Business Question

1 Unit-4 Assignment Mit Dani Purdue University Global GB550-01 Financial Management Sinan Yildirim 04/30/24 2 Evaluating Investment Projects Question One The estimated cost of common equity using CAPM can be obtained as follows: 𝐶𝑜𝑠𝑡 𝑜𝑓 𝑒𝑞𝑢𝑖𝑡𝑦 = 𝑅𝑖𝑠𝑘𝑓𝑟𝑒𝑒 𝑟𝑎𝑡𝑒 𝑜𝑓 𝑟𝑒𝑡𝑢𝑟𝑛 − 𝐵𝑒𝑡𝑎 × (𝑀𝑎𝑟𝑘𝑒𝑡 𝑅𝑒𝑡𝑢𝑟𝑛 − 𝑅𝑖𝑠𝑘𝑓𝑟𝑒𝑒 𝑅𝑎𝑡𝑒 𝑜𝑓 𝑅𝑒𝑡𝑢𝑟𝑛 𝐶 = 4% + 0.08(15% − 3%)=4.96% Question Two 12% 0 1 2 3 4 5 6 7 8 8 $ (60,000.00) $ 10,000.00 $ 10,000.00 $ 10,000.00 $ 10,000.00 $ 10,000.00 $ 10,000.00 $ 10,000.00 $ 10,000.00 IRR NPV $ (10,323.60) PV $49676.40 a. Finding NPV Initial investment: $60,000 6.876% 3 Cash flow per year: $10,000 Number of years: 8 Discount rate : 12%. NPV calculation using Excel: 𝑁𝑃𝑉 = 10000 10000 10000 10000 10000 10000 10000 10000 + + + + + + + − 60000 1.12 1.122 1.123 1.124 1.125 1.126 1.127 1.128 = −$10,323.60 b. Finding IRR Calculating IRR on Excel: I𝑅𝑅 = 𝐼𝑅𝑅(𝐵3: 𝐵11) = 6.88% c. Finding MIRR Finding MIRR on Excel: = 𝑀𝐼𝑅𝑅(𝐵3: 𝐵11, 𝐵1, 𝐵12) = 6.88% d. Project’s PI Profitability index of the project is given by: 𝑃𝑉 𝑜𝑓 𝐹𝑢𝑡𝑢𝑟𝑒 𝐶𝑎𝑠ℎ 𝐹𝑙𝑜𝑤𝑠 ; 𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡𝑠 == 𝑃𝑉(𝐴1, 𝐵1, 𝐵11,0,0) $49676.40 = = 0.83 60,000 60000 e. Project’s payback period 𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 $60,000 𝑃𝑎𝑦𝑏𝑎𝑐𝑘 𝑝𝑒𝑟𝑖𝑜𝑑 = Annual Cash flow = $10,000 = 6 𝑦𝑒𝑎𝑟𝑠 4 f. Project’s discounted payback period 𝑈𝑛𝑟𝑒𝑐𝑜𝑣𝑒𝑟𝑒𝑑 𝑎𝑚𝑜𝑢𝑛𝑡 0 𝐷𝑖𝑠𝑐𝑜𝑢𝑛𝑡𝑒𝑑 𝑃𝑎𝑦𝑏𝑎𝑐𝑘 𝑝𝑒𝑟𝑖𝑜𝑑 = 𝑌𝑒𝑎𝑟𝑠 𝑢𝑛𝑡𝑖𝑙 𝐵𝑟𝑒𝑎𝑘 𝑒𝑣𝑒𝑛 + 𝑅𝑒𝑐𝑜𝑣𝑒𝑟𝑦 𝑌𝑒𝑎𝑟 𝐶𝑎𝑠ℎ 𝐹𝑙𝑜𝑤 = 6 + 6 = 6 𝑦𝑒𝑎𝑟𝑠 Question Three Part (a) Initial Investment = -$20,000,000 Cash Flows: Year 1: $5,000,000 Year 2: $10,000,000 Year 3: $20,000,000 For Project B: Initial Investment = -$20,000,000 Cash Flows: Year 1: $20,000,000 Year 2: $10,000,000 Year 3: $6,000,000 5 NPV when Cost of capital is 5% Project A: 5000000 10000000 20000000 + + − 20,000,000 = $31,108,951.52 − 20,000,000 1.051 1.052 1.053 𝑁𝑃𝑉𝐴 = = $11,108,951.52 Project B 𝑁𝑃𝑉𝐵 = 20000000 10000000 6000000 + + − 20000000 = $13,300,939.42 1.051 1.052 1.053 NPV when Cost of capital is 10% Project A: 𝑁𝑃𝑉𝐴 = 𝑁𝑃𝑉𝐵 = 5000000 1.11 + 10000000 1.12 + 20000000 1.13 − 20,000,000 = $7836213.37 20000000 10000000 6000000 + + − 20000000 = $10954169.80 1.11 1.12 1.13 NPV when Cost of capital is 15% Project B: 𝑁𝑃𝑉𝐴 = 𝑁𝑃𝑉𝐵 = 5000000 1.151 + 10000000 1.152 + 20000000 1.153 − 20,000,000 = $5,059,587.41 20000000 10000000 6000000 + + − 20000000 = $8,897,838.42 1.151 1.152 1.153 Part (b) IRR for Project A =IRR(B3:B6); IRR for Project B =IRR(E3:E6) Year 0 1 2 3 Project A CF $ (20,000,000.00) $ 5,000,000.00 $ 10,000,000.00 $ 20,000,000.00 Year 0 1 2 3 Project B CF $ (20,000,000.00) $ 20,000,000.00 $ 10,000,000.00 $ 6,000,000.00 6 IRR 26.73% IRR Therefore, 𝐼𝑅𝑅𝐴 = 26.73% 𝑎𝑛𝑑 𝐼𝑅𝑅𝐵 = 47.63% 47.63%