Student Number ______________________________________________

MAN706 PRFIT DETERM. & FINANCIAL ANALYSIS

Individual Tutorial Task 3 (Take Home)
Due Date: 12 October 2020

Time: 90 minutes Total marks: 30

Instructions:
Answer all questions
Where calculations are required, show your working.
You can either type your answers or handwrite them, whichever is easier for you.
Write your student number on each answer sheet used.

Question 1 (5 marks)

Times are tough for Auger Biotech. Having raised $85 million in an initial Public
Offering of its stock early in the year, the company is poised to launch its product. If
Anger engages in a promotional campaign costing $60 million this year, its annual
after-tax cash flow over the next five years will only be $70,000. If it does not
undertake the campaign, it expects its after-tax cash flow to be minus $18 million
annually for the same period. Assuming the company has decided to stay in its
chosen business, is this campaign worthwhile when the discount rate is 10 percent?
Why or why not? (5 marks)

Question 2 (9 marks)

You have the following information about Burgundy Basins, a sink manufacturer.

Equity shares outstanding 20 million

Stock price per share $40.00
Yield to Maturity on debt 7.5%
Book value of interest-bearing debt $320 million
Coupon interest rate on debt 4.8%
Market value of debt $290 million
Book value of equity $500 million
Cost of equity capital 14%
Tax rate 35%

Burgundy is contemplating what for the company is an average-risk investment

costing $40 million and promising an annual after-tax cash flow of $6.4 million in
perpetuity.

a) What is the internal rate of return on the investment? (3 marks)

b) What is Burgundy’s weighted-average cost of capital? (3 marks)
c) If undertaken, would you expect this investment to benefit shareholders? Why
or why not? (3 marks)

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Student Number ______________________________________________

Question 3 (16 marks)

(You will need a computer for this problem.) The following information is available
about an investment opportunity. Investment will occur at time 0 and sales will
commence at time 1.

Initial cost $28 million

Unit sales 400000
Selling price per unit, this year $60.00
Variable cost per unit, this year $42.00
Life expectancy 8 years
Salvage value $0
Depreciation Straight line
Tax rate 37%
Nominal discount rate 10.00%
Real discount rate 10%
Inflation rate 0%

a. Prepare a spreadsheet to estimate the project’s annual after-tax cash flows.

(3 marks)
b. Calculate the investment’s internal rate of return and its NPV. (3 marks)
c. How do your answers to questions (a) and (b) change when you assume a
uniform inflation rate of 8 percent a year over the next 10 years? (Use the
following equation to calculate the nominal discount rate:
i n=( 1+i r ) ( 1+ p )−1 , where i n is the nominal discount rate, i r is the real discount
rate, and p is expected inflation.) (6 marks)
d. How do you explain the fact that inflation causes the internal rate of return to
increase and the net present value to decrease? (2 marks)
e. Does inflation make this investment more attractive or less attractive? Why?
(2 marks)

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