BUSINESS FINANCE 2

Name:
ID:
Year: 2021

Question 1:
Solution:

Let suppose that "r" is the internal rate of return

0|Page
Discount rate at which all the cash flows present values are equivalent to 0 is
recognized as IRR or internal rate of return.

Therefore,

$6,000 cash flow discounted at rate "r" is = $5000

As NPV is Zero

Hence, $6,000 / (1 + r) 1 = $5,000

(1 + r) 1 = $6,000 / $5,000

(1 + r) 1 = $6 / $5

1 + r = 1.20

-1+ 1 + r = 1.20 - 1.00

r = 0.20

IRR = r = 20%

As a result, the IRR of this opportunity is 20%

Question 2:

Solution:

The NPV of the investment opportunity is considered as follows

NPV = -200000 + 1000000/ (1+20)9

Net Present Value = - $6193.3

Due to negative net present value this investment opportunity should not be
accepted or undertaken. 

The discount rate at which present values of cash inflows and initial investments
are equal is known as IRR. 

It is defined as follows

$200,000 = $1000000/ (1+interest rate) 9

In the above equation, the interest rate obtained in the above equation is the IRR.

1|Page
 (1+ r) 9 = $1000000/ $200,000 

(1+r) 9 = 5

(1+r) 9 = 5

(1+r) 9 = √ 5

(1+r) = √9 5

1 + r = 1.195813175

Interest rate = (1.195813175 - 1)   100 

Internal rate of return = 19.58 % 

In the cost of capital estimate maximum deviation allowable is = 0.20 - 0.1958 

Allowable maximum deviation = 0.42% 

Question 3:
Solution:

NPV = present value of foregone speaking fees + advance payment for the book

When

Cost of capital = Rate

PV’s of inevitable speaking fees 

NPER = 3 (Years of Fees Foregone)       

PMT = 8000000     (annual dues)

Present Value = -$19,894,816

Present value of foregone speaking fees = -$19,894,816

NPV = $10,000,000 + (-$19,894,816)

NPV = -$9,894,816

b)

2|Page
 Calculating the present value of royalties at the period the book is ended

Year 3.

First payment / (cost of capital - growth rate) = PV of perpetuity

Present Value of royalties at 3rd year = first year royalty / (cost of capital - royalties
growth rate)

Present Value = $5,000,000 / (10% - (-30%))

PV = $12,500,000

Present value of royalties at year 0

Rate and cost of capital are equal

So,

Number of years of fees foregone = NPER = 3        

PMT = 0     (there are no yearly payments until royalties begin)

FV = -12500000       

(PV of perpetuity at year 3.  This is entered with a negative sign because we are
calculating the PV of an amount expected in the future)

PV calculated is = $9,391,435

Advance payment for book + present value of royalties at year 0 + present value of
foregone speaking fees is equal to NPV with royalty.

NPV of book with royalty = $10,000,000 + $9,391,435 + (-$19,894,816)

NPV of book with royalty = -$503,381

Question 4:
Solution:

3|Page
We assume that taxes are zero,

Cost of capital = (equity weight * equity cost) + (weight of debt* debt cost)

Equity Value = Outstanding Shares*share price

Value of equity =10,000*50

Value of equity = 500,000

Now,

Value of debt = 300000

Equity Weight = 500000/800000

Equity Weight =62.5%

Weight of debt = 300000/800000

Weight of debt = 37.5%

Weight of debt is 37.5%

Cost of capital = (62.5%*15%) + (37.5%*8%)

Cost of capital =12.375%

If stock price rise, then the estimated rate of return/cost of equity decreases. 

Formula of cost of equity = (next year Dividend payment / Share price) + growth rate

If the price of share rise, the denominator rise, so the equity cost will decreases.

Due to reduction in the estimated yield on equity cost of capital will decrease. This is
again better for industry or business.

4|Page