Step 1: 

In this question, we will be helping Balaka Airlines is exploring the possibility of

starting domestic flights s either for the DHK-CTG route or the DHK-RAJ route.

Step 2:

Calculate the specific cost of each source of financing (Round the answer to the nearest
two decimal points percent, like 11.12%)

Calculation Debt Costs

Bond BDT 1,000 par-value,

10%coupon interest rate, 10-year bonds

The current market price of the bond is BDT 1,200.

By using the excel formula RATE ( no. of the period, payment per period, Present Value,
Future Value )

=RATE ( 10, (BDT 1000* 10%), -BDT 1200, 1000 )

= 7.13%

Calculation of Preferred Stock Cost

Preferred stock: The firm can sell 10% (annual dividend)   

at its BDT 100 per share par value.

Selling the preferred stock is expected to be

BDT 2.5 per share.

Cost of Preferred Stock = Annual Dividend Preferred Stock

Market price per share

= 10%*1BDT 100+BDT 2.5

BDT 100

= BDT 12.5
BDT 100

= 12.5%

Cost Of Equity stock

PV of Stock - Flotation Cost = DIV 0 *(1+g)

R-G

BDT 80 - BDT 3   = BDT 6 *(1+6%)

R - 6%

R   = 14.26%

2. Calculate WACC (The firm’s optimum capital structure shows 40% Long-term
debt,
15% Preferred stock, and 45% Common stock equity).

  

WACC = 14.26%*45%+ 12.5%*15%+ 7.13%*(1-40%)*40%

WACC = 6.42%+1.88%+ 1.71%

WACC = 10.00%

3. Determine the Payback period, net present value, internal rate of return and
profitability index for both of the routes.

      

        
        
        
        
 

By using the Excel formula NPV

= NPV( Discount Rate, Cash flow 0, Cash Flow 1, Cash flow 3, Cash Flow 4, Cash Flow 5,)

CTG JSR Option

= NPV( 10%, -3,500,000,1,530,428,2,022,266,1,930,629,1,930,377,1,530,428)

= $2,983,501.26

CTG- RAJ options

= NPV( 10%, -4,000,000,1,910,234,1,930,377,1,930,629,2,022,266,1,910,234)

= $3,045,253.92

By Using Excel formula IRR

=IRR( Cashflow 0, Cashfloww 1, Cashflow 2, Cashflow 3, Cashflow 4, Cashflow 5 )

CTG JSR Option

= IRR(-3,500,000,1,530,428,2,022,266,1,930,629,1,930,377,1,530,428)

= 41.91%

CTG- RAJ options

= NPV( -4,000,000,1,910,234,1,930,377,1,930,629,2,022,266,1,910,234)

=39.03%

Pay Back period

Pay Back Period = Initial Investment

Cash Flow per Year

CTG - JSR

= 1,530,428 ( 1 Year) +( 3,500,000-1,530,428)

2,022,266

= 1 Year + 1,969,572

   2,022,266

= 1 Year+ 0.974

= 1. 97 Year

CTG- RAJ

= 1,910,234( Year 1)+ 1,930,377( Year 2)+ 4000000-(1,910,234+1,930,377()

  1,930,629

= 2 Years+ 0.83

= 2.83 Year

CTG - JSR

Profitability Index = PV of Future Cash Flow

Initial Investment

= BDT 6,781,851.38

BDT 3,500,000

= 1.94

CTG- RAJ

Profitability Index =

Profitability Index = PV of Future Cash Flow

                               Initial Investment
= BDT 7,349,779.31

BDT4,000,000

= 1.84

4. Which one is the best route if they are independent or mutually exclusive
projects?

If we used the NPV tool to evaluate the projects CTG - JSR, and CTG- RAJ, the CTG - RAJ
will be given greater NPV than the CTG - JSR route.

But if we also consider the other method of evaluation project i.e.

IRR (  CTG - JSR > CTG -RAJ , 41.91%> 39.03%)

Pay Back period (CTG -JSR < CTG - RAJ, 1.97 years < 2.83years whichever is less)

Profitability Index(CTG -JSR > CTG - RAJ, 1.94 years>1.84 years whichever is more)

Therefore, the best route is CTG -JSR