College of Administrative and Financial Sciences

Assignment 2
Principles of Finance (FIN101)
Deadline for students: (13/11/2022@ 23:59)

Course Name: Principles of Finance Student’s Name:

Course Code: FIN101 Student’s ID Number:
Semester: 1st CRN:
Academic Year: 1444/1445 H, Second Semester
For Instructor’s Use only
Instructor’s Name:
Students’ Grade: Level of Marks:

Instructions – PLEASE READ THEM CAREFULLY

 This assignment is an individual assignment.
 The Assignment must be submitted only in WORD format via the allocated folder.
 Assignments submitted through email will not be accepted.
 Students are advised to make their work clear and well presented. This also includes
filling in your information on the cover page.
 Students must mention question numbers clearly in their answers.
 Late submitted assignments will NOT be entertained.
 Avoid plagiarism; the work should be in your own words; copying from students or other
resources without proper referencing will result in ZERO marks. No exceptions.
 All answered must be typed using Times New Roman (size 12, double-spaced) font. No
pictures containing text will be accepted and will be considered plagiarism).
Submissions without this cover page will NOT be accepted.
Assignment Questions: (Marks: 15)

1. AAA is a fast-growing communications company. The company did not pay a dividend last year
and is not expected to do so for the next two years. Last year the company’s growth accelerated,
and management expects to grow the business at a rate of 40 percent for the next four years
before growth slows to a more stable rate of 10 percent. In the third year, the company has
forecasted a dividend payment of $1.10. Dividends will grow with the company thereafter.
Calculate the value of the company’s stock at the end of its rapid growth period (i.e., at the end of
four years). The required rate of return for such stocks is 15 percent. What is the current value of
this stock? (3 Marks)

2. Premium Manufacturing Company is evaluating two systems to use in its plant that produces the
towers for a windmill power farm. The costs and the cash flows from these systems are shown
below. If the company uses a 10 percent discount rate for all projects, determine which forklift
system should be purchased using the net present value (NPV) approach. Also, Compute the IRR
and Payback Period for each of the two systems. (3 Marks)

Year 0 Year 1 Year 2 Year 3

System 1 -$4,123,450 $1,979,225 $1,358,886 $2,111,497
System 2 -$5,137,410 $1,875,236 $1,765,225 $2,865,110

3. You are considering opening another restaurant in the Pizza chain. The new restaurant will have
annual revenue of $200,000 and operating expenses of $80,000. Th e annual depreciation and
amortization for the assets used in the restaurant will equal $20,000. An annual capital
expenditure of $10,000 will be required to offset wear and tear on the assets used in the
restaurant, but no additions to working capital will be required. Th e marginal tax rate will be 30
percent. Calculate the incremental annual after-tax free cash flow for the project. (3 Marks)

4. The XXX Co. currently has debt with a market value of $300 million outstanding. The debt
consists of Bank loan with 4.5% refinancing interest rate. The firm also has an issue of 2 million
preferred shares outstanding with a market price of $11.00 per share. The preferred shares pay an
annual dividend of $1.10. Imaginary also has 14 million shares of common stock outstanding
with a price of $25.00 per share. The firm is expected to pay a $3 common dividend one year
from today, and that dividend is expected to increase by 5 percent per year forever. If Imaginary
is subject to a 40 percent marginal tax rate, then what is the firm’s weighted average cost of
capital? (3 Marks)

5. Since venture capital only invest in startup business, very high-risk investments, explain how
venture capital minimize their level of risk? (3 Marks)
Assignment Answers:

Year Dividends PV at PV Dividends Answer Q1 :

15%
3 $1.10 1.5209 $0.72
4 $1.54 1.7490 $0.88
5 $2.16 2.0114 $1.07
6 $3.02 2.3131 $1.30
7 $4.23 2.6600 $1.59
Terminal $92.97 $34.95
value
Value if stock $40.52

1
D 1=D 0 × ( 1+ g )

D 4=1.1 × ( 1+0.40 ) =1.54

D 4=1.54 × ( 1+1.10 )=1.69

D1
P 0=
R−g

D5 1.69
P 4= = =$ 33.88
R−g 0.15−0.10

D D D
P 0= + +
( 1+ R ) ( 1+ R ) ( 1+ R )3
1 2

1.1 1.54 33.88

P 0=0+0 + + =$ 20.97
( 1+0.15 ) ( 1+ 0.15 ) ( 1+0.15 )4
3 4

Value of stock at the end of year 4 = $33.88

Current value of the stock = $20.97

Answer Q2 :

Year System 1 System 2

0  $ -41,23,450.00  $ -51,37,410.00
1  $  19,79,225.00  $  18,75,236.00
2  $  13,58,886.00  $  17,65,225.00
3  $  21,11,497.00  $  28,65,110.00

Formula's

Calculations:
As the NPV of system-1 and system-2 are positive but the NPV of system-1 is higher than
system-2. Therefore; We should select system-2 as per the NPV rule.

Answer Q3 :
Given data are :

Revenue = $200,000 Operating expenses = $80,000. Depreciation = $20,000

Capital expenditure = $10,000 Tax rate = 30%

Taxable Income = Revenue - Operating  exp. -  Depreciation

= $200,000 – $80,000 – $20,000 = $100,000

Net Income = Taxable Income × (1 - Tax rate)

= $100,000 x (1 - 0.30) = $70,000

Free Cash flow = Net Income + Depreciation - Capital Exp.

= $70,000 + $20,000 – $10,000 = $80,000

Hence, The incremental annual after-tax free cash flow for the project is $80,000

Answer Q4 :
First we need to find the cost of each components using the below formula

After tax Cost of debt = Rate × (1– t)

= .045 x (1– 0.4) = 0.027

Cost of preferred = Dividend / price

= 1.10 / 11 = 0.10

Cost of equity = Expected dividend/price + g

= 3/25 + .05 = 0.1700

Now we need to find the market value of each components

Market value of debt = 300 million

Market value of preferred = price × share

= 11x 2 = 22

Market value of equity = price + share

 = 14× 25 = 350

Total market value = Market value of debt + equity + preferred

= 300 + 350 + 22 = 672

We can find the weighted average cost of capital using the below formula

WACC = weight of equity × cost of equity + weight of preferred × cost of preferred + weight of

debt ×after tax cost of debt

350 22 300
WAcc= ×17 + ×10+ ×27=10.39
672 672 672

Firm's weighted average cost of capital = 10.39%

Answer Q5 :
Venture capital (VC) is a type of private value and a sort of supporting that financial backers

give to new businesses and independent companies that are accepted to have long haul

development potential. Venture capital for the most part comes from well-off financial backers,

venture banks, and some other monetary establishments.

The risks to be reduced through venture capital are as follows:

1. Time expansion

2. Stage enhancement

3. Sector enhancement

4. Pro-rata or over favorable to rata contributing over the long run

5. Number of interests in the portfolio.