CORPORATE FINANCE

ANSWER 1.

INTRODUCTION:

When planning large-scale projects or investments, a corporation might use capital budgeting to
streamline the process. Capital budgeting activities, such as building a new factory or investing
heavily in an external organization, demand capital planning as soon as practicable. If long-term
financial inflows and outflows are reviewed as part of capital budgeting, consider using predicted
returns to define a benchmarking target. This sort of appraisal is frequently called an "investment
appraisal." It analyses the initial cash outflow required to support a project, as well as the mix of
expected future cash inflows from income and refurbishment costs. Businesses use capital
budgeting to research major projects, investments, and new facilities and equipment. The estimated
return on a mission's cash inflow and outflow is assessed. Discounted cash flow, payback, and
throughput studies are three popular capital planning methods.

CONCEPT AND APPLICATION:

Money today is worth more than money tomorrow due to inflation and prospective gains from
alternative investments made in the meantime. That is, a dollar earned in the future is worth less
than a dollar acquired now. The NPV formula's discount rate portion accounts for this.

Assume an investment might receive $100 today or in a year. A prudent investor would not delay
payment. Consider the option of receiving $100 today versus $105 in a year. If the payer was solid,
the extra 5% might be worth the wait, but only if the investors had other options for their $100.

An investor may be willing to wait a year to earn an extra 5%, but not all investors may be. In this
scenario, the discount rate is 5%, which varies by investor. If an investor knew they might earn

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8% on a secure investment over the next year, they would not delay payment for 5%. The investor's
discount rate is 8%.

The discount rate can be calculated using the expected return of similar projects or the cost of
borrowing the funds required to fund the project. For example, a corporation may forego a project
with a 10% annual return if it costs 12% to fund it or if an alternative project yields 14%.

Assume a corporation may invest $1,000,000 in equipment that will create $25,000 each month
for five years. The corporation has the capital to buy the equipment or put it in the stock market
for an annual return of 8%. Purchasing equipment or investing in the stock market are considered
equal risks.

CALCULATION OF THE GIVEN PROBLEM:

(a) Calculation of NPV:

PROJECT A:

Year Cash Flow Present Value of Cash Inflow

Discounted at 12%

0 -500

1 100 89.29

2 110 87.69

3 120 85.41

4 175 111.22

5 240 136.18

6 300 151.99

Total Present Value of Cash Inflow = 661.78

Total Investment = 500

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Net Present Value = Present Value of Cash Inflow - Total Investment

Net Present Value = 661.78 – 500

Net Present Value = 161.78

PROJECT B:

Year Cash Flow Present Value of Cash Inflow

Discounted at 12%

0 -875

1 150 133.93

2 200 159.44

3 250 177.95

4 375 238.32

5 530 300.74

6 680 344.51

Total Present Value of Cash Inflow = 1,354.88

Total Investment = 875

Net Present Value = Present Value of Cash Inflow - Total Investment

Net Present Value = 1,354.88 – 875

Net Present Value = 479.88

Therefore, based on the NPV, the company should opt for Project B as it has a higher NPV at the
same discounting factor than Project A.

(b) Profitability Index:

Putting money into something worthwhile is a wise decision. Ratio or income investment (VIR)
(VIR) The ratio (PIR), which evaluates the link between the project's expenses and benefits, is

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known as the proposed project profitability index (PI). Miles is computed as a percentage of a
project's expected future cash flows as a percentage of its initial investment. The project will be
more interesting to potential investors if the PI is greater.

Profitability Index = (Net Present Value + Initial Investment) / Initial Investment

Project A:

Profitability Index = (161.78 + 500) / 500

Profitability Index = 1.32

Project B:

Profitability Index = (479.88 + 875) / 875

Profitability Index = 1.54

(c) Regular Payback Period:

An investment's attractiveness is proportional to its return on investment. The payback period is

the number of years it takes to repay the cost of an investment. The payback period refers to how
long it takes for an investment to recoup its initial investment. The appeal of assets with a shorter
payback period is greater.

