BFF5956 CORPORATE FINANCING DECISIONS Week 01
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BFF5956 CORPORATE FINANCING DECISIONS
Week 01 Tutorial Solutions – Warmup
Question 1:
What is corporate finance? What is the objective of corporate finance?
Suggested Solution:
A field of finance that deals with financial decisions that companies make, and the tools that they use to make these decisions. Examples: raising new equity capital, acquiring a target company, selling-off a division, repurchasing shares, issuing bonds, paying dividends to shareholders, etc.
The primary goal of corporate finance is to maximise shareholder’s wealth.
Question 2:
You have decided to form a new start-up company developing applications for the iPhone. Give examples of the three distinct types of financial decisions you will need to make.
Suggested Solution:
As the manager of an iPhone applications developer, you will make three types of financial decisions.
i. You will make investment decisions, such as determining which type of iPhone application projects will offer your company a positive NPV and that your company, therefore, should develop.
ii. You will make the decision on how to fund your iPhone application investments and what mix of debt and equity your company will have.
iii. You will be responsible for the disbursement decision, determining how much the company should distribute to its shareholders as dividends (or through share repurchases).
Question 3:
Explain the differences between equity finance and debt finance.
Suggested Solution:
Equity Finance is the act of raising money for company activities by selling stock to investors. In return for the money paid, shareholders receive ownership interests in the corporation.
Debt Finance is the act of raising money for company activities by selling bonds, bills, or notes to investors (e.g. borrowing). In return for the money, the investors become creditors and receive a promise that the principal and interest on the debt will be repaid.
Question 4:
Explain the following:
(i) Annuity (ii) Annuity due
(iii) Perpetuity
(iv) Growing perpetuity
Suggested Solution:
(i) Annuity - A series of equal cash flows paid/received at the end of each period for n number of periods. Example: Mortgage payments (when the interest rate on the mortgage is fixed).
(ii) Annuity due – This is also an annuity but the cash flows are paid/received at the
beginning of each period.
(iii) Perpetuity - A series of equal cash flows that occur at regular intervals and last
forever. Example: If a company pays the same dividend per share, for the purpose of valuing this share using the dividend discount model, we assume that the company pays the same dividend forever.
(iv) Growingperpetuity – A series of equal cash flows that occur at regular intervals and
grow at a constant rate forever. Example: If a company increases its dividend per share by the same rate every year, for the purpose of valuing this share using the constant growth model, we assume that the company’s dividend grows at a constant rate forever.
Question 5:
You are 23 years old and decide to start saving for your retirement. You plan to save $5,000 at the end of each year (so the first deposit will be one year from now), and will make the last deposit when you retire at age 68. Suppose you earn 9% per year on your retirement savings.
(i) How much will you have saved for retirement?
(ii) How much will you have saved if you wait until age 32 to start saving (again, with your
first deposit at the end of the year)?
Suggested Solution:
(i) = 5000 × [(1 + 0.09)45 − 1]=$2,629,293.67
(ii) = 5000 × [(1 + 0.09)36 − 1]=$1,180,623.61
Question 6:
You are provided with the following information for Zigma Ltd. for its recent financial year:
Sales Revenue
Operating expenses Administrative and sales expenses Depreciation
$54,000 million
$20,000 million
$10,000 million
$1,000 million
The company pays corporate tax at a rate of 40%. Its capital expenditure for the year was $8,000 million and the increase in net working capital for the year is $500 million.
(i) Calculate the free cash flow for the firm.
(ii) If the company’s cost of capital is 12% and free cash flow is expected to grow at a
rate of 4% annually, calculate the value ofthe firm.
Suggested Solution:
(i) The free cash flow is calculated as follows (in $ million):
Sales Revenue |
$54,000 |
Less: Operating expenses Administrative and sales expenses Depreciation |
$20,000 $10,000 $1,000 |
EBIT |
$23,000 |
Less: Income tax at 40% |
$9,200 |
Unlevered Net Income |
$13,800 |
Plus: Depreciation Less: Capital expenditure Less: Increase in net working capital (NWC) |
$1,000 ($8,000) ($500) |
Free cash flow |
$6,300 |
The company has generated free cash flows of $6,300 million last year.
(ii) The value of the firm can be calculated using the constant growth model. 0 =$6,300
WACC = 0.12
g = 0.04
0 = 1 = 0(1+) = 6,300(1+0.04) = $81,900 (million)
The value ofthe firm is $81,900 million.
2022-03-29