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Accounting and Finance - Question 1

The above table shows the financial feasibility conducted on the latest project of Martin Heating Ltd as it decided to construct a new plant in Thailand. The initial investment was for \$100 million along with \$30 million to buy the land for establishing the facility. The project incurs a fixed amount for \$5 million annually for the estimated life of the project at 10 years. The project is supposed to manufacture 60,000 units annually to be sold at \$30,000 per unit. The facility would have the salvage value of \$60 million at the end of the project while the net working capital expended initially for \$2 million would be recovered at the end of the project. So its financial feasibility would be evaluated using the NPV method at a discount rate of 12%.

The Net Present Value (NPV) for the project undertaken by Martin Heating was derived at \$6.935 billion indicating that the project is worth to be taken. A business project is generally evaluated using the NPV mechanism as it stands for the most significant aspect of the capital budgeting process (Malmendier, 2018). NPV shows the difference between the present worth of the cash inflows and the present worth of the cash outflows and investment to understand profitability of the investment. In this case, the project has a positive NPV of \$6.935 billion indicating that the project is worth to be undertaken having potentiality to unlock the business potentiality and profitability over the period.

Accounting and Finance - Question 2

1. Steps involved in calculating cost of capital

The aspect of cost of capital is represented by the Weighted Average Cost of Capital (WACC) which is a combination of equities, preferred stocks, and debts (Dang, Li, & Yang, 2018). Each of the distinctive capital is weighted as per its proportion in the total capital and then added to get the value. WACC is a significant aspect of financial modelling and is represented in the following manner –

WACC = (E/V x Ke) + ((D/V x Kd) x (1 – Tax rate)) + (P/V x Kp)

Step 1 – Cost of equity:

Determining the cost of equity is an important yardstick to have the WACC equating the rate of return to fluctuations indicating risks versus rewards (Vishny & Zingales, 2017). It is derived using the following formula –

Ke = Rf + ß x (Rm – Rf)

Rf = Risk-free rate like that of the 10-year US Treasury bond yield

Rm = Yearly return of the market

ß = Leverage beta of equity

The cost of equity shows the opportunity cost of the capital or the probable shareholder return motivating them to invest in stocks. It is composed of the risk-free rate (Rf) which provides the return against investment in risk-free securities like the government bonds. Then there is the equity risk premium (Rm) determining the capability of the stocks in delivering a suitable return over and above the risk-free securities (Damodaran, 2016). The stock beta (ß) is another component which determines the level of fluctuation in stocks stating its risk proposition.

Step 2 – Cost of debt:

Cost of debt is represented by Kd takes consideration of the market interest rates that the organisation is willing to pay to honour its obligations. It also considers the interest expenditures with relevance to the tax implications stating the yield to maturity (YTM) on the debt capital of the firm (Fracassi, 2016). It is represented by the following formula –

Kd = YTM x (1 – Tax rate)

Step 3 – Cost of preference stocks:

The cost of preference stocks is derived using the yield on the preference stocks of the firm. It is derived using the following formula –

Kp = Dp / Po

Kp = Cost of the preference stocks

Dp = Dividend on preference stocks

Po = Current price of the preference stocks

1. Calculation of WACC

Cost of debts = YTM x (1 – Tax rate)

C = 8%

FV = \$1,000 (Taken)

PV = \$800 (Assumed)

T = 10 years

YTM = ((80 + (1,000 – 800)/10) / (1,000 + 800)/2

= 100 / 900 = 11.11% or 0.1111

Tax rate = 30% or 0.3

Now, Kd = 0.1111 x (1 – 0.3) = 0.1111 x 0.7 = 0.0778 or 7.78%

Cost of equity = Risk-free rate + Equity risk premium

Rf = 10%

Rm = 11%

Now, Ke = 10% + 11% = 21% or 0.21

Cost of preference stocks = Dp / Po

Dp = \$5

Po = \$50

Now, Kp = 5/50 = 0.1 or 10%

Calculation of WACC –

E/V = 30% or 0.3

Ke = 0.21

D/V = 65% or 0.65

Kd = 0.0778

D/P = 5% or 0.05

Kp = 0.1

Tax rate = 30% or 0.3

WACC = (E/V x Ke) + ((D/V x Kd) x (1 – Tax rate)) + (P/V x Kp)

