BEA343, Corporate Finance

Home Work 1
Hassan Shabbir 410080

Question 1:

Ans(a):

Expected Rate of Return for A:

E(RA)=(0.3*0.1)+(0.4*-0.055)+(0.2*0.24)+(0.1*015)

=0.03-0.02+0.048+0.015

=0.073=7.3%

Expected Rate of Return for B:

E(RB)=(0.3*0.04)+(0.4*0)+(0.2*0.15)+(0.1*0.2)

=0.012+0+0.03+0.02

=0.062=6.2%

(b):

Var(RA)=0.3(0.1-0.073)2+0.4(-0.05-0.073)2+0.2(0.24-0.073)2+0.1(0.15-0.073)2

=0.0123

Standard Deviation for A:

=√ 0.0123= 0.11=11%

Var(RB)= 0.3(0.04-0.062)2+0.4(0-0.062)2+0.2(0.15-0.062)2+0.1(0.2-0.062)2

=0.00513

Standard Deviation for B:

=√ 0.00513= 0.071=7.1%

Question 2:
Ans (a) :

Annual depreciation= Value of project (machine/equipment)/5

=200000/5= 40000

Accounting break even= (fixed cost+ Depreciation)/ (Price per unit)-(variable price per unit)

= (100000+40000)/(22-10)

= 140000/12=11666 units

(b):

OCF= revenue-variable cost- fixed cost -tax+ depreciation

= unit sales (p-v)-fc (1-T) +depreciation*T

= [55000(22-10)-100000](1-0.3)+40000(0.3)

OCF (Base) =$404000

NPV= -200000+ 404000*(PVIFA 5, 10%)

=-200000+ 404000*3.791

= 1331564

Best case Sales:

Sales*(1+15%)= 55000*(1+0.15)

= 63250

OCF [Best] = [63250(22-10)-100000] (1-0.3) +40000(0.3)

=659000(0.7)+12000

=473300

NPV Best Case= -200000+ 473300 PVIFA(5, 10%)

= -200000+1794280.3
= 1594280

Worst Case Sales

=Sales* 0.85

= 55000*0.85

= 46750

OCF(Worst)= [46750(22-10)-100000](1-0.3)+ 40000(0.3)

= 561000-100000)*0.7+ 40000(0.3)

= 334700

NPV (Worst case) = -200000+ 334700*PVIFA(5,10%)

=-200000+ 334700* 3.791

=1068847.7

(c) Base Case

Q=55000, P=22, V=10, F=10000

Best Case

Q= 55000*1.15= 63250

P= 22* 1.05= 23.1

V= 10*0.95= 9.5

F= 100000*0.95= 95000

Worst Case:

Q= 55000* 0.85= 46750

P= 22* 0.95= 20.9

V= 10*1.05= 10.5

F= 100000* 1.05

= 105000
Best Case:

OCF= [63250(23.1-9.5)-95000](1-0.3)+ 40000(0.3)

=547640

NPV= -200000+ 547640* PVIFA(5,10%)

= -200000+ 2076103.24

= 1876103.24

Worst case:

OCF= [46750(20.9-10.5)-105000](1-0.3)+ 400000(0.3)

= 266840+12000

=386840

NPV= -200000+ 386840*PVIFA(5,10%)

= -200000+ 1466510.44

= 1266510.44

Question 3:
1.
(a)
Sales Year 1 Year 2 Year 3 Year 4 Year 5
Units 64000 100000 87000 80000 50000
Price $ 31,040,000.00 $ 48,500,000.00 $ 42,195,000.00 $ 38,800,000.00 $ 24,250,000.00
VC $ 12,800,000.00 $ 20,000,000.00 $ 17,400,000.00 $ 16,000,000.00 $ 10,000,000.00
F.C $ 5,100,000.00 $ 5,100,000.00 $ 5,100,000.00 $ 5,100,000.00 $ 5,100,000.00
Depreciation $ 4,928,571.43 $ 4,928,571.43 $ 4,928,571.43 $ 4,928,571.43 $ 4,928,571.43
EBT $ 8,211,428.57 $ 18,471,428.57 $ 14,766,428.57 $ 12,771,428.57 $ 4,221,428.57
Tax $ 2,463,428.57 $ 5,541,428.57 $ 4,429,928.57 $ 3,831,428.57 $ 1,266,428.57
NI $ 5,748,000.00 $ 12,930,000.00 $ 10,336,500.00 $ 8,940,000.00 $ 2,955,000.00
OCF(NI+depreciation) $ 10,676,571.43 $ 17,858,571.43 $ 15,265,071.43 $ 13,868,571.43 $ 7,883,571.43

Book Value of equipment=34500000-(4928571.43*5)=$9857142.85 *$200,000 for a marketing study is ignored as it is sunk cost
Taxes on sale of equipment=(BV-MV)*tc=(9857142.85-5500000)*0.30=$1307142.855
CF on sale of equipment= 1307142.855+5500000=$6807142.855 unit sale price= $485
Cash flows for the project are: V.C per unit= $200
Time(year) Cash flow($)
0 -34500000.00
1 10676571.43
2 17858571.43
3 15265071.43
4 13868571.43
5 7883571.43
NPV $ 13,421,851.20

NPV = –$34500000 + ($10676571.43 / 1.12) + ($17858571.43 / 1.122) + ($15265071.43 / 1.123)

+ ($13868571.43 / 1.124) + ($7883571.43 / 1.125)

NPV = $13421851.20

2.

