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  • Subject Name : General Accounting and Finance

Corporate Finance

Answer 1) a) Irrelevant costs are costs that won’t be affected by a managerial decision. Irrelevant costs are those that will not change in the future when you make one decision versus another. Examples of irrelevant costs are sunk costs, committed costs, or overheads as these cannot be avoided (Kenton, 2020).

Relevant cost is a managerial accounting term that describes avoidable costs that are incurred only when making specific business decisions. The concept of relevant cost is used to eliminate unnecessary data that could complicate the decision-making process. As an example, relevant cost is used to determine whether to sell or keep a business unit (Tuovila, 2020).

Relevant Cost

Irrelevant cost

Revenue

Plant and Machinery

Employee related expense

Research and development

Other Expense

Depreciation

Working Capital Cost

Sunk cost

b) We will have to use cash flows as these are more suited to find out if we need to go ahead with the project or not. These are used in the calculation of Net present value so if the value is positive then we can progress with the project. In case of negative NPV, the project will be unprofitable. This method can be used with the cash flows coming up each year. If the present value of cash inflows is greater than the amount spent initially then the project will give profit.

Profits are calculated by subtracting cost from revenue but this does not account for the revenues in the coming years and the current value of the same so this is not a relevant methods for determining the financial worth of the project.

c) Interest expense pertains to the cost of borrowing the money/debt. Since it is reported in the same period in which it is accrued so it has to be subtracted from revenues when we have to calculate the net income. Thus while preparing cash flow from operating activities, it will be included in the net income part.

d) Inflation means the change in value of things with the change in time. The cost of an article today will not be the same in future. It is bound to change and most probably increase. This shows the increase in the cost of various things in future. While trying to determine the project’s feasibility, the inflation in the cost of labour, machinery, etc should be kept in mind so that we get a more realistic measure of the total cost that will be incurred if we undergo the project.

e) It is always better to keep the project option alive because there may be situational reasons for a project for not being profitable at any particular instance. The situations may change and the project may get positive NPV in future so if the company keeps the option alive then it can postpone to invest in the project today and invest in it when the NPV becomes positive.

Similarly, the company may have a lot of options in case of project choice, but it may not have the budget to implement them all together so it can choose the project which has the highest NPV and keep others for investment at a later date when the funds become available.

The calculation process of NPV remains the same always but if we conduct the NPV methods for mutually exclusive projects then we will have to take a decision to accept one project and reject the other. But if we conduct this process multiple times then it may be possible that under new circumstances, the project becomes profitable and gives higher returns. So it is better to keep the options alive than sabotaging it in a Yes/No decision.

Answer 2) Note: All the figures are in $millions.

a) The beta calculation for Amazon is shown in excel file.

Beta values

 

Price calculated daily

-0.144

Quarterly

1.154

Monthly

0.273

Yearly

5.801

b) Weighted average cost of capital

WACC= E/(E + D)*Cost of Equity + D/(E + D)*Cost of Debt*(1 - Tax Rate)

The calculations are shown in excel file.

Market Cap (Dec. 2019 )=Share Price (Dec. 2019 ) *Shares Outstanding (Dec. 2019 )

= $1847.84*498 = $920,224

2019

 

Market Capitalisation (E)

920224

Debt(D)

63205

D+E

983429

D/(D+E)

0.06427002

E/(D+E)

0.93572998

WACC= E/(D+E)*Re+D/(D+E)*Rd*(1-taxrate)

2.60%

Re(Monthly from 2017 to 2019)

2.64%

cost of debt

2.53%

 

2019

 

Market Capitalisation (E)

920224

Debt(D)

63205

D+E

983429

D/(D+E)

0.06427002

E/(D+E)

0.93572998

WACC= E/(D+E)*Re+D/(D+E)*Rd*(1-taxrate)

7.55%

Re(Quaterlyy from 2017 to 2019)

7.93%

cost of debt

2.53%

c) Terminal Value = FCFF x ( 1 + g ) / ( WACC – g ) (Ganti, 2020)

where,

FCF (free cash flow) = Forecasted cash flow of a company

g = Expected terminal growth rate of the company (measured as a percentage)

WACC = Weighted average cost of capital

TV = FCFF x ( 1 + g ) / ( WACC – g )

4241887

g

3%

WACC (considering quarterly returns)

7.55%

d)

Enterprise Value (Dec. 2019 ) = Market Cap +Preferred Stock+Long-Term Debt & Capital Lease Obligation+ Short-Term Debt & Capital Lease Obligation+Minority Interest - Cash, Cash Equivalents, Marketable Securities (CFI, 2020)

= 920224.32 + 0 + 63205 + 0 + 0 – 55021 = 928,408

e) The implied value of the share determines the profit that has been received by the shareholders. The method to determine the basic implied value per share is to divide the net income of the company by the total number of outstanding shares. The calculation has been shown in excel file (Rogers, 2019).

