Business Finance Task

MIDTERM ASSESSMENT Activity brief BCO222 BUSINESS FINANCE II Online campus Professor: Julia Sokolova ([email protected])

Description Assignment consisting of a set of case studies on the material of Weeks 1-4. This is an individual task. Remember that as a student you are bound by the school ethics and all the work you submit should be of your own.

Format This activity must meet the following formatting requirements:

• Font size 12 • Double-spaced • Harvard Referencing System

Goal(s) To assess the students’ learning on the first half of the course.

Due date Date: Monday, 21 June 2021 Time: 14:00 CET via Moodle (Turnitin)

Weight towards final grade

This activity has a weight of 50% towards the final grade.

Learning outcomes

1. 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.

2. Understand what free cash flow is and how to measure it.

3. Understand a company’s capital structure and dividend policy.

Assessment criteria

For computational questions, you should show all your workings and the results. For conceptual questions, you should demonstrate thorough understanding of finance concepts and principles. The student’s work will be assessed by deepness of analysis, solid judgments, logic of statements, and understanding of implications of finance and business.

CASE 1 (30 points) The following information is available for Star Corporation: Debt: 12,000 bonds outstanding that are selling for 106 percent of par value €1,000; bonds with similar characteristics are yielding 4.5 percent, pretax. Common stock: 580,000 shares outstanding, selling for €47 per share; the beta is 1.12. Preferred stock: 40,000 shares of 3.2 percent preferred stock outstanding, par value €100 per share, currently selling for €68 per share. Market: 8 percent market risk premium and 3.4 percent risk-free rate. Assume the company’s tax rate is 25 percent. Instructions:

1. Calculate the firm’s market value capital structure. (10 points)

2. Calculate the firm’s costs of common equity, preferred stock and debt. (10 points)

3. Calculate the weighted average cost of capital. (5 points)

4. If the company is considering an average risk project with an internal rate of return of 12%, should it accept the project? Explain. (5 points)

CASE 2 (30 points)

Consider the data for the following two projects, Beta and Zeta:

Year Cash Flow (Beta) Cash Flow (Zeta)

0 −€35,000 −€36,000

1 17,000 18,000

2 14,000 15,000

3 12,000 13,000

Instructions:

1. Using company cost of capital 12%, calculate the following investment criteria for both projects:

a. Payback period (5 points) b. Net Present Value (NPV) (5 points) c. Internal Rate of Return (IRR) (5 points) d. Profitability Index (PI) (5 points)

2. If projects Beta and Zeta are independent, which one(s) will you choose? Why? (5 points)

3. If projects Beta and Zeta are mutually exclusive, which one will you choose? Why? (5 points)

CASE 3 (20 points)

The company is considering a five-year project that will require €500,000 for new manufacturing equipment that will be depreciated straight-line to a zero-book value over five years (depreciation rate is 20% per year). At the end of the project, the equipment can be sold for 15 percent of its original cost. The project requires an initial investment in net working capital of €98,000, all of which will be recovered at the end of the project. The project is expected to generate annual sales of €725,000 with annual costs of €525,000. The tax rate is 30 percent and the required rate of return is 18.5 percent. Instructions:

Complete the pro forma below and determine free cash flows for each year of project’s life. Explain your decision whether you recommend to accept or reject the project.

Year 0 1 2 3 4 5 Sales Costs Depreciation EBIT Taxes Net income Operating Cash Flow

Capital spending Net Working Capital After-tax salvage value Free Cash Flow

CASE 4 (20 points)

The balance sheet for Solomon Corporation is shown here in market value terms. There are 30,000 shares of stock outstanding.

Market Value Balance Sheet (€)

Cash 200,000 Debt 800,000

Other Assets 1,800,000 Equity 1,200,000

Total 2,000,000 Total 2,000,000

Instructions:

Consider the following alternatives:

1. The company has declared a cash dividend of €4.00 per share. The stock goes ex dividend tomorrow. Ignoring any tax effects, what is the stock selling for today? What will it sell for tomorrow? What will the balance sheet look like after the dividends are paid? (5 points)

2. Suppose that instead of cash dividend the company has announced it is going to repurchase €60,000 worth of stock. 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. Suppose that instead of cash dividend or stock repurchase, the company has declared a 20 percent stock dividend. The stock goes ex dividend tomorrow. What will the ex-dividend price be? (5 points)

Points are stated at the end of each question.

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.