Let’s assume that the sales price will be 10% higher than baseline value. Provided other inputs
constants, the discounted net cash flows will be as follow:

Best Case (price 10% up)

Sales Year 1 Year 2 Year 3 Year 4 Year 5
Units 64000 100000 87000 80000 50000
Price $ 34,144,000.00 $ 4,850,000.00 $ 46,414,500.00 $ 42,680,000.00 $ 26,675,000.00
VC $ 12,800,000.00 $ 20,000,000.00 $ 17,400,000.00 $ 16,000,000.00 $ 10,000,000.00
F.C $ 5,100,000.00 $ 5,100,000.00 $ 5,100,000.00 $ 5,100,000.00 $ 5,100,000.00
Depreciation $ 4,928,571.43 $ 4,928,571.43 $ 4,928,571.43 $ 4,928,571.43 $ 4,928,571.43
EBT $ 11,315,428.57 $ (25,178,571.43) $ 18,985,928.57 $ 16,651,428.57 $ 6,646,428.57
Tax $ 3,394,628.57 $ (7,553,571.43) $ 5,695,778.57 $ 4,995,428.57 $ 1,993,928.57
NI $ 7,920,800.00 $ (17,625,000.00) $ 13,290,150.00 $ 11,656,000.00 $ 4,652,500.00
OCF(NI+depreciation) $ 12,849,371.43 $ (12,696,428.57) $ 18,218,721.43 $ 16,584,571.43 $ 9,581,071.43

Book Value of equipment=34500000-(4928571.43*5)=$9857142.85 *$200,000 for a marketing study is ignored as it is sunk cost
Taxes on sale of equipment=(BV-MV)*tc=(9857142.85-5500000)*0.30=$1307142.855
CF on sale of equipment= 1307142.855+5500000=$6807142.855 unit sale price= $485
Cash flows for the project are: V.C per unit= $200
Time(year) Cash flow($)
0 -34500000.00 $ 3,414,400.00
1 12849371.43 $ 485,000.00
2 12696428.57 $ 4,641,450.00
3 18218721.43 $ 4,268,000.00
4 16584571.43 $ 2,667,500.00
5 9581071.43
NPV $ 16,038,246.44

The change in sales price affects sales figures only

NPV = $16038246.44

$16038246.44-$13421851.20
% change in NPV =   = 19.5%
$13421851.20
19.5%
Sensitivity of NPV =   = 1.95
10%
As

An increase in the sales price by 1% will result in an increase in the NPV by 1.95%, and if the
sales price drops by 1%, the NPV of a project will decrease by 1.95%.

Worst Case (price 10% down)

Let’s assume that the sales price will be 10% lower than baseline value. Provided other inputs
constants, the discounted net cash flows will be as follow:
Sales Year 1 Year 2 Year 3 Year 4 Year 5
Units 64000 100000 87000 80000 50000
Price $ 27,936,000.00 $ 43,650,000.00 $ 37,975,500.00 $ 34,920,000.00 $ 21,825,000.00
VC $ 12,800,000.00 $ 20,000,000.00 $ 17,400,000.00 $ 16,000,000.00 $ 10,000,000.00
F.C $ 5,100,000.00 $ 5,100,000.00 $ 5,100,000.00 $ 5,100,000.00 $ 5,100,000.00
Depreciation $ 4,928,571.43 $ 4,928,571.43 $ 4,928,571.43 $ 4,928,571.43 $ 4,928,571.43
EBT $ 5,107,428.57 $ 13,621,428.57 $ 10,546,928.57 $ 8,891,428.57 $ 1,796,428.57
Tax $ 1,532,228.57 $ 4,086,428.57 $ 3,164,078.57 $ 2,667,428.57 $ 538,928.57
NI $ 3,575,200.00 $ 9,535,000.00 $ 7,382,850.00 $ 6,224,000.00 $ 1,257,500.00
OCF(NI+depreciation) $ 8,503,771.43 $ 14,463,571.43 $ 12,311,421.43 $ 11,152,571.43 $ 6,186,071.43

Book Value of equipment=34500000-(4928571.43*5)=$9857142.85 *$200,000 for a marketing study is ignored as it is sunk cost
Taxes on sale of equipment=(BV-MV)*tc=(9857142.85-5500000)*0.30=$1307142.855
CF on sale of equipment= 1307142.855+5500000=$6807142.855 unit sale price= $485
Cash flows for the project are: V.C per unit= $200
Time(year) Cash flow($)
0 -34500000.00 $ 2,793,600.00
1 8503771.43 $ 4,365,000.00
2 14463571.43 $ 3,797,550.00
3 12311421.43 $ 3,492,000.00
4 11152571.43 $ 2,182,500.00
5 6186071.43
NPV $ 3,983,754.08

The change in sales price affects sales figures only

NPV = $3983754.08

$3983754.08-$13421851.20
% change in NPV =   = -70.3%
$13421851.20
-73.3%
Sensitivity of NPV =   = -7.03
10%
As

This means that with a decrease in sales price of 1%, the NPV of a project will decrease by 7.03.

3.

Sensitivity analysis is used to evaluate how sensitive the output variable is to the change in one
of the variables while other input variables remain unchanged. This was done in part 2, It also
provides a better understanding of the risks associated with a project.

In question 1, result shows that NPV value is positive, and the new project will be profitable. It
can be seen from question 2, that if we change value of price of smart phone by 10%, the NPV
value will be negative, in worst case scenario, so before starting the new project, care should be
taken while assigning price of smart phone.