PROJECT A:

Year Cash Flow Payback Period

0 -500 -
1 100 = (500 -100) = 400 (1 year)
2 110 = (400 – 110) = 288 (1 year)
3 120 = (288 – 120) = 168 (1 year)
4 175 = (168 – 175) = - 7

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 = 168 / 175 = 0.96 years
5 240 -
6 300 -

Payback Period = 1 + 1 + 1 + 0.96

Payback Period = 3.96 years

PROJECT B:

Year Cash Flow Payback Period

0 -875
1 150 = (875 – 150) = 725 (1 year)
2 200 = (725 – 200) = 525 (1 year)
3 250 = (525 – 250) = 275 (1 year)
4 375 = (275 – 375) = -100
= 275 / 375 = 0.73
5 530 -
6 680 -

Payback Period = 1 + 1 + 1 + 0.73

Payback Period = 3.73 years

CONCLUSION:

This has resulted in a higher profitability index for project B as well as a shorter payback period
than for project A.

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ANSWER 2.

INTRODUCTION:

To meet many of our most basic necessities in today's environment, we have become more reliant
on loans in recent years. If you've ever purchased a home, a vehicle, or even taken out a loan to
pay your children's international education, you're well aware of how loans have become engrained
in our daily lives. Loans are complicated, but one aspect that must be understood is the EMI, which
is short for monthly interest payment. The importance of understanding that an EMI (equivalent
monthly instalment) is a monthly payment on a loan that we have chosen to take out cannot be
overstated. EMI instalments include both principal and interest because EMI instalments contain
both principal and interest. The interest component of the EMI fee is the most substantial during
the beginning stages of the fee. Over time, the interest repayment component of the loan decreases,
while the contribution to the most important repayment portion of the loan increases. For example,
the loan amortization schedule is a table that depicts the annual percentage rate (APR) of the loan
over the course of its life. The interest rate and other significant increases to the charge are depicted
in the graph below for each EMI term. It is possible to keep track of how much money is being
paid back and when the loan will be completely paid off with the help of a loan reimbursement
plan. Charge schedules, EMIs, interest payments, and outstanding obligations are all examples of
what is included. If the borrower decides to foreclose on the debt or refinance the loan, this
technique will be incredibly favorable.

CONCEPT AND APPLICATION:

It's the fixed amount of money you pay to a bank or lender each month to repay a large debt (EMI).
Customers of banks and other financial institutions can borrow money and repay it over a
predetermined length of time in monthly instalments. Each month, the client is expected to pay the
bills on a certain day. The EMI can be paid by check or online, with the option of auto-debit.

In the early years of EMI, the rate of interest was a key aspect. To make an EMI, you must pay the
principal plus interest. For example, if you borrow money for a long time, you can end up paying
more in fees than interest.
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Home Loan EMI: To purchase a property, a home loan can be obtained from any bank or non-
banking financial corporation (NBFC). In today's world, a home loan is one of the most
important and sought-after loans. Owning a house is a fantastic idea, both from the standpoint of
an owner and an investor, as the value of the property continues to rise.

You take out a house loan for a large sum of money over a longer period of time. A particular
interest rate would be charged by the bank or financial organisation. The principal and interest
portions of the home loan EMI are both fixed for the duration of the loan.

Home Loan EMI Calculator: The Home Loan EMI Calculator is a simulation that will assist
you in calculating the EMIs that you will be responsible for on your home loan. The monthly
EMIs will be calculated using a home loan calculator that takes into account the principal,
interest, and loan term.

