JUNE 2022 – Individual Assignment

STUDENT ID
PRESENTED TO
DATE
 Question 1

To calculate Peace Corps's weighted average cost of capital, we need to determine its
weighted average cost of capital.

Market Capitalisation of Equity = RMB 20 million

Capital Asset Pricing Model (CAPM) is used to calculate equity cost (Ke).

As per CAPM, Ke = Rf + (Rm-Rf)*B

Where, Rf = risk free rate = 4.5%

Rm – Rf = Risk Premium = 5%

B = Beta = 0.9

So, Ke = {4.5 + (5*0.9)} %

=9%

Therefore, Cost of Equity = 9% per year

Market Value of Preference shares = RMB 5 million

Cost of Preference shares (Kp) = 7.5% per year

Debt of the firm = RMB 15 million

Cost of Debt (kd)= 6.5% per year

Tax rate = 30%

Cost of debt after tax = 6.5*(1-0.30)

= 4.55%

Total invested capital = (20 + 5 + 15) million

= 40 million

Weight of equity (We)= 20/40 = 0.5

Weight of debt (Wd) = 15/40 = 0.375

Weight of preference shares (Wp) = 5/40 = 0.125

Weighted average cost of capital = (0.5*9 + 0.375*4.55 + 0.125*7.5)

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 = 7.14%

Therefore, the WACC for Peace corp is 7.14%.

Question 2

Part a

Investing in the most feasible projects and putting a few restrictions on new investments are
both examples of Capital Rationing. In other words, a company is unable to invest in all
profitable projects because of a crisis of funds, even if all of the projects have a positive net
present value. Capital rationing can be further classified into two types: hard capital rationing
as well as soft capital rationing. When there is a limited amount of funds available to fund
capital projects, capital rationing is used to make a decision about which capital projects to
fund. There may also be rationing imposed when there is enough funding for the business,
but the management chooses to restrict it to certain parts of the business in order to focus
more on investing in other areas of the business (AccountingTools, 2022).

A concept known as hard capital rationing or external rationing refers to the problem of a
company having a difficult time in raising funds from the equity market externally due to the
rationing of capital. The hard capital rationing, or what is known as the "external" rationing,
occurs when the company is not able to raise funds on the external equity markets in order to
fund its operations. As a result, there may be a lack of capital to finance new projects within
the company, which can cause a shortage of funds. The concept of hard capital rationing
refers to a type of capital rationing that takes place externally. Due to a variety of factors, the
company has found itself in a position where it is unable to generate any external funds in
order to finance its investments (FinanceManagement, n.d.).

It can also be referred to as 'Internal Rationing', a form of soft capital rationing where the
restrictions are due to company's internal policies that relate to raising funds for potential
investments (Gompers & Lerner, n.d.). Soft capital rationing is the process of restricting
capital which happens when the company's internal policies result in "internal" rationing. A
company may choose to have certain restrictions that limit the amount of funds available for
investment in a project on a voluntary basis. It is important to note, however, that these
restrictions can be modified at any time in the future, which is why the term 'soft' is used.

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Part b

A net present value is calculated by discounting each year's cash flow and bringing it up to
the current year's value:

Available Funds = RMB 600000

For Project A

Yea Project A (RMB) Discounting Factor @ 10% Present Value (RMB)

r

1 100 0.9091 90.91

2 10 0.8264 8.264

3 200 0.7513 150.26

4 200 0.6830 136.60

NPV = Present value of all cash inflows – Initial Investment

= (90.91 + 8.264 + 150.26 + 136.60) – 300

= RMB 86.034

For Project B

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 Year Project B Discounting Factor @ 10% Present Value (RMB)
(RMB)

1 0 0.9091 0

2 0 0.8264 0

3 0 0.7513 0

4 400 0.6830 273.20

NPV = Present value of all cash inflows – Initial Investment

= 273.20-200

= RMB 73.20

For Project C

Yea Project C (RMB) Discounting Factor @ 10% Present Value (RMB)

r

1 0 0.9091 0

2 0 0.8264 0

3 80 0.7513 60.104

4 80 0.6830 54.64

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NPV = Present value of all cash inflows – Initial Investment

