# Capital Structure and Capital Budgeting Case Study Help

Mini Case study Assignment Help on Capital  Structure and Capital

Mini Case study Assignment Help Solution : 1). Weighted Average Cost of Capital of Firm:

 Sources Amount Weight After Tax Cost Weighted Cost Debt 18000 .40 .0684 .0273 Equity 27000 .60 .1836 .1102 Weighted Average Cost of Capital (WACC) . 13.75%

WACC = rD (1- Tc)*(D / V) + rE *(E / V) (Source: Boehme) Where, rD = Return on Debt (10.68%) Tc = Rate of Corporate Tax (36%) D = Value of Debt (\$18000) V = Total Value (\$45000) rE = Return on Equity (18.36%) E = Value of Equity (\$27000) = 10.68(1-0.36) × (.4) + 18.36 × (.6) = 6.8352 × .4 + 18.36 × (.6) = 2.73408 + 11.016 = 13.75 % 2). Traditional Net Present Value (NPV): NPV = -C0 + + ………… + C0 = Initial Investment (\$45000) C = Cash Flow (\$13000) r = Discount Rate (13.75%) T = Time (20 Years)

Calculation of Net Present Value:

 Years Annual Cash Flow PVIF @ 13.75% Present Value (in \$) 1 13000 .879 11427 2 13000 .773 10049 3 13000 .679 8827 4 13000 .597 7761 5 13000 .525 6825 6 13000 .462 6006 7 13000 .406 5278 8 13000 .357 4641 9 13000 .314 4082 10 13000 .276 3588 11 13000 .242 3146 12 13000 .213 2769 13 13000 .187 2431 14 13000 .165 2145 15 13000 .145 1885 16 13000 .127 1651 17 13000 .112 1456 18 13000 .098 1274 19 13000 .086 1118 20 13000 .076 988 Net Present Value (Annuity Due) T= 0 to N-1 6.719% 87347

= NPV – Initial Investment = \$87347– \$45000 = \$42347 (Good Deal) In addition, net present value can also be calculated by the following formula: NPV = Total of PVIF × Annual Cash Flow = 6.719 × \$13000 = \$87347 Decision to Undertake: This project should be undertaken by the project manager, because it will provide a benefit of \$42347 for its shareholders. The profit is calculated on the basis of present value of cash outflows and present value of cash inflows. 3).

Return on Unlevered Equity (Modigliani and Miller’s Proposition H.):

 Cash Flow Unlevered EBIT \$13000 Interest Nil EBT \$13000 Tax (36%) \$4680 Net Income \$8320

In an unlevered firm, return of equity with tax will be calculated by the following formula: k= ku + (ku – kd) (1-T) (Lee & Lee, 2006) Where, ku= = = .3081 k= 0.1068 T = Tax rate (36%) k= ku + (ku – kd) (1 – T) = 0.3081 + (0.3081 – 0.1068) (1- 0.36) = 0.3081 + (0.2013) (0.64) = 0.3081 + 0.1288 = 0.4369 or 43.69% 4).

Adjusted Present Value (APV) Method: Investment = \$45,000 Cash flow from equity = \$27,000 Cost of equity = 18.36% Cost of Debt = 10.68% Tax = 36% APV in Levered Firm = NPV – PV (Source: Boehme) NPV = – Initial investment + (Value of Equity / Cost of Equity) NPV = -\$45,000 + (\$27,000 / 18.36%) = -\$45,000 + \$147058.82 = \$102058.82 PV = Tax Rate × Cost of Debt (Damodaran, 2012) PV = (36% x \$18,000 × 10.68%) / 10.68% = \$6480 = \$102058.82 + \$6480 = \$108538.82 (Good Deal) Decision to Undertake: This project should be undertaken by the project manager of the company, because the NPV of this project is positive. A project manager should invest in the project that has not positive NPV otherwise; it will be a loss for the firm. 5). Flow-To-Equity (FTE): Levered Cash Flows (LCF) = [EBIT – rDB] [1 – TC] = [\$13000 – (10.68%) (\$18000)] [1-.36] = [\$13000 – 1922.4] [.64] = \$11077.6 × .64 = \$7090 Cost of Leveraged Equity (rE) = r0 + (r0 – rD) (1 – TC) (D/E) (Source: Boehme) = 18.36% + (18.36% – 10.68%) (1-.36) (.4/.6) = 18.36% + (7.68%) (.64) (2/3) = 18.36% + 4.9152 (2/3) = 18.36% + 3.2768% = 21.64% NPV = LCF/rE – Initial Equity Investment = \$7090 / rE – \$45000 = \$7090 / 21.64% – \$45000 = \$32763.40 – \$45000 = – \$12236.60 Decision to Undertake: By calculating Flow-To-Equity, it is found that the NPV is also negative that is not good for the wealth and financial growth of the company. So, project manager of Fiera Corporation is recommended that he/she should not undertake this project. It is because; it is not a profitable project for the company.

References Boehme, R. (n.d.).Corporate Finance. Retrieved April 23, 2012 from http://www.rdboehme.com/MBA_CF/Chap_12.pdf Boehme, R. (n.d.).Corporate Finance. Retrieved April 23, 2012 from http://www.rdboehme.com/MBA_CF/Chap_15.pdf Damodaran, A. (2012). Investment Valuation: Tools and Techniques for Determining the Value of Any Asset. (3rd ed.) Canada: John Wiley & Sons. Lee, C.F. & Lee, A.C. (2006). Encyclopedia of Finance. USA: Springer.

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