Organizations or intermediaries that help the financial system operates efficiently and transfer funds from savers and investors to individuals, business and government that seek to spend or invest the funds.
These are the physical location or electronic forums that facilitate the flow of funds amongst investors, business and governments
It involves sale or marketing of securities, the analysis of securities, and the management of investment risk management of investment risk through portfolio diversification.
It involves financial planning, asset management, and fund raising decision to enhance the value of business.
Question No. 1:
Net Present Value:
It is basically the difference between the present value of cash inflows and the present value of cash outflows. NPV is used in capital budgeting to analyze the profitability of an investment or project. If the NPV of the project is positive, then the project should be accepted. However, if NPV of that project is negative, the project should probably be rejected because cash flows of that project will also be negative.
Calculations for Alice and Wonderland Limited:
The market weighted gearing of Alice Ltd £1 ordinary shares amounts 500 million GBP = owns 500 million shares. Market value of shares = 500-4 = £2000 million Market value of bonds = 5.7-93 = £530.1 million Market value of debt = £530.1 million Total value = 2700+530.1 = £3230.1 million Fraction debt = 530.1/3230.1 = 16.4% Fraction equity = 2700/3230.1 = 83.6%
Asset beta for Alice Ltd
Assets beta = (2700/ (2700+530.1-.65))-1.5 = (2700/ (2700+344.565))-1.5 = (2700/3044.565)-1.5 = 0.887-1.5 = 1.33
Wonderland equity beta
Beta wonderland = 1.33 (1 + (0.35-0.65/0.65)) = 1.33 (1 + 0.35) = 1.33- 1.35 = 1.796
Cost of equity
Using CAPM (Capital Asset Pricing Model), the formula for cost of equity is Cost of equity = risk free rate + beta- (market return – risk free rate) Cost of equity = 3.5% + 1.796- (12% – 3.5%) = 3.5% + 1.796-8.5% = 3.5% + 15.27% = 18.77%
It is a model which describes the relationship between risk and expected return and that is used in the pricing of risky securities. This model says that the expected return of a portfolio or of a security equals the rate on a risk-free security plus a risk premium. If this expected return does not match or beat the required return, then the investment should not be undertaken. The security market line plots the results of the CAPM for all different risks (betas)
Cost of equity for Wonderland Inc. = 18.77%
Capital Asset Pricing Model Cost of equity = 18.77% Cost of debt = 8% Fraction debt = 35% Fraction equity = 65%
WACC (Weighted Average Cost of Capital):
Corporate assets are financed by two ways either by debt or by equity. WACC is the average of the costs of these sources of financing, each of which is calculated by its respective use in the given situation. By taking a calculated average, we can see how much interest the corporate has to pay for every penny a corporate finances in the project or in its business. WACC can be calculated as follow:
WACC = Fraction equity – cost of equity + fraction debt – cost of debt- (1 – T)
WACC = 0.65-0.1877 + 0.35-0.8- (1 – 0.35) = 12.2% + 0.35-0.8-0.65 = 12.2% + 18.2% = 30.4%
NPV for Wonderland Theme Park:
Admission price = 25- (0.3-20,000) + 15-(0.7-20,000) = 150,000 + 210,000 = £360, 00 Contribution from food and drinks = 10-20,000-0.4 = £80,000 Contribution from gifts and souvenirs = 7-20,000-0.45 = £63,000
Revenues = £503,000/day
Annual revenues = 503,000-365 = £183.6 million
Revenues at year 0 = £183.6 million Revenue at year 1 = 183.6-1.05 = £192.78 million Revenue at year 2 = 192.78-1.05 = £202.4 million Revenue at year 3 = 202.4-1.05 = £ 212.52 million Revenue at year 4 = 212.52-1.05 = £223.146 million Revenue at year 5 = 223.146-1.05 = £234.3033 million Wonderland can secure a loan of £400 million at 8% fixed rate. Thus the company will pay an interest on the loan which is tax-free. Hence this must be excluded from the taxable income similar to capital allowance. Hence the company will pay £32 million as interest every year. The after tax realizable value of the non-current assets after five years of the project is given to be between £100 million and £200 million. This is assumed to be £150 million.
NPV= initial cash outlay of -250 -net working capital of -60= net cash flow of -310
Going with the NPV rule for single projects, the negative NPV of cash flows indicates that the theme park project should not be undertaken.