= (0.3 x 0.21) + ((0.65 x 0.0778) x (1 – 0.3)) + (0.05 x 0.1)

= 0.063 + (0.0505 x 0.7) + 0.005

= 0.063 + 0.0353 + 0.005 = 0.1033 or 10.33%

Therefore, the after-tax WACC for Western Mining Ltd is 10.33%

1. Preference on equity or debt capital

Raising finance is a significant proposition for business and it has to be careful while choosing either equity or debt financing or combination of both for its upcoming projects. There are certain differences between equity or debt capital which organisations like the Western Mining Ltd has to keep in mind which choosing the suitable financing option. The firm would undertake the decision based on its cash flow scenario and the capital structure to support the financing proposition (Atanasov & Black, 2016).

Equity financing could be preferred by the organisation as it tends for a long-term capital that does not need to be repaid unless liquidation of the business. But in this process, the owner has to provide a proportionate ownership to the plausible investors (Malmendier, 2018). Equities does not impose any kind of financial burden to the company and as does not promise any sort of periodic amount to the investors. So the entire amount could be exploited to pursue upcoming business projects. But raising equity financing is a time-consuming and expensive process and runs the risk of dilution of control and ownership as the equity investors ought to be consulted before undertaking any new project.

Debt financing means borrowing a sum of money and repaying it within the scheduled period. Debt or loans could be managed by the firm provided the firm maintains a lower debt-to-equity ratio seeking its capability to raise and pay off the additional liabilities (Vishny & Zingales, 2017). Loans are generally preferred by the business as the lender has no say in running the business and the interest of debts are tax deductible. It provides a scope to forecast the business expenses as the loan payments seldom fluctuates.

It is seen that Western Mining is pursuing a new project, so it would be better to have a combination of capital say both equity and debt capital in respective proportions. It would be helping in keeping the risks at bay say less interference of the investors owing to their negligible investment and less business expenses as the loan amount would not be hefty.

Accounting and Finance - Question 3

1. Annual interest rate on the loan from computer supplier

Principal = \$100,000

Annual instalments = \$48,780.50

Time = 5 years

Total amount = \$48,780.50 x 5 = \$243,902.50

So interest will be: \$243,902.50 – \$100,000 = \$143,902.50

Annual interest rate = Interest x 100% / (Principal x Time)

= \$143,902.50 x 100% / (\$100,000 x 5) = 347.45%

1. Annual interest rate on the loan from Elite Bank

Principal = \$300,000

Amount = \$425,000

Time = 5 years

Now, interest = \$425,000 – \$300,000 = \$125,000

Annual interest rate = Interest x 100% / (Principal x Time)

= \$125,000 x 100% / (\$300,000 x 5) = 8.33%

1. Borrowing analysis

In the 1st case, the computer supplier is willing to provide a down payment of \$100,000 and in return asking for \$48,780.50 for the next 5 years to be paid annually. The annual interest comes as 347.45% which is an absurd figure as Maxco Ltd has to repay a total amount of \$243,902.50 against the principal amount of \$100,000 which is around its 5 times. Contrarily, the proposal of the Elite Bank is reasonable as against the principal amount of \$300,000 asking for a lump sum repayment of \$425,000 at the end of the 5th year. So the firm would incur an annual interest of 8.33% which is reasonable and ought to be exploited by the firm to expand its business.

Bibliography for Martin Heating Ltd. Analysis

Atanasov, V., & Black, B. (2016). Shock-based causal inference in corporate finance and accounting research. Critical Finance Review, 5(2), 207-304.

Damodaran, A. (2016). Damodaran on valuation: security analysis for investment and corporate finance (324 ed.). London: John Wiley & Sons.

Dang, C., Li, Z., & Yang, C. (2018). Measuring firm size in empirical corporate finance. Journal of Banking & Finance, 86(1), 159-176.

Fracassi, C. (2016). Corporate finance policies and social networks. Management Science, 63(8), 2420-2438.

Malmendier, U. (2018). Behavioral corporate finance. In Handbook of Behavioral Economics: Applications and Foundations 1 (pp. 277-379). London: North-Holland.

Vishny, R., & Zingales, L. (2017). Corporate Finance. Journal of Political Economy, 125(6), 1805-1812.

Remember, at the center of any academic work, lies clarity and evidence. Should you need further assistance, do look up to our Accounting and Finance Assignment Help

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