= (60.104+54.64)-100

= RMB 14.744

For Project D

Yea Project D (RMB) Discounting Factor @ 10% Present Value (RMB)

r

1 60 0.9091 54.546

2 60 0.8264 49.584

3 60 0.7513 45.078

4 60 0.6830 40.98

NPV = Present value of all cash inflows – Initial Investment

= (54.546 + 49.584 + 45.078 + 40.98)-100

=RMB40.188

The funds should be allocated to the project with the highest NPV if the projects are divisible

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 Projects Ranking Investments Funds to be
Required allotted
A 1 300 300

B 2 200 200

C 4 100 0

D 3 150 100 (Balance)

Part c

Projects that are indivisible can either be accepted or rejected completely depending on
whether they are separate or not. Consequently, the funds can only be allocated to projects A
and B in the example above.

Question 3

Part a

Sales Unit per year 24000

Sales Price per unit ($) 65
Variable cost per unit 53
Contribution per unit 12
Total Contribution every year 24000*1
($) = 2
288000
Initial Investment ($) = 1500000

Calculation of IRR of the project of Tsing Tao company

Discounting
Cash flow Discounting Present Present
Year Factor
per year Factor @10% Value Value
@20%
1 288000.00 0.90909091 261818.2 0.83333333 240000
2 288000.00 0.82644628 238016.5 0.69444444 200000
3 288000.00 0.7513148 216378.7 0.5787037 166666.7

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 4 288000.00 0.68301346 196707.9 0.48225309 138888.9
5 288000.00 0.62092132 178825.3 0.40187757 115740.7
6 288000.00 0.56447393 162568.5 0.33489798 96450.62
7 288000.00 0.51315812 147789.5 0.27908165 80375.51
8 288000.00 0.46650738 134354.1 0.23256804 66979.6
Present Value 1536459 1105102
Less: Initial Investment 1500000 1500000
Net present value 36458.74 -394898

Formula for calculation of A +

IRR [-a(B-A)/b-a]

Where,
A= discount rate where NPV is positive
B= discount rate where NPV is negative
a= NPV at discount rate A
b= NPV at discount rate B

10+[-36458.74*(20-10)/(-394898-
IRR = 36458.74)

10.85%

Part b

Revised IRR in case of increase in sales volume by 5%

Cash flow Discounting Present Discounting Present

Year
per year Factor @10% Value Factor @20% Value
1 302400.00 0.90909091 274909.1 0.83333333 252000
2 302400.00 0.82644628 249917.4 0.69444444 210000
3 302400.00 0.7513148 227197.6 0.5787037 175000
4 302400.00 0.68301346 206543.3 0.48225309 145833.3

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 5 302400.00 0.62092132 187766.6 0.40187757 121527.8
6 302400.00 0.56447393 170696.9 0.33489798 101273.1
7 302400.00 0.51315812 155179 0.27908165 84394.29
8 302400.00 0.46650738 141071.8 0.23256804 70328.58
Present Value 1613282 1160357
Less:Initial Investment 1500000 1500000
NPV 113281.7 -339643

IRR = 10+[-113281.70*(20-10)/(-339643-113281.20)

12.50%

Revised IRR in case of increase in sale price by 5%

Cash flow Discounting Present Discounting Present

Year
per year Factor @10% Value Factor @20% Value
1 366000.00 0.90909091 332727.3 0.83333333 305000
2 366000.00 0.82644628 302479.3 0.69444444 254166.7
3 366000.00 0.7513148 274981.2 0.5787037 211805.6
4 366000.00 0.68301346 249982.9 0.48225309 176504.6
5 366000.00 0.62092132 227257.2 0.40187757 147087.2
6 366000.00 0.56447393 206597.5 0.33489798 122572.7
7 366000.00 0.51315812 187815.9 0.27908165 102143.9
8 366000.00 0.46650738 170741.7 0.23256804 85119.9
Present Value 1952583 1404400
Less:Initial Investment 1500000 1500000
NetPresent Value 452583 -95599.5

