=

Submitted to:
Ms. Tasneem Bareen Hasan
Senior Lecturer, Independent University Bangladesh

Name ID
Syed Zayed Islam 1611207
Mazed Rahman 1611210
Faysal Faiz Siam 1620167
Md. Abrar Shariyar Haque 1730130
Sams Swin 1730745
The airline industry of Bangladesh is still in its infancy. Especially the domestic
routes are not lucrative enough yet since very few fly on air from one district to
another. Currently there are four major airlines operating in Bangladesh: Biman,
NovoAir, Regent and US Bangla. A new airline company named Balaka Airlines is
exploring the possibility of starting domestic flights either for DHK-CTG route or
DHK-RAJ route. Expenses to consider include aircraft rental cost, gate and landing
fees and labor costs such as local baggage handlers and maintenance workers.

The following table provides a summary of the after-tax cash flows associated
with two investment alternatives. The after-tax cash flows associated with each
investment are:

Year Net Cash flow

DHK-CTG DHK-RAJ
0 (BDT 35,00,000) (BDT 40,00,000
1 1611207 1611207
2 1611210 1611210
3 1620167 1620167
4 1730130 1730130
5 1730745 1730745

The firm needs to decide now which project it should invest and thus it needs to
apply different capital budgeting tools.
A number of capital budgeting tools need a discount rate. The financial manager
of the company identified that the firm’s WACC is the appropriate discount rate
for evaluating the projects applying the capital budgeting tools. But, its WACC is
not yet calculated.
So, now the firm is interested in measuring its overall cost of capital. The firm is in
the 40% tax bracket. Current investigation has gathered the following data:
Debt: The firm can raise an unlimited amount of debt by selling BDT 1,000 par-
value, 10% coupon interest rate, 10-year bonds on which annual interest
payments will be made. Current market price of the bond is BDT 1,200.
Preferred stock: The firm can sell 10% (annual dividend) preferred stock at its
BDT 100 per share par value. The cost of issuing and selling the preferred stock is
expected to be BDT 2.5 per share. An unlimited amount of preferred stock can be
sold under these terms.
Common stock (New issue): The firm’s common stock is currently selling for
BDT 80 per share. The firm expects to pay cash dividends of BDT 6 per share next
year. The firm’s dividends have been growing at an annual rate of 6%, and this
rate is expected to continue in the future. Floatation costs are expected to
amount to BDT 3 per share.

The financial manager of the company is already overwhelmed with enormous

workload and hence hired you as the assistant manager of the finance
department for the company and seeing

your competence in the area of finance assigned you to suggest the best route
based on the following calculations:

1. Calculate specific cost of each source of financing (Round the answer to the
nearest two decimal points percent, like 11.12%).

2. Calculate WACC (The firm’s optimum capital structure shows 40% Long-
term debt; 15% Preferred stock, and 45% Common stock equity).

3. Determine the Payback period, net present value, internal rate of return
and profitability index for both of the routes.

4. Which one is the best route if they are independent or mutually exclusive
projects?

5. Suppose DHK-CTG route is risky due to the possible entry of new

competitor in the future. Accordingly, the risk-adjusted discount rate for
 this route will be 7% plus existing rate. How this will affect your decision?
Support you decision by calculation.

EXCECUTIVE SUMMARY

This report is based on airline industry of Bangladesh is still in its infancy.

Especially the domestic routes are not lucrative enough yet since very few flies on

air from one district to another. Currently there are four major airlines operating in

Bangladesh: Biman, NovoAir, Regent and US Bangla. A new airline company

named Balaka Airlines is exploring the possibility of starting domestic flights

either for DHK-CTG route or DHK-RAJ route. The financial manager of the

company is already overwhelmed with enormous workload and hence hired us as

the assistant manager of the finance department for the company and seeing our

competence in the area of finance assigned us to suggest the best route based on

the given calculation known as Cost of each source of financing, Weighted average

cost of Capital, Payback period, Net Present Value (NPV), Internal Rate of Return

(IRR) & Profitability Index

Require - 1

The given question asked to calculate specific cost of each of financing

Cost of Capital: Cost of capital is the required return necessary to make a capital

budgeting project, such as building a new factory, worthwhile. When analysts and

investors discuss the cost of capital, they typically mean the weighted average of a

firm’s cost of debt and cost of equity blended together.

Following information is already given in question.

