Business finance
BCO222 Business Finance II Task brief & rubrics
Task: Midterm Assignment (40% of course grade)
You are asked to answer all the questions in the proposed four cases.
This task assesses the following learning outcomes:
Develop sound analytical frameworks to grasp the process of decision making with respect to making investment in fixed assets and the methods used
to evaluate new projects.
Understand what free cash flow is and how to measure it.
Understand a companys capital structure and dividend policy.
LAUNCH: WEEK 4 Friday August 21st 2020 / DELIVERY: WEEK 4 Sunday August 23rd 2020, 23:59hrs ON MOODLE
Submission file format: Word document with all the answers, clearly identifying each case separately.
CASE 1 (25 points)
Look at the below book-value balance sheet for Universal Corporation. The preferred stock currently sells for 15 per share and pays a dividend of 2 a share. The
common stock currently sells for 20 per share and has a beta of 0.8. The bonds currently sell at 935.82. The market risk premium is 10%, the risk-free rate is 6%,
and the firms tax rate is 40%.
Instructions:
1. Calculate the firms outstanding number of bonds, preferred shares and common shares. (4 points)
2. Calculate the firms market value capital structure. (6 points)
3. Calculate the firms costs of common equity, preferred stock and debt. (5 points)
4. Calculate the weighted average cost of capital. (5 points)
5. If the firm is considering an average risk project with an internal rate of return of 14%, should it accept the project? Explain. (5 points)
BOOK-VALUE BALANCE SHEET (Figures in millions)
Assets Liabilities and Equity
Cash and short-term securities 1 Bonds (par value 1000; coupon 8% paid annually; maturity 10 years; yield to maturity 9%) 10
Accounts receivable 3 Preferred stock (par value 20) 2
Inventories 7 Common stock (par value 0.10) 0.1
Plant and equipment 21 Additional paid-in stockholders equity 9.9
Retained earnings 10
Total 32
32
CASE 2 (25 points)
Consider the following two projects:
Year Cash Flow (Alpha) Cash Flow (Omega)
0 64,000 52,000
1 46,000 25,000
2 68,000 22,000
3 68,000 21,500
4 458,000 17,500
Whichever project you choose, if any, you require a return of 11 percent on your investment.
Instructions:
1. If you apply the payback criterion, which project will you choose? Why? (5 points)
2. If you apply the NPV criterion, which project will you choose? Why? (5 points)
3. If you apply the IRR criterion, which project will you choose? Why? (5 points)
4. If you apply the profitability index criterion, which project will you choose? Why? (5 points)
5. Based on your answers in (1) through (4), which project will you finally choose? Why? (5 points)
CASE 3 (25 points)
The company is considering a new four-year expansion project that requires an initial investment in manufacturing machinery of 1,670,000. The machinery will
be depreciated straight-line to zero over its four-year tax life (depreciation rate is 25% per year). At the end of the project, the machinery can be sold for 26% of
its original cost. The project requires an initial investment in net working capital of 198,000; all of which will be recovered at the end of the project. The project
is estimated to generate 1,850,000 in annual sales; with annual costs of 1,038,000. The tax rate is 21 percent and the required return for the project is 16.4%.
Instructions:
1. Complete the pro forma below and determine free cash flows for each year of projects life. (20 points)
2. Would you recommend to accept or reject the project? Explain your decision. (5 points)
Year 0 1 2 3 4
Sales
Costs
Depreciation
EBIT
Taxes
Net income
Operating Cash Flow
Capital expenditure
Net Working Capital
After-tax salvage value
Free Cash Flow
CASE 4 (25 points)
The balance sheet for Serenity Corporation is shown below in market value terms. There are 2.4 billion shares outstanding.
MARKET-VALUE BALANCE SHEET (Figures in millions)
Cash 315 Equity 4,022
Non-current assets 10,256 Liabilities 6,549
Total 10,571 Total 10,571
Instructions:
1. The company declared a cash dividend of 0.61 per share. It goes ex-dividend tomorrow. Ignoring any tax effects, what are the shares selling for today? What
will they sell for tomorrow? What will the market value balance sheet look like after the dividends are paid? (10 points)
2. What if instead of cash dividend, the company has announced it is going to repurchase 1 billion worth of equity. What effect will this transaction have on the
equity of the firm? How many shares will be outstanding? What will the price per share be after the repurchase? (10 points)
3. Ignoring tax effects, explain how the share repurchase is effectively the same as a cash dividend. (5 points)
Rubrics
Descriptor
9-10 The student demonstrates an excellent understanding of the
concepts.
8-8.9 The student demonstrates a good understanding of the concepts.
7-7.9 The student demonstrates a fair understanding of the concepts.
6-6.9 The student demonstrates some, but insufficient understanding of the
concepts.
3-5.9 The student demonstrates insufficient understanding of the concepts.
They may mention some relevant ideas or concepts, although it is
clear that the relationship between them is not understood by the
student.
1-2.9 The student demonstrates insufficient understanding of the concepts
and does not mention any relevant ideas or concepts.
0 The student leaves the question blank or cheats.
Points are stated at the end of each question.