IRR = 10+[-452583*(20-10)/(-95599.50-452583)

18.26%

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Revised IRR in case of increase in cost of sales by 5%

Cash flow Discounting Present Discounting Present

Year
per year Factor @3% Value Factor @8% Value
1 224400.00 0.97087379 217864.1 0.92592593 207777.8
2 224400.00 0.94259591 211518.5 0.85733882 192386.8
3 224400.00 0.91514166 205357.8 0.79383224 178136
4 224400.00 0.88848705 199376.5 0.73502985 164940.7
5 224400.00 0.86260878 193569.4 0.6805832 152722.9
6 224400.00 0.83748426 187931.5 0.63016963 141410.1
7 224400.00 0.81309151 182457.7 0.5834904 130935.2
8 224400.00 0.78940923 177143.4 0.54026888 121236.3
Present Value 1575219 1289546
Less: Initial Investment 1500000 1500000
Net Present Value 75218.93 -210454

IRR = 3+[-75218.93(8-3)/(-210454-75218.93)

11.32%

Part c

An IRR that exceeds the required rate of return should be considered for acceptance. The
project should be rejected, however, if the IRR is below the required return rate.

Question 4

Debt financing is the practice of borrowing money and paying it back with interest at a later
date. An unsecured loan as well as a secured loan may be available. An acquisition or
working capital loan is taken out by a company. The long term needs of a company can be
financed through equity or debt. Here are some of the ways debt can be financed:

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  Loans from Bank – A loan from a bank is one of the most popular and common ways
for a business to access debt financing. It is customary to obtain loans from banks for
a limited period of time for a fixed cost as well as a fixed rate of interest to be repaid
on a regular basis according to the repayment schedule. Depending on the
requirements of the company, a loan can be of a long or short term duration or a
medium term duration. Loans are made on the collateral security in exchange for
money.
 Overdraft facility – Overdraft facilities are provided by banks to companies that have
a good credit history by granting them additional credit limits. Overdrafts occur when
an account does not have enough money to cover a transaction or withdrawal, but a
bank allows it regardless. As a result of an account reaching zero, the financial
institution extends credit. Overdrafts allow the account holder to withdraw money
even if there are no funds in the account or insufficient funds to cover the withdrawal
amount (Kagan, 2022).
 Bonds – Among the bonds that can be issued by a company are both corporate and
government bonds. The corporate finance is one of the sources of long-term funding
that is offered by the huge corporations for the financing of their operations. It is safe
to say that corporate bonds are generally more risky than treasury bonds since they
carry a relatively higher risk. According to Kotey (1999), it serves as a source of debt
financing for bond issuers (Issuing authorities)

As the name implies, equity financing means you raise money by selling shares in your
business, either to existing shareholders or to new investors, allowing you to raise a large
amount of money. The various ways of Equity financing are

 Issue of equity shares - It is raised through a public offering or further issuances of

equity shares. Despite the higher risk, investors are expecting a higher return.
 Retained Earnings – This can be achieved through the company's own retained
earnings which are the portion of the company's earnings that is kept for investment
purposes instead of being distributed as dividends to its shareholders.
 Venture Capitalist – As a group, they are the ones who invest in the investments
which are growing the fastest. Finn (1976) call this type of financing 'Private
Financing' because it is commonly known by that name. Early-stage businesses are
financed by venture capitalists (VCs) in order to help them grow. Instead of investing
their own funds, VCs invest the money of large institutions such as pension funds
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 (British Business Bank, n.d.). They generally demand a bigger stake in exchange for a
significant return on their investment. In addition to taking part in the day-to-day
running of your business, VCs can provide valuable input when deciding the direction
and strategy of your business. Often, this means becoming a board member

In addition to the above financing problems, small businesses face a