Assignment Answers: fFinancial Firm Specializing 600543

1
Coursework Template
Module Title Current Issues in Financial Management
Module Code 600543
Coursework Element Assignment …

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1
Coursework Template
Module Title Current Issues in Financial Management
Module Code 600543
Coursework Element Assignment
Module Leader Qin Xiao
Word Count n.a.
First Sit or Resit? First sit
Reassessment by
resubmission or new
assessment?
Note: reassessment should be
by resubmission wherever
possible
By resubmission
Note:
1. Please type all your answers using a Word document .
2. Submit via Canvas when completed.
2
2021 -22 Assignment Title : As sessment
1. You are a financial analyst for a financial firm specializing in investing in young
companies. The CFO of your firm asked you to value a buy -and -hold investment
project. This venture can be sold at the market value upon maturity 20 years from
now . After intensive research, you have come up with t he following information
regarding the cash flows of the venture in three different scenarios . Compound
annual returns for the different scenarios are based on an estimate d initial once –
and -for -all investment cost $10,000.
Scenario Probability Return on Market Projected Cash
Flow per acre at
Harvest
Compound Annual
Rate of Return on
Investment
Boom 40% 25% $164,000 15%
Normal 30% 10% $96,000 12%
Bust 30% -10% $67,000 10%
After confirming that the market risk premium for similar investment projects is
4.5%, you ha ve estimated that, based on risk -adjusted discount rate (RADR)
method, the NPV of this project is $24,749. To be more confident of your
conclusion, you have re -estimated the value of the project using certaint y
equivalent method (CEQ) and concluded that the NPV of this project is
$24,968. Hence, you have recommended to the CFO that this project is worth
pursuing. The CFO, after examining the information you have presented to
him, however, concluded that this in vestment should not go ahead. His
rational is that the venture is very risky and the best way to evaluate it is by
using venture capital (VC) valuation method with 20% discount rate .
a. What is the NPV of the investment based on the method suggested by
your CFO ?
(5 marks)
Answer
Expected Value = 164000*40%+ 96000*30%+ 67000*30%= $ 114500
PV = 114500/(1+20%)^20= $ 2986
NPV= 2987 -10000= -7013
NPV of the project is negative,
b. Discuss the strengths and weaknesses of VC valuation method
relative to RADR and CEQ .
Answer
The strengths and weaknesses of VC valuation method are as follows :
Strength of VC valuation relative to RADR are as follows :
1. It is very much simple and easy
2. It is appealing to risk averse investors
3. It reduce uncertain ty and fluctuations involved
Weakness of VC valuation relative to RADR are as follows
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1. To get an accurate risk premium is very much challenging
2. It assumes that the investors are risk averse
Strength of VC valuation relative to CEQ are as follows
1. An idea can be framed of the risk volume an investor much take for an
increase in return.
2. This method is helpful as it provides minimum return that can be possible
from an investment value .
Weakness of VC valuation relative to CEQ are as follows
1. Based on market demand
2. Not applicable to all kinds of investment
3. Applicable only to risk averse people not to other form of investors
(20 marks)
c. Do you think the 20% discount rate is justifiable? Explain your answer
using the relevant theories.
Answer
No it is not justified as the return requirement is not so high for the project and such
high rate makes the project unacceptable. Also, the risk premium for similar project is
4.75% and thus using a blank rate of 20% is unacceptable. Venture Capital rate is also
used for risky capital projects and the risk element of the project is not so high and
thus using the said rate shall not be an ideal choice. Further, the market rate expected
is 10% based on probability model and thus risk of 20% is much high
(25 mar ks )
(Total 50 Marks)
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2. Testa Energy plc is considering investing in a new project for transporting
solar energy from Algeria to Germany . The investment requires an initial
once -and -for -all expenditure of £ 19.75 million with future cash flows given in
the table below (in £ mn)
Year 1 2 3
Cash flow 3 9 12
Testa Energy plans to finance this project by selling risk -free zero -coupon
bonds maturing at the end of year 1, 2 and 3 respectively which matches the
timing of the project cash flow. The current prices of these bonds are given
below
Maturing year 1 2 3
Face value 3 9 12
price at 0 2. 75 7.5 9.5
a. Calculate the yield to maturity of the zero -coupon bonds
maturing at the end of year one, two and three.
(10 Marks)
The computation of YTM of the bonds is as under
For year 1= 3/2.75 -1=9.09%
For Year 2= (9/7.5)^(1/2) -1=9.55%