 

2016

2017

2018

2019

2020

2021

2022

2023

2024

2025

Revenue

1,35,987

1,77,866

2,32,887

2,80,522

340506

413316

501696

608973

739190

897251

Cost of Revenue/Expense

88,265

1,11,934

1,39,156

1,65,536

209923

254811

309297

375434

455713

553158

Depreciation/Amortization

287

366

475

565

565

565

565

565

565

565

Expense to Sales Ratio

0.6491

0.6293

0.5975

0.5901

           

Gross Profit

47,722

65,932

93,731

1,14,986

1,30,583

1,58,506

1,92,399

2,33,540

2,83,477

3,44,093

EBIT

47,435

65,566

93,256

1,14,421

1,30,018

1,57,941

1,91,834

2,32,975

2,82,912

3,43,528

Tax@21%

10,022

13,846

19,684

24,147

27,422

33,286

40,404

49,043

59,530

72,260

Net Income after tax

37,413

51,720

73,572

90,274

1,02,596

1,24,654

1,51,430

1,83,931

2,23,382

2,71,269

Changes in working capital

 

-242

-1,043

-2,438

-1,741

-1,741

-1,741

-1,741

-1,741

-1,741

Cap Ex

-7804

-11955

-13427

-16861

-21978

-28649

-37344

-48677

-63451

-82708

FCFF = Net Income + Depreciation - Cap Ex- Changes in working capital

29,896

39,889

59,577

71,540

79,441

94,830

1,12,911

1,34,078

1,58,755

1,87,384

No of outstanding shares

477

484

491

498

504

510.854

517.802

524.844

531.982

539.217

Implied value per share

78.4348

106.86

149.842

181.273

203.563

244.012

292.448

350.449

419.905

503.079

Answer 3)

i) EV/EBITDA (Finance, 2020)

 Enterprise Value of Tesla for year ending 2019 = Market Cap + Preferred Stock + Long-Term Debt & Capital Lease Obligation + Short-Term Debt & Capital Lease Obligation + Minority Interest - Cash, Cash Equivalents, Marketable Securities

= 75747.2877 + 0 + 12627 + 1842 + 849 – 6268 = 84797

EBITDA (2019) = 2174

Therefore, EV/EBITDA = 84797/2174 = 39

ii) EV to Sales:

Revenue = 24578

EV= 84797

EV to Sales = 84797/24578 = 3.45

iii) Price-to-earnings ratio (PE ratio)

P/E Ratio=Share Price/ Earnings per Share

Share price on 31/12/2019 = 83.67

Earning per share is zero for Tesla in 2019. It is making a loss (-0.98) so the value of this ratio is zero. Other way to calculate the /E ratio is to calculate it by the formula:

P/E= Market Cap/ Net Income;

In this case also Net income is negative so the ratio cannot be calculated.

iv) Price-to-book ratio

Book Value Per Share =(Total Stockholders Equity- Preferred Stock)/Shares Outstanding

=(6,618-0)/905 = 7.31

Share Price = 83.67

P/B = 83.67/7.31= 11.41

v)

a) Ford Motors (F): Ratios for year ending 2019 (Finance, 2020)

i) EV/EBITDA = 17.87;

Enterprise Value=Market Cap+ Preferred Stock+ Long-Term Debt & Capital Lease Obligation +Short-Term Debt & Capital Lease Obligation+ Minority Interest- Cash,CashEquivalents, Marketable Securities

= 36873.849+0+102408+54313 +45-34651 =158,989

EBITDA= 8899

EV/EBITDA= 158989/8899= 17.865

ii) EV/Sales:

Revenue= 155900

EV/Revenue= 158989/155900 = 1.02

iii) P/E ratio:

