm used Payback Rule for there would be no gain for shareholders if the two-year period were used as in this example verse NPV. The reason that IRR is less advantageous verse NVP is all the conditions that one must aware of or else an incorrect decision could be made. There is a new option on the horizon to help NVP correct some of it shortcomings; it is called Expanded (Strategic) NPV. This method use NPV plus the ability to account for the options of active management such as project abandonment and the different cost of funding over the life of the project.

The next method to look at is Payback Rule. This rule is designed to show how long it will take to recover the cost of investment for the ...