## Thursday, December 5, 2019

### Principles of Corporate Finance Market Price Bond

Question: Describe about the Principles of Corporate Finance for Market Price Bond. Answer: 1. Face value of the bonds = \$ 1000 Coupon payment = 15% of 1000 = \$ 150 paid semi-annually Time remaining to maturity = 4 years Current market price of the bond = \$890 Hence, YTM would be the discount rate at which the present value of the expected payments from the bond would be equal to \$ 890 (Damodaran, 2008). This comes out as 20.27% pa from the calculation shown below. Half Year Cash inflow PV of cash flows 1 75 68.10 2 75 61.83 3 75 56.14 4 75 50.97 5 75 46.28 6 75 42.02 7 75 38.15 8 1075 496.51 Total 860.00 Thus, YTM = 20.27%pa. 2. As per Fischer effect equation, (1+Real Interest Rate)*(1+Inflation rate) = (1+Nominal Interest Rate) Hence, (1+Real Interest Rate)*(1.03) = 1.14 Thus, 1+Real Interest Rate = 1.1068 Solving the above, Real interest rate = 10.68% pa 3. Let the price today be \$ X Thus, Return on Stock = [(Next year price - Current Price + Dividend)/Current Price]*100 Here, next year price = \$ 78, Dividend = \$ 6, Return on stock = 10% Hence, 0.1 = (78-X+6)/X Solving the above, we get X = \$ 76.36 4. As per the information given, EMI = \$ 220, Principal = \$ 5,000, Interest rate per month= 2% We use the formula for EMI which is stated below EMI = P*R*(1+R)N/((1+R)N -1) Here N is the time period in months which is unknown Hence, 220 = 5000*0.02*(1.02)N/[(1.02)N-1] Solving the above we get, N = 30.59 months or 31 months Nominal Annual Interest Rate = Monthly rate * 12 = 2* 12 = 24% pa Annual Effective Rate = [(1+0.02)12 -1] = 26.82% pa 5. As per the question, money to the tune of \$ 4,000 would be deposited at the end of 2nd, 3rd and 4th year. Starting amount in the account at the beginning of the 1st year = \$ 7,000 Interest rate = 8% pa Hence, amount at the end of the three years = 7000(1.08)3 + 4000(1.08) + 4000 = \$ 17,138 Amount at the end of the four years = 7000(1.08)4 + 4000(1.08)2 + 4000(1.08)+ 4000 = \$ 22,509 6. Expected Sales = \$ 600,000 Hence, current assets = 0.65*600000 = \$ 390,000 Fixed assets = \$ 1,600,000 Thus, total assets = 1,600,000 + 390,000 = \$ 1,990,000 EBIT = 0.18*600000 = \$ 108,000 Non-current liabilities = 0.45*Fixed Assets = 0.45*1,600,000 = \$ 720,000 Hence, interest expense = 0.07*720000 = \$50,400 Hence, PBT (Profit before tax) = EBIT interest = 108000 50400 = \$ 57,600 Since no tax is applicable for the company, hence PBT and PAT are equal. ROA = (Net profit or PAT/Total Assets)*100 = (57600/1990000)*100 = 2.89% 7. The relevant model to be used is Gordon Dividend Growth Model. As per this model, Intrinsic market price = Next year dividend /(Required return Dividend Growth Rate) Next year dividend = 1.8*1.04 = \$ 1.872 Price of share = 1.872/(0.16-0.04) = \$ 15.6 8. The various benefits of a just in time inventory system are highlighted below (Brealey, Myers Allen, 2008). The inventory holding costs are minimised since the inventory stock held is minimal. There is high inventory turnover and hence minimal inventory obsolescence. The cash investment in terms of inventory is lower which provides additional liquidity to the company. The mistakes in the production are easier to spot which saves time and fixing costs. The various costs of a just in time inventory system are highlighted below (Parrino Kidwell, 2011). Significant delays if the supplier cannot supply the inventory on time An elaborate end to end IT infrastructure is required for the integration of the client and supplier so that orders are automatically placed based on the orders received. Any unexpected increase in demand in product may have adverse consequences since the availability of inventory cannot be increased at short notices specially where there is little in way of idle capacity. 9. The nominal value of the investment does not consider the impact of time value of money and hence is equal to the sum of all cash inflows = 10000 + 15000 + 11000 + 20000 = \$ 56,000 The appropriate amount that B should pay for this investment is equal to the present value of these investments. The expected returns on the investment is given as 6% pa Appropriate amount = 10000/1.065 + 15000/1.066 + 11000/1.067 + 20000/1.068 = \$ 37,910.9 Assuming that the opportunity cost of money or time value of money is zero, hence maximum amount payable is equal to the nominal value or \$ 56,000 (Petty et. al., 2015). References Brealey, R, Myers, S Allen, F 2008, Principles of Corporate Finance (Global edition), 10th edn, McGraw Hill Publications, New York Damodaran, A 2008, Corporate Finance, 2nd edn, Wiley Publications, London Parrino, R Kidwell, D 2011, Fundamentals of Corporate Finance, 3rd edn, Wiley Publications, London Petty, JW, Titman, S, Keown, AJ, Martin, P, Martin JD Burrow, M 2015, Financial Management: Principles and Applications,6th edn, Pearson Australia, Sydney