MANAGEMENT OF COMAPANY FINANCE

Management of Company finance



Management of Company finance

Calculate WI's cost of debt, cost of equity and weighted average cost of capital (WACC) associated with a bid for Mutch ?

The cost of capital is the rate of return you should get the company on its investments to market value remains unchanged, given that this cost is also the discount rate of future corporate profits, which is why the corporate finance manager should be provided with the necessary tools to make decisions on future investments and therefore the most convenient to the organization(Hoffmanet.al,1989).

WACC= Kdwd (1-T) + weke

Where,

Kd= cost of debt

Wd= weighted of debt

T=Corporate Tax rate

We= weight of equity

Ke= Cost of Equity

The concept of cost of capital is one of the basic theory of financial management. It characterizes the level of return on invested capital, which should provide the company not to reduce its market value. The lower cost of funds, the higher the investment opportunities of the enterprise, the more profit it can earn from their projects, respectively, the higher its competitiveness and sustainable position in the market.

In addition, the cost of capital (with possible adjustments for inflation and risk) is often used as the discount rate, the analysis of future cash flows and assess the effectiveness of productive investment.

DATA AVAILABLE

Mutch Investment Opportunity

 

 

Amount of equity

GBP 1,000

Amount of debt

GBP 10,000

Tax rate

26%

Equity beta

3.80

 

 

Acquisition

 

 

 

% Debt

40%

% Equity

60%

Tax rate

26%

 

 

1+ (1-T)D/E

1.49

Project equity beta

3.80

 

 

Risk-free rate

3.40%

Market risk premium

5.10%

Average Market Return

8.50%

Calculating Cost of equity

Project equity beta

3.80

Market risk premium

5.10%

Equity risk premium

19.38%

Plus risk-free rate

3.40%

Cost of equity

22.78%

Calculating Cost of Debt

Cost of Debt Acquired from Loan

4.20%

Cost of Debt From Bond

3.40%

Legal & admin cost of Borrowing

1.20%

Cost of debt

8.8%

Calculation

Cost(K)

Weights

Weighted

Cost

 

 

 

 

After-tax cost of debt

6.5%

50.0%

3.3%

Cost of equity

22.8%

50.0%

11.4%

 

 

 

 

WACC

14.6%

Using the WACC as the discount rate, calculate the net present value of the acquisition on the basis of a five-year cash flow analysis (including the assumption that the business is sold at the end of year 5)?

Discount Rate=WACC=14.6%

 

 

 

 

 

 

 

Year

0

1

2

3

4

5

 

 

 

 

 

 

 

Cash flow

(1,067)

 

 

 

 

13500

PV factor

100%

100%

100%

100%

100%

100%

PV of cash flow

(1,067)

- - - - 13,500

Cumulative PV

(1,067)

- - - - 13,500

Net Present Value

12,433

 

 

 

 

 

 

 

 

 

 

 

 

Calculate the internal rate of return and the period of payback on the investment opportunity?

The easiest way to find IRR is to find a discount rate where NPV become ZERO (Buono, Bowditch, 1989).

IRR

66.14%

 

 

 

 

 

 

 

Year

0

1

2

3

4

5

 

 

 

 

 

 

 

Cash flow

(1,067)

 

 

 

 

13500

PV factor

100%

60%

36%

22%

13%

8%

PV of cash flow

(1,067)

- - - - 1,067

Cumulative PV

(1,067)

- - - - 1,067

Net Present Value

(0)

 

 

 

 

 

In the light of the results from questions two and three, discuss whether or not WI ought to proceed with the acquisition?

From NPV perspective accept the project when NPV > 0 if and only if IRR > Cost of Capital

From IRR perspective, accept the project when IRR is greater than the cost of capital

If and only if IRR > Cost of Capital

Here, in this case, both the conditions have been fulfilled, so we can conclude that WI should go for this acquisition. The NPV criterion is preferred over the criteria for IRR and ...