It comprises of a box with three sliders, the most important of which are 'Loan Amount,' 'Loan
Tenure,' and 'Interest Rate.' Once you've entered your information, you'll see how much EMI
(Equated Monthly Instalments) you'll have to pay the bank each month to repay the house loan
within the chosen term.
Home Loan EMI Calculators Work: You can calculate your home loan EMI amount with the
help of the mathematical formula:
EMI Amount = [P x R x (1+R) ^N]/[(1+R) ^N-1], where, P, R, and N are the variables. The EMI
value will change each time you change any of the three variables.
Let’s discuss these variables in detail.
P stands for the ‘Principal Amount’. The principal amount is the original loan amount given to
you by the bank, on which the interest will be calculated.
R stands for the rate of interest set by the bank.
N is the number of years for which the loan has been taken. As EMIs are paid every month, the
duration is calculated in the number of months.
So, assuming that you take a home loan of Rs 50 lakh with an average interest rate of 12%
for a tenure of 10 years, the approximate EMI will be:
P = Rs 50 lakh, R = 12/100/12 or 0.01 (convert to months), N = 10 years or 120 months
EMI = [5000000 x 0.01 x (1+0.01) ^120] / [(1+0.01) ^120-1]
EMI = Rs 71,735.

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Right here are the significant elements that impact the EMI:

• Interest rate: A bank or financial institution charges an interest rate on loan

repayment. The rate is decided by a number of factors, including the credit profile of
the borrower.
• Loan Term: The loan term refers to how long the borrower needs to pay off the entire
mortgage, including interest and other costs, before it is declared paid off. In general,
the longer the time, the greater the profit you may deliver to the bank or lender.
• Principal Loan Amount: The original loan amount is obtained from a bank or lender.
In terms of EMI quantity, it is the most essential factor. The following are the primary
causes of rising interest rates.

EMI = P × r × (1 + r) ^ n / ((1 + r) ^ n – 1)

Here,

P = Loan amount.

r = Rate of interest, which is calculated on a monthly basis.

n = Loan tenure (in months)

In the given case,

Principal Amount = 50 lakhs

Rate of Interest = 9%

Tenure = 20 years

EMI = (50, 00,000 * 9% * (1+0.09) ^20) / ((1 + 0.09) ^ 20 -1)

Loan EMI = Rs. 44, 986

Total Interest to be paid for 20 years = Rs. 57, 96,711

Total Payment to be made (Principal + Interest) = Rs. 1, 07, 96,711

In this we have to calculate present value factor and then can calculate the monthly payment.

Period =20 years

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Total period= 20 \times 12=240=20×12=240 months

Monthly interest rate= 9/12 = 0.75

Loan amount= Present value factor x monthly payment

5000000= 111.14495403 x monthly payment
Monthly payment=Rs 44986.30
would be the equated monthly instalment (EMI).

CONCLUSION:

EMI is neither bad nor insufficient, unless you think debt is dreadful and buying things is the only
"exact" alternative. Aspects of the EMI's borrowing benefits It assists debtors in managing their
finances by breaking the debt into monthly instalments. They are aware of their debts and the time
it will take to repay them.

ANSWER 3A.

INTRODUCTION:

The two types of capital that a corporation uses to finance its operations and expansion are
incorporated debt and equity. Stock ownership and claims to destiny coins, as well as earnings
from activities, are all sources of equity capital. Fairness could be represented by regular inventory,
desired inventory, retained income, or other kinds of equity instead of debt. In addition to long-
term debt, short-term debt is included in the capital structure.

CONCEPT AND APPLICATION:

The Impact of Financing

There are two types of financing available.

The two types of financing available in capital markets are equity and debt. The word capital
structure refers to a company's total finance structure. Changes in capital structure can have an
impact on a company's cost of capital, net income, leverage ratios, and liabilities.

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The overall cost of capital for a company is measured by the weighted average cost of capital
(WACC). A change in capital structure affects the WACC if the cost of debt is not equivalent to
the cost of equity capital. Because the cost of equity is usually higher than the cost of debt,
increasing equity financing frequently raises WACC.