 Additional Information BDT
Face Value 1,000
Coupon Interest Rate 10%
Coupon Interest Payment 100
Bond Maturity 10
Bond Yield 7.1% Formula of Cost of Calculated
Bond Selling Price 1,200 Capital Amount
Preferred stock Dividend 10 Kd (Cost of Debt)
Common Stock Dividend 6 Formula:kd=Bond 0.0428 or 4.28%
Flotation Cost, Preferred yield(1-tax)
2.5
Stock Kp (Cost of Preferred)
Preferred stock, Price 100 Formula:Kp= Dp/(Pp- 0.1025 or 10.25%
Common Stock, price 80 F)
Growth Rate, Annually 6%
Ke (Cost of Common)
Expected Common Flotation Formula:Ke= (D1/P0-F) 0.1379 or 13.79%
3
Cost +g
Tax Bracket 40%

Require - 2

Face value = 1000, tax rate=40%

Coupon rate= 10%, n= 10 years,
Price of bond=$1200,
 pricipal pay− price of band
Annual ∫ payment +
A= 10% of 1000 =$ no . of yrs of matarity 100
0.6 ( price of bond )+ 0.4( principal payment )
pricipal pay− price of band
Annual ∫ payment +
YTM= no . of yrs of matarity
0.6 ( price of bond )+ 0.4( principal payment )
+ 1000−1200
100 10
100−20
YTM =
0.6 ( 1200 )+ 0.4(1000)
80
= 1120

YTM = 7.14%

Kd = YTM (1-T)
= 7.14 (1-0.40)
= 4.28%
D1
Ke = p +g
0−F

6
= 80−3 +0.06

= 13.79%
Dp
Kp = p +¿
p−F

10
= 100−2.5

= 10.25%
∴WACC = kd (wd) + kp (wp) +ke(wc)
4.28(.40) +10.25(.15) +13.79(.45)
=9.45%
Require -3
Payback-Dhk-Ctg

Nco−c
A+ D
3500000−3222417
=2+ 1620167

=2.17

9Payback 2-Dhk-Raj

Nco−c
A+ D
3500000−3222417
=2+ 1620167

=2.47
NPV of DHK- CTG:

1611207 1611210 1620167 1730130 1730745

NPV = 1+.0945 + (1+.0945) 2 + (1+.0945) 3 + (1+.0945) 4 + (1+.0945)5 - (35, 00,000)

=1472094.107+1344994.836+1235698.4+1205634.517+1101930.632-
3500000
=6360352.492-3500000
=2860352.492
1611207 1611210 1620167 1730130 1730745
NPV = 1+.4 + (1+.4) 2 + (1+ .4)3 + (1+.4 )4 + (1+.4)5 - (35, 00,000)

=3335520.053 -3500000
=-164479.947
( 0.4−0.0945 ) 2860352.492
IRR=0.0945+
2860352.492−(−164479.947)

=0.3834
=38.34%
Pv of inflow=6360352.492
3500000
Pv of outflow= (1.0945)5

=2228379.81
6360352.492
Profitable index= 2228379.81

=2.85
Now 2.85>1(Acceptable)

NPV of DHK-Raj:
 1611207 1611210 1620167 1730130 1730745
NPV = 1+.0945 + (1+.0945) 2 + (1+.0945) 3 + (1+.0945) 4 + (1+.0945)5 - (40, 00,000)

=828384.06+425908.0+220221.15+120903.56+62177.757-4000000
=6360352.492-4000000
=2360352.492
1611207 1611210 1620167 1730130 1730745
NPV = 1+.35 + (1+.35)2 + (1+.35) 3 + (1+.35) 4 + (1+.35)5 - (40, 00,000)

=3642923.276-4000000
=-35707.724
( 0.35−0.0945 ) 2360352.492
IRR=0.0945+
2360352.492−(−35707.724 )

=0.396
=39.6%
Pv of inflow=6360352.492
4000000
Pv of outflow= ( 1.0945 ) 5

=2546719.782
6360352.492
Profitable index= 2546719.782

=2.5
Now 2.5>1(acceptable)

Require -4

From the result of IRR Dha-Raj rote is best

The Dha-Raj project will be acceptable because 39.6% is more than wacc rate
On the other hand Dha-Raj route 39.6% is more than Dha-ctg route 38.34%
So for mutually exclusive project Dha-raj route is best
But from profitable index Dha-Ctg is the best route. Because 2.85>2.5

Require -5

For DHAKA- CHITTAGONG:

Payback Period:

Year. Cash flow. Cumulative Cash flow.

0. (3500000) (3500000)
1. 1611207 (1888793)
2. 1611210 (277583)
3. 1620167 1342584
4. 1730130 3072714
5. 1730745 4803459

PBP = 2 + (277583/1620167)
= 2+ 0.17
= 2.17 years

Net Present Value:

NPV = { [ 1611207/(1+.1645)^1 ] + [ 1611210/(1+.1645)^2] +

[1620167/(1+.1645)^3] +
[1730130/ (1+.1645) ^4] + [1730745/(1+.1645)^5] - [3500000] }
 = $ 1846827.02

Profitable Index:

PI = PV of all future cash flow/ initial investment

= 5346827.02/3500000
= 1.53 times

Internal Rate of Return:

LDR = 9.45 + 7
= 16.45 %
= 0.1645

NPV of LDR = $1846827.02

HDR = 40%
= .40

NPV of HDR = (164480)

IRR = LDR + (HDR – LDR) * NPV of LDR/ (NPV of LDR – NPV of HDR)

= 0.1645 + (.40 - .1645) * 1846827.02/ (1846827.02 – (-164480))

= 0.1645 + (0.2355) * (0.918)

= 0.1645 + 0.216
= 0.38
= 38%