North South University

EMB 660
Corporate Finance
Final Assignment
Fall 2020
Deadline: January 20, 2021 (Late assignment submission gets an incomplete. You may use
Excel to solve problems. Do not break the sequence in answering questions.)

1. Villadella Pharmaceuticals Limited believes in a target capital structure of 40 percent debt and
60 percent equity. It has been a highly successful business generating a ROE of 32 percent. Current
share price in the market is Tk 220. Usually, 60 percent of the profits are returned to the shareholders
as dividend. EPS for the latest year is Tk 36. The cost of debt is 14 percent for the company and its
marginal tax rate is 30 percent.

a) Determine the cost of retained earnings, k e.

b) What is the WACC of Villadella?

2. Mazar Corporation applies Certainty Equivalent approach for evaluating high risk projects. The
following cash flows are estimated for one such high-risk project: Year 1 = Tk 88,000, Year 2 = Tk 95,000,
Year 3 = Tk 110,000, Year 4 = Tk 120,000, Year 5 = Tk 125,000, and Year 6 = Tk 105,000. The initial outlay
was estimated to be Tk 230,000. The following are the certainty equivalent coefficients for the six years:
.9, .9, .8, .8, .7, and .6. The WACC is 20 percent and the risk-free rate is 11 percent.

a. Determine the certainty equivalent NPV of the project.

b. Should the project be selected? Why? Provide proper interpretation of your decision.
c. What are the long-term effects of relying on one discount rate for all projects and no
adjustment is made for risk?

3. Modernization of a production system will require purchasing and installing a new German machine.
The purchase price of the proposed new machine is Tk 9,80,000. Shipping and installation costs are
estimated to be Tk 2,00,000. It will take an additional Tk 72,000 to modify it for use in the production
plant. It will replace an old equipment that currently has a book value of Tk 35,000. It can be sold for
net of Tk 1,30,000 now. The new equipment will require an incremental investment of Tk 2,00,000 in
working capital. Marginal tax rate is 30 percent.
Determine the initial Outlay, IO, for the investment proposal.

4. Explain how capital budgeting decisions are made (that is, decision rules adjusted) in
mutually exclusive situations if
a) Project sizes are very different.
b) Project lives are different.
A. Project risk are different.
5. The new parts may be manufactured either with a German Machine or with an Swedish
Machine. The Initial Outflow and future flows are given below:
Year CF (German) CF (Swedish)
0 (180,000) (150,000)
1 25,000 40,000
2 37,500 45,000
3 45,000 50,000
4 70,000 55,000
5 90,000 60,000
6 110,000 60,000
7 125,000 70,000

a. Determine the IRR of the two projects.

b. Determine the Cross-over Rate.
c. Compute the NPVs of the two options using discount rate starting with 10% going up to 28%
using only even rates (that is, 10%, 12%, 14%….)
d. Draw the NPV profile of the two projects on the same graph showing the IRR and Cross-over
rates.
e. If the cost of capital is 18 percent, which machine should be selected? Fully explain.
Assume equal risk.
f. Discuss all the reasons why we prefer NPV to IRR.

6. Andover Limited is planning to bid for an 8-year government contract. The contract will pay Tk
40,000 next year. The payment will increase by Tk 5,000 every year until the final year. The
equipment required to supply the product will require an investment of Tk 1,30,000 now, but it will
last for only four years. Therefore, if Andover Ltd. bids for the contract, it must plan to reinvest in
the same equipment in the 4th year, but equipment cost in the 4th year will increase to Tk 150,000.
There will be a net after-tax salvage value of Tk 30,000 at the end of the 8 th year. The initial
investment of Tk 9,000 in net working capital will be returned.
a) Determine the IRR of the project.
b) Using a financing rate of 16 percent, determine the MIRR.
c) Determine the NPV of the project at 16 percent.
d) Make a recommendation statement about the bid.

7. Project X and Y are mutually exclusive, and it is reasonable to assume indefinite life for both
projects. X is a five-year project with a net present value of Tk 6,405.63. Project Y is a 7-year
project with a net present value of Tk 7,378.84. The NPV estimates are based on a discount
rate of 18 percent. Both projects are average risk projects.
a. Determine the equivalent annual annuity of the two projects.
 b. Which project should be selected and why? (Must be the right reason).
8. The following table shows the risk classes of seven projects and the IRR estimates. The firm’s WACC
is 20 percent. The firm has a policy of adding 3 percent to WACC for increasing level of risk and deduct 3
percent for the decreasing level of risk. The company has a policy of classifying capital budgeting
projects in five risk groups, each group having a discount rate differential of 3 percent from the next
group. Identify which projects are to be accepted and which are to be rejected. Provide detailed
decision statement for projects individually.