Self-Financing

Equity financing, which involves generating funds by selling new shares of stock, has no effect on
a company's profitability, but it can dilute existing shareholders' holdings by dividing the
company's net income among a larger number of shares. When a corporation raises capital through
equity financing, the cash flows from financing activities section shows a positive item, as well as
an increase in common shares at par value on the balance sheet.

Debt Capitalization

When a company raises capital through debt financing, the financing portion of the cash flow
statement shows a positive item, as well as a rise in liabilities on the balance sheet. Principal, which
must be repaid to lenders or bondholders, and interest are both part of debt finance. Interest
payments on debt lower net income and cash flow, even when debt does not dilute ownership. This
decrease in net income also results in a tax gain because the taxable income is reduced. Leverage
ratios such as debt-to-equity and debt-to-total capital rise when debt levels climb. Covenants are
commonly attached to loan funding, requiring a company to achieve particular interest coverage
and debt-level restrictions. Debt holders have priority over equity investors in the case of a
company's liquidation.

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The Capital Asset Pricing Model (CAPM) is a mathematical model that describes systematic risk
and expected return for assets such as stocks (CAPM). CAPM is a mathematical model that is
extensively used in finance to price risky securities and forecast property returns.

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Traders expect to be compensated for taking risks and considering the time value of money. In the
CAPM calculation, the risk-free charge compensates for the temporal value of currency. The other
components in the CAPM system compensate for the increased risk.

The beta of an investment reveals how risky it is when compared to a market-beating portfolio.
The beta of a riskier inventory, for example, is higher. A store with a beta of less than one reduces
the risk in a portfolio.

The cost of Debt is given to be 9%

Using Capital Asset Pricing Method (CAPM) to find cost of equity:

Cost of Equity = risk free rate + beta x (Average equity return – risk free rate)

Cost of Equity = 6% + 1.10 x (12% - 6%)

Cost of Equity = 12.60%

Therefore, the cost of equity is 12.60%

CONCLUSION:

The total value of a company's capital is determined by the value of its stock and the cost of its
loans. Low capital expenditures are usually connected with lucrative, well-established businesses.

ANSWER 3B.

INTRODUCTION:

The cost of capital of a company is calculated using a "weighted average cost of capital," which is
a weighted average of the costs of capital for each type of capital considered. There is no way to
calculate WACC without taking into account all of the available capital sources. When an
employer's beta and return on equity rise, the WACC rises as well, indicating a fall in valuation
and an increase in probability for the commercial company as a whole.

CONCEPT

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As the term implies, WACC stands for "weighted average cost of capital" (WACC). A weighted
common approach can be used to compute the interest that an agency must pay on each dollar
borrowed.

Debt and equity are the two most common types of capital investment for businesses. Lenders and
stock investors will expect specific returns in exchange for their money or coins. As a result, while
the value of capital measures the expected return on equity owners (or shareholders) and loan
holders, WACC measures the expected return on each stakeholder type (fairness owners and
creditors). In simple terms, a company's WACC is the opportunity cost to an investor of risking
their money by investing in it.

WACC is used by many investors to judge whether a company is worth their time. It's simple:
WACC is the minimum profit and customer satisfaction necessary for a company to make a profit.
An investor's return on investment can be calculated by subtracting a company's return percentage
from the WACC.

To further understand WACC, think of a company as a pool of capital. Debt and equity are the two
types of money that might be used in the collecting process. Because it does not pay dividends to
shareholders, a company does not qualify as a third source of cash after paying off its debt.

WACC = weight of debt * cost of debt * (1 – tax rate) + weight of equity capital * cost of equity

WACC = 35% * (9% * (1 – 25%) + 65% * 12.60%

WACC = 10.55%

Therefore, WACC for LT India Ltd. is 10.55%

CONCLUSION:

In other words, a company's WACC is the amount of cash it needs to stay viable. Business
executives typically utilize WACC to assess the economic feasibility of acquisitions and other
expansionary possibilities. The WACC rate must be applied to all cash flows with a probability of
occurring, just like it must be applied to the firm's entire bet.

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