1 We take nominal because nominal includes IP, LP, MRP, DRP

2 Historical Cost should be ignored and is irrelevant as it is a Sunk Cost

3N 15
paid quarterly
N 60
Coupon Rate 0.12
FV 1000

PMT 30
PV -1153.72
Rd 2.5%
 rd 0.1001
Assuming Tax = 40% 0.6
rd (1-T) - component of debt 6.01%

5 Aramco paid dividends consistently, there was less profit

oil price slump, investors don’t deviate
and positive signal to investor

6 CCC = Days Inventory + Days Receivables - Days Payable

Inventory - cash convert - how much time
Pandemic
Days Inventory - huge non-essential
Days receivables - huge
Days Payable - huge
 For example, would a new machine earn a return greater than the
cost of the capital needed to acquire the machine? The rate at which the firm
has borrowed in the past is irrelevant when answering this question because
we need to know the cost of new capital. For these reasons, the yield to
maturity on
outstanding debt (which reflects current market conditions) is a better
measure of the
7 cost of debt than the coupon rate.

8 Effective Annual Rate Is related to continuous compounding

R = ((1+I)/N)N-1
We always take nominal cost of debt because it reflects capital budgeting and rates consistently

9 wd 0.25
wc 0.75
rd 0.07
Rrf 0.06
RPm 0.07
rs 0.145
T 0.4
Bu 0
D/E wd/1-wd
0.3
Bl 1.21
 Bu 1.01
WACC 11.93%

Various trade offs that firms face while trying to establish their optimal
dividend policy are:
1)Excess cash: if the firm has excess cash in hand and has no upcoming
investment projects then it can pay it out to shareholder. On the other hand
it could be used to repurchase stock, if this is a one time phenomenon the
company has to consider future financing needs.
2)The bird in hand fallacy: Dividends now are more certain than capital gains
later. Hence stocks with a consistent dividend history are valued higher. On
the other hand the comparison should be between the amount of dividend
10 now and the amount of expected capital gain/upside after the ex dividend.
Years

consumer
s and
business.
US
started
with Fed's
QE and
various
governme
nts
followed
to
prevent
utter and
extreme
collapse
of the
It is system
important and to
to assure
emphasiz things
e that the kept
cost of moving.
debt is Better
the managem
interest ent of
rate on working
new capital is
debt, not indeed a
outstandi solution
ng debt. to
We are comeout
interested of trouble
in the of having
cost of long cash
new debt conversio
because n cycles.
 6. PMT =
1000 *
0.12 / 4 =
$30

Answer:

Using
Excel's
Rate
function
= RATE
(60,30,-
1153.72,1
000)
Rd = 2.5%
since paid
quarterly
the
nominal
rate Rd =
10.01% =
market
interest
rate on
debt

Compone
nt Cost of
Debt:
Assuming
tax rate =
30%
rd (1-T) =
0.10(0.7)
= 0.07

3%
consistently

The dividend paid by Aramco depsite the oil turmoil world has seen values at $73.2

The core point of MM irrelevancy theories is to shed light on what makes the capit

component of debt makes it riskier

preferring
which
capital
the firm
should
take first.
Hence,
despite
highlighti
ng
irrelevanc
e
between
firm's
value and
its capital
structure,
MM
theory
has
favored
more and
more
discipline
d studies
on
subject of
relaxing
their
assumpti
ons to
find out
real world
relevance
between
the two
things.
world has seen values at $73.2B. This value is 10 times more than other global giants such as BP, Total or Sinopec. Despite oil price at reco

light on what makes the capital structure effect on firm's value relevant. There are various theories in practical world which were revealed
opec. Despite oil price at record lows and their production at record high - the costs overweighted the earnings but Aramco paid out mass

cal world which were revealed to be relevant when work on modern capital structure theory got started in context of relaxing MM's ideal
ngs but Aramco paid out massive divided in respect of sending out positive signals to its investors that the market will rebound which is un

ontext of relaxing MM's ideal listing of assumptions. Of these capital structure theories lie the trade off theory establishing relevance of d
 arket will rebound which is unlikely keeping in mind the direction oil prices faced in peak covid era.

ory establishing relevance of debt tax saving for risk of bankruptcy, Signaling Theory stating
INPUT DATA

Initial Costs
Equipment $135,000
Shipping and installation $8,000
Expected salvage value $94,500
Changes in NOWC
Inventories $10,000
Accounts payable $5,000