Project Risk Class IRR

M Above Average 22.4 %
N Average 20.8 %
P Highest 30.9 %
Q Below Average 15.97%
R Average 20.9
S Lowest 14.8
T Above average 22.4

9. Mandaloy Corporation is considering an investment for expansion of capacity. Currently

the annual revenue of the company is Tk 1,20,35,000. The investment will make Mandaloy a
company with an annual sales of Tk 2 crore. The initial Investment required is estimated at Tk
67,00,000 that includes investment in net working capital, shipping, and installation. The
equipment will have a life of 6 years. Cost of Goods sold is normally 45 percent. Cash
administration, selling and marketing cost, and all other indirect cost generally turn out to be
about 25 percent of revenue. The equipment is to be depreciated over 6 years using the
following rates: 20%, 32%, 19%, 12%, 11%, and 6 percent. Depreciable Basis is Tk 60,00,000.
Tax rate is 32 percent. Total terminal year non-operating cash flow at the end of the 6 th year is
10,20,000.
(a) Determine the periodic cash flows for 6 years.
(b) After adjusting the final year business cash flows with terminal year non-operating cash
flows, determine the IRR and NPV of the project. Use a discount rate of 22 percent.
Assume average risk.
(c) State your decision.
10. Maskulka Corporation currently has a production volume of 400,000 per year which is
expected to go up by 15% next year. Fill up the blank cells and compute EPS.

Volume 400,000 460,000

Price per unit 50 50
Sales 20,000,000 23,000,000
Variable Cost 45% 9,000,000
Gross Profit 11,000,000 12,650,000
Fixed Cost 1,200,000 1,200,000
Depreciation 1,000,000 1,000,000
EBIT 10,450,000
Interest 2,500,000 2,500,000
EBT 6,300,000 7,950,000
Taxes 35% 2,782,500
Net Income 4,095,000
Number of shares 900,000 900,000
EPS

(Interpretation needed.)
a. Compute the Degree of Operating Leverage.
b. Compute the Degree of Financial Leverage.
c. Compute the Degree of Total Leverage

10. Treemont Partners are in the business of building gas stations and selling the after 3
years of operation. Their required return on investments currently is 18 percent. A project in
the Ocaloosa neighborhood is expected to cost Tk 12,50,000. The net after-tax cash flow
expected in the first year is Tk 50,000. The project will be fully operational in the second year
and will generate Tk 1,28,000. The third year cash flow will increase by 40 percent, and after
that, the growth rate will match the expected inflation rate of 6 percent.
a. Determine the terminal value of the project at the end of the third year of operation.
b. Prepare a table of cash flows.
c. Determine the net present value of the project.
d. State a recommendation.
11. Shalala Corporation has a target capital structure of 40% debt, 60% equity. It also has a
policy of never having a TIE ratio below 6. Currently, its capital structure consists of Tk
8,00,00,000 in Equity and Tk 3,00,00,000 in debt. Currently, the rate on this debt is 11%
annually. The expected retained earnings for this year (not included in the above equity figure)
is Tk 1,00,00,000. Shalala will need to raise an additional Tk 4,00,00,000 in new capital.
(d) What is the available debt capacity of Shalala using the debt ratio test?
(e) Assuming 13% interest cost on new debt, what is the available debt capacity using TIE Test?
Expected EBIT is Tk 3,00,00,000.
(f) How much new debt can Shalala add and still stay within the policy limits of its capital
structure and TIE ratio?

12. Sinclair Corporation has approached its investment banker to raise Tk 2,50,000 in new
capital. The investment banker advised Sinclair that if new bonds are issued, they need to carry
an interest rate of 14 percent. Alternatively, the amount may be raised by selling shares each
share netting Tk 16. Currently, Sinclair has 72,000 shares outstanding and has debt amounting
to Tk 9,00,000 carrying an interest rate of 12 percent. Tax rate is 30 percent.

(a) Prepare a table showing the EPS values assuming (A) Tk 2,50,000 is raised by selling new
common shares. Use EBIT values of Tk 2,50,000 and Tk 3,50,000.
(b) Prepare a table showing the EPS values assuming (B) Tk 2,50,000 is raised by selling new
bonds. Use EBIT values of Tk 2,50,000 and Tk 3,50,000.
(c) Compute the indifference point.
(d) Draw a chart and identify the range where equity issue is preferred to debt issue.