For Year 3= (12/9.5)^(1/3) -1=8.10%
b. If the projected cash flow is riskless, should the project be
pursued by Testa Energy according to the NPV principle?
Support your answer with appropriate calculations.
(15 Marks)
Ans b
If the project cash flow is risk free the computation of PV is as under
PV= 2.75+ 7.5+ 9.5= 19.75
Cash outflow=19.75
NPV= 19.75 -19.75=0
Pr oject acceptance is challenging as NPV is Zero and shall generate required return
only. Thus, if better project is available company should consider that.
c. Suppose an investment project alternative to the above is also
put forward for consideration. The cash flow of this project is
shown in the table below
0 1 2 3
5
Alternative project -20 6 20 10
Given the resource constraint of Testa Energy , only one of these
two projects can be pursued. Evaluate your choice based on the
NPV principle. Would your answer be different if incremental
cash flow is used to calculate NPV?
(15 Marks)
Ans c
PV = 6/(1+9.09%)+ 20/(1+9.55%)^2+10/(1+8.10%)^ 3=30.08
Outflow =20
NPV= 30.08 -20= 10.08
Project shall be accepted.
If incremental approach is used
PV = 3/(1+9.09%)+ 11/(1+9.55%)^2+ -2/(1+8.10%)^3=10.33
Outflow =10
NPV= 10.33 -10=0.33
NPV is positive and project shall be accepted.
d. Explain the economic rationale of using incremental cash flow
approach.
Answer
Incremental cash flow analysis tries to ascertain the future cash flows involved of a
business if new project is considered .It is very much helpful to management to
ascertain if the proj ect is worth doing or not . The project is considered be worthwhile
if a positive incremental cash flow is generated from same and it shall be declined if a
negative cash flow is expected from a project .
(10 Marks)
(Total 50 Marks)
—– THE END —-
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2. Learning outcomes to be assessed
LO1 Explain and evaluate recent and future potential developments in corporate
finance.
LO2 Describe and critically evaluate the overall relationship between the chosen
topics of study
LO3 Evaluate the increasing realities of the complexity of the current financial
environment
LO4 Critically assess the political nature and socio -economic influence of
financial information
3. Assessment criteria
o Analysing relevant information in appropriate ways;
o Seeking academic support;
o Understanding the implications of both theory and empirics;
o Numerical skills as are appropriate for the level.
o Displaying capability of integrating knowledge and using it to serve the
purpose (persuasively argue for the points you are trying to ma ke, whatever
it might be).
4. Grading descriptors
First (>=70)
 Direct & penetrating in answering question, drawing on wide range of
relevant evidence.
 Fluent, reasoned & sustained argument, with excellent use of supporting
evidence.
 Excellent & critical und erstanding of concepts of current conceptual issues, &
of current debates &/or issues in field of study.
 Clear evidence of critical ability & of insight, perceptiveness & originality.
Extensive & comprehensive information base.
 Clear evidence of famili arity with relevant literature, including recent
research literature*.
 Significant ‘value added’ to material from lectures & prescribed reading.
Upper Second (60 – 69)
 Direct in answering question, drawing on range of relevant evidence.
 Reasoned & susta ined argument, with effective use of supporting evidence.
 Clear understanding of concepts, of current conceptual issues, & of current
debates & or issues in the field of study.
 Evidence of critical ability & perhaps some evidence of insight or
perceptive ness.
 Wide & sound information base.
 Evidence of familiarity with relevant literature, including the recent research
literature*.
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 Considerable ‘value added’ to material from lectures & prescribed reading.
Lower Second (50 – 59)
 Answers question, drawin g on limited range of relevant evidence.
 Some evidence of ability to develop reasoned & sustained argument, with
adequate use of supporting evidence.
 Understanding of concepts & conceptual issues. Limited evidence of
critical ability.
 Adequate information base.
 Evidence of awareness of relevant literature & of some of the recent
research literature*.
 Little or limited ‘value added’ to material from lectures & prescribed
reading.
Third (40 – 49)
 Attempts to answer question, but may di gress at times & may have limited
awareness of implications of question.
 Argument not always fully reasoned or sustained, perhaps with limited use of
supporting evidence.
 Limited understanding of concepts & conceptual issues.
 Little or no evidence of cr itical ability.
 Limited &/or shaky information base.
 Little awareness of relevant literature, with little or no awareness of the
recent research literature*.
 No significant ‘value added’ to
Fail (

QUALITY: 100% ORIGINAL PAPER – NO PLAGIARISM – CUSTOM PAPER

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