Market Capitalisation= 36874

Net Income= 1603

Therefore, P/E Multiple = 23

iv) P/B ratio:

Book Value in 2019 = 35349

Therefore, P/B ratio= 36874/35349 = 1.043

b) General Motors: (Finance, 2020)

i) EV= 131900

EBITDA = 14174

EV/EBITDA = 9.305

ii) EV/ Sales:

Revenue (2019)= 137200

Therefore, EV/Sales = 131900/137200 = 0.961

iii) P/E ratio:

Market Capitalisation= 52293

Net Income= 8819

Therefore, P/E Multiple = 5.929

iv) P/B ratio:

Book Value in 2019 = 44554

Therefore, P/B ratio= 1.174

vi)

The ratios of the three companies are as follows:

2019

Tesla

Ford Motors

General Motors

EV/EBITDA

39

17.87

9.305

EV/Sales

3.45

1.02

0.961

P/E

0

23

5.929

P/B

11.41

1.043

1.174

The EV/EBITDA values determine the returns made by a company on its capital investments. It is used as a tool for valuing the company. It analyses the return on investment and the value of the company. It shows whether the company is overvalues or undervalued. The value of this ratio is considered to be healthy if it is less than 10. Since the value of this multiple for General Motors is less than 10 and it is also less than the other compared companies, this is considered to be the best investment among the three.

The EV to Sales ratio generally have values between 1 to 3 range. An undervalued company with respect to this data will be having lower value of this ratio. Again amongst the three companies, this ratio is lowest for General Motors, indicating an undervalued staock.

The P/E multiple is used to determine the market value of the scrip as companred to the net income of the company. A higher P/E multiple shows that the shareholders’ expectation of returns are higher from the company than the market performance. A higher P/E ratio may indicate that the company is over valued so it might not be a good investment. Generally speaking, companies with P/E less than 15 are considered to be undervalued. Since the P/E of Tesla cannot be calculated, so in the above case General Motors is cheaper than Ford Motors. The historical P/E values for S&P is around 25. So even Ford Motors is also not highly overvalued.

The P/B ratio compares the market value of the company to its book value. The value of this ratio under 1 is considered to be good, but many analysts consider the value of this metric o be good if it is under 3. In the above case, the value of P/B for Ford Motors is the lowest so it is a better investment, similar is the case with General Motors whose value is very close to 1. But for Tesla, this value is 11.41 which is on a very high side, so it is considered to be a risky investment.

Conclusion

The above analysis of the ratios shows that the share of General Motors is undervalued and the shares of Tesla are overvalued. The undervalued shares are considered to be attractive for investment by the investors. So, General Motors shares are a good investment. The value of ratios for Ford Motors is also pretty good so it can be considered as a good investment bet. But the value of all the ratios for Tesla are higher than the range for the ratios so the share is overvalued and is not recommended to buy at the current value.

The trailing twelve months figures can be used to generate the current ratios for all these companies.

References for Yahoo Finance on Ford Motor Company

CFI view on Enterprise Value 2020, Corporate Finance Institute, viewed 18 October 2020< https://corporatefinanceinstitute.com/resources/knowledge/valuation/what-is-enterprise-value-ev/>

CFI view on EBITDA 2020, Corporate Finance Institute, viewed 18 October 2020< https://corporatefinanceinstitute.com/resources/knowledge/finance/what-is-ebitda/>

Kenton, W 2020, Irrelevant Cost, Investopedia, viewed 18 October 2020< https://www.investopedia.com/terms/i/irrelevantcost.asp#:~:text=Relevant%20costs%20are%20costs%20that,as%20these%20cannot%20be%20avoided>

Tuovila, A 2020, Relevant Cost, Investopedia, viewed 18 October 2020< https://www.investopedia.com/terms/r/relevantcost.asp>

Yahoo Finance on Ford Motor Company 2020, Yahoo Finance, viewed 18 October 2020<https://finance.yahoo.com/quote/F/history/>

Yahoo Finance on General Motors Company 2020, Yahoo Finance, viewed 18 October 2020<https://finance.yahoo.com/quote/GM/history/>

Yahoo Finance on Tesla Inc. 2020, Yahoo Finance, viewed 18 October 2020<https://finance.yahoo.com/quote/TSLA/history/>

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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