MACRS 3-year depreciation rates

Year 1 2 3 4
Rate 0.33 0.45 0.15 0.07

Expected unit sales 0

Price per unit $0.00
Oper. costs (% of sales) 0.0%

Tax rate 35.0%

WACC 8.0%

Years
0 1 2 3
I. Investment Outlays
Equipment cost $ (135,000)
Installation (8,000)
CAPEX $ (143,000)

Increase in inventory (10,000)

Increase in A/P 5,000
ΔNOWC $ (5,000)

II. Project Operating Cash Flows

Unit sales 0 0 0
Price per unit $ - $ - $ -
Total revenues $ - $ - $ -
Operating costs (w/o deprn) (52,000) (52,000) (52,000)
Depreciation 47,190 64,350 21,450
Total costs $ (4,810) $ 12,350 $ (30,550)
EBIT (Operating income) $ 4,810 $ (12,350) $ 30,550
Taxes on operating income 1,684 (4,323) 10,693
EBIT (1 ‒ T) = AT operating income $ 3,127 $ (8,028) $ 19,858
Depreciation 47,190 64,350 21,450
EBIT (1 ‒ T) + DEP $ 50,317 $ 56,323 $ 41,308

III. Project Termination Cash Flows

Salvage value $94,500
Tax on salvage value (29,572)
After-tax salvage value $64,929
ΔNOWC = Recovery of NOWC $5,000
Project Free Cash Flows $ (148,000) $ 50,317 $ 56,323 $ 111,236

Cumulative Cashflows $ (148,000) $ (97,684) $ (41,361) $ 69,875

Discounted Cashflows $ (148,000) $ 46,589 $ 48,287 $ 88,303
Cumulative Discounted Cashflows $ (148,000) $ (101,411) $ (53,123) $ 35,180

IV. Results
NPV $35,180
IRR 19.02%
MIRR 15.96%
Payback 2.37 years
Discounted Payback 2.60
4

$ (143,000)
132,990 -8
$ (10,010)
INPUT DATA

Initial Costs
Equipment $135,000
Shipping and installation $8,000
Expected salvage value $94,500
Changes in NOWC
Inventories $10,000
Accounts payable $5,000

MACRS 3-year depreciation rates

Year 1 2 3 4
Rate 0.33 0.45 0.15 0.07

Expected unit sales 0

Price per unit $0.00
Oper. costs (% of sales) 0.0%

Tax rate 35.0%

WACC 8.0%

Years
0 1 2 3
I. Investment Outlays
Equipment cost $(135,000)
Installation (8,000)
CAPEX $(143,000)

Increase in inventory (10,000)

Increase in A/P 5,000
ΔNOWC $ (5,000)

II. Project Operating Cash Flows

Unit sales 0 0 0
Price per unit $ - $ - $ -
Total revenues $ - $ - $ -
Operating costs (w/o deprn) (52,000) (52,000) (52,000)
Depreciation 47,190 64,350 21,450
Total costs $ (4,810) $ 12,350 $ (30,550)
EBIT (Operating income) $ 4,810 $ (12,350) $ 30,550
Taxes on operating income 1,684 (4,323) 10,693
EBIT (1 ‒ T) = AT operating income $ 3,127 $ (8,028) $ 19,858
Depreciation 47,190 64,350 21,450
EBIT (1 ‒ T) + DEP $ 50,317 $ 56,323 $ 41,308

III. Project Termination Cash Flows

Salvage value $94,500
Tax on salvage value (29,572)
After-tax salvage value $64,929
ΔNOWC = Recovery of NOWC $5,000
Project Free Cash Flows $(148,000) $ 50,317 $ 56,323 $ 111,236
Discounted Cashflow

IV. Results
NPV $35,180
IRR 19.02%
MIRR 15.96%
Payback 2.37 years
0 1 2 3
$(148,000) $ (97,684) $ (41,361) $ 69,875
Discounted Payback 2.60
0 1 2 3
$46,589 $48,287 $88,303
$(148,000) $ (101,411) $ (53,123) $ 35,180

