CORPORATE FINANCE

Assignment

Department of Business Administration Mohammad Ali Jinnah University Islamabad

FUBUKI CO CASE ASSIGNMENT MBA SECTOIN 01

Submitted By Ghazanfar Ali MB101004

Submitted To Mr. NASIR RASOO

2 (a) Base Case Net Present Value

CORPORATE FINANCE
Assignment Fubuki Co: Project Evaluation The inflation rate increases 3% per year. Note: Full credit will be given where the assumption is made that allowances are 75 in the first !nits "roduced and35 in the final year. three years and sold #$3 #%& &$54% &$'75 () %nit Price&cost In'(ation Now )ear * )ear 2 )ear + )ear , *ales revenue &.5 3% 3&5 4'%7 '$75% 73 % +irect costs #.& %% #5' &$35, 35'' 4 44 Attributable fi-ed costs #$ 5% # # 5 ## 3 ##5% Pro'its -./ *201 2/1. 2*/.or/ing capital #5% 04%% 0&#5 03## 0%& #$ ,' Ta-ation 1w#2 0# 0#57 03' 03'4 Incre!enta( cas2 '(ows 3nvestment4sale 0#4$ #'$ 5et cash flows 0#4$4%% 4'5 %# #$'47 #%$%3% "resent 6alue 1# %2 1w&2 0#4$4%% 4&& '7 #$&37 #&$%'7 7ase case 5"6 7 % Working (w*) Pro'its -./ *201 2/1. 2*/8ess9 allowances '5 '5 '5 '5 Ta-able profits 4 '&% #43, #45' Ta# #57 3' 3'4

Working (w2) Discount rate (Hai u!"s ungeare# $e)

CORPORATE FINANCE
Assignment ke(g) 3 ke(u) 4 (*5 t)(ke(u) 5 k#)6#&6e 6e 3 278+ 9 *8 3 +07.8 6# 3 ,/ 9 /7.,11 3 +07.82 Assu!e 6#&6e 3 * *, 3 ke (u) 4 /702 9 (ke(u) 5 ,78) 9 * *, 3 *702ke(u) 5 +72, $e (u) 3 */7/2 assu!e 3*/: Note: The discount rate can be estimated by calculating the asset beta and then using that to estimate the cost of e:uity. The base case net present value is calculated as appro-imately (7 %$ . This is positive but marginal. T2e 'o((owing 'inancing si#e e''ects a;;(< Issue costs ,&.- 9 =*,>,11 Ta9 ?2ie(# Annua( ta9 re(ie' 3 (*,>,11 9 1/: 9 /7/88 9 28:) 4 (*,>,11 9 2/: 9 /7/08 9 28:) 3 *8.7, 4 8,7+ 3 2*+70 2*+70 9 +7811 ?u@si#< @ene'it *,>,11 9 1/: 9 /7/2 9 08: 9 +7811 Tota( @ene'it o' 'inancing si#e e''ects A#Auste# ;resent Ba(ue (0/1 4 01-) ="/// (-/,)

0--2, 01*>,.,

5ote9 Full credit will be given if the issue costs are included in the funds borrowed. The addition of the financing side effects gives an increased present value and probably the pro;ect would not be considered marginal. <nce these are ta/en into account Fubu/i =o would probably underta/e the pro;ect. 5ote9 3n calculating the present values of the ta- shield and subsidy benefits$ the annuity factor used is based on 4>5% debt yield rate for four years. 3t could be argued that 7>5% may also be used as this reflects the normal borrowing4default ris/ of the company. =redit will be given where this assumption is made to estimate the annuity factor.

(@) The ad;usted present value can be used where the impact of using debt financing is significant. ?ere the impact of each of the financing side effects from debt is shown separately rather than being imputed into the weighted average cost of capital. The pro;ect is initially

CORPORATE FINANCE
Assignment evaluated by only ta/ing into account the business ris/ element of the new venture. This shows that although the pro;ect results in a positive net present value$ it is fairly marginal and volatility in the input factors could turn the pro;ect. *ensitivity analysis can be used to e-amine the sensitivity of the factors. The financing side effects show that almost ## % value is added when the positive impact of the ta- shields and subsidy benefits are ta/en into account even after the issue costs. Assu!;tions (Cre#it giBen 'or a(ternatiBe> Ba(i# assu!;tions) ?ai@um =o)s ungeared cost of e:uity is used because it is assumed that this represents the business ris/ attributable to the new line of business. The ungeared cost of e:uity is calculated on the assumption that Aodigliani and Ailler)s 1AA2 proposition & applies. 3t is assumed that initial wor/ing capital re:uirement will form part of the funds borrowed but the subse:uent re:uirements will be available from the funds generated from the pro;ect. The feasibility study is ignored as a past cost. 3t is assumed that the five0year debt yield is e:uivalent to the ris/0free rate. 3t is assumed that the annual reinvestment needed on plant and machinery is e:uivalent to the ta- allowable depreciation. 3t is assumed that all cash flows occur at the end of the year unless specified otherwise. All amounts are given in () to the nearest () . .hen calculating the units produced and sold$ the nearest appro-imation for each year is ta/en. Assumptions 4$ 5$ '$ 7 and % are standard assumptions made for a :uestion of this nature. Assumptions #$ & and 3 warrant further discussion. Ta/ing assumption 3 first$ it is reasonable to assume that before the pro;ect starts$ the company would need to borrow the initial wor/ing capital as it may not have access to the wor/ing capital needed. 3n subse:uent years$ the cash flows generated from the operation of the pro;ect may be sufficient to fund the e-tra wor/ing capital re:uired. 3n the case of Fubu/i =o$ because of an e-pected rapid growth in sales in years & and 3$ the wor/ing capital re:uirement remains high and the management need to assess how to ma/e sufficient funds available.