The entire point of cost of capital calculation is its use in capital budgetin

Nominal cost of debt should be used because it is a consistent measure

and
inventory
were at a
standstill.
Most of the
governments
in the world
started relief
efforts for
facilitation of
both
consumers
and business.
US started
with Fed's QE
and various
governments
followed to
prevent utter
and extreme
collapse of
the system
and to assure
things kept
moving.
Better
management
of working
capital is
indeed a
solution to
comeout of
trouble of
having long
cash
conversion
cycles. S
132,990 $ (10,010)
 8%

ation is its use in capital budgeting decisions. A firm needs capital to increase assets and that capital may be aquired via common equity, p

cause it is a consistent measure in the context of cost of capital, capital budgeting and value of a busines firm. Using effective interest rate
be aquired via common equity, preferred stock or debt. Whether taking on that new asset (capital budgeting decision) is feasible or not, d

firm. Using effective interest rate might add in value but will not be comparable and relevant on broad scale to overall firm objective sinc
g decision) is feasible or not, depends on whether it generates enough returns in future to offset the cost of capital. Hence, this exercise is

e to overall firm objective since the firm uses bank rate/YTM (based on market interest rate) for cost of debt and nominal figures follow th
capital. Hence, this exercise is done in future context (incremental value) therefore historic costs are irrelevant. Moreover, the componen

and nominal figures follow the pattern for WACC calculation. Eventually capital budgeting and capital structure decisions are also continu
ant. Moreover, the component cost of debt in WACC is actually called 'the interest rate firm must pay on NEW debt', same applies to the i

ure decisions are also continued with the nominal cost of debt values and the objective of impacting the intrinsic value of firm is realized w
W debt', same applies to the issuance of new stock or in that case - the existing (not historical) opportunity costs for retained earnings. In

rinsic value of firm is realized without the use of effective annual cost.
costs for retained earnings. In the light of assignment, the risk-free rate
Tenalpina Tools
Case 1
Entrepreneur Dilemma

Seems like
Ch 13 - make or buy analysis
Vertical Integration excess capacity
Outsourcing add/drop
Giulia
rock climbing company and product
5 yr experience
then MBA
always wanted to do business
father equivalent cost of money for
business
Guilia declined the offer
related internships
Piton sales
Titanium pitons - more efficient
the internship company will buy if
price OK
Drop forging process - factory nearby
Factory - excess capacity
Seller, Buyer, Maker - Outsource
contract
Denver - Customer
Seller - Guilia
Maker - Factory
Purchase Titanium alloy bars
Drop forging process - factory nearby
sell

Reorder rate 1,000.00

Sale price 11.00
factory price 9.00

Material waste and recover 1.45

Total cost 10.45
CM per unit 0.55
Units 1,000.00
Revenue 550.00

Value
 Ways

Customer Arrangement
Time 2.00
Qty 4,000.00
Sale price 10.50
demand can even be 10% higher
four times current quantity
no discounts

barely covering costs

factory - capacity quadruple
factory - more price or not?
factory owner - close down, retire
factory owner - sons not doing same
business
China cut down his demand
Guilia only customer since last 3
monhts
buyer looking to sell all asset with
workers

Workers 6.00
Capacity of factory 4,000.00
worker salary 57,500.00
total VC (worker salary) 345,000.00
Expected units 48,000.00
Labor cost per unit 7.19
Electricity (VMOH 1.90
Own salary -

Fixed costs:
lease, occupancy, maintenance, real
estate 33,000.00
Equipment middle of its useful life
Depreciation 14,335.00
RM cost 0.11
Admin Cost 600.00
CAPEX 100,000.00

How business model changed? make or buy

excess capacity

revenue stream ?
Cost structure? ?
Breakeven analysis ?
Comment on Break even ?
Counsel ?
lighweight high strength

Outsource
Reorder rate 1,000.00 units per month
Sale price 11.00 per unit
Cost Structure
factory price 9.00 per unit
Material waste and recover 1.45 per unit
Total cost 10.45 per unit
units per month CM 0.55 per unit
per unit Net profit 0.55 per
unitsunit
per
per unit For 1,000.00 month
dollars profit
Net Profit 550.00 per month

Buy forge
Initial outlay CAPEX 100,000.00
Sales 10.50 per unit
Variable Labor cost 7.19 per unit
Variable MOH - per unit
Electricity per unit 1.70 average cost
VC of product 1.45
Start-up proved with low capital and
risk Own Salary - per unit
to increase profits Raw Material cost 0.11 per unit
add a product line Total VC 10.45 per unit
CM 0.05 per unit
years Fixed Equipment Cost
units per month Fixed Depreciation Cost
Fixed Admin Cost
Total Fixed Cost
Net profit

Breakeven Fixed cost/CM per unit

Units 90,891.67 Units
Dollars 954,362.50 $

units per month

per year

per year

per unit
for first year

per year 2,750.00 0.69

depreciation
last year 1,194.58 0.30
per unit
per month 0.15

for both arrangements

 Case 2

42,000
28,760
-
6,800
5,800

-
 440
41,800
200
2,750.00
1,194.58
600.00
4,544.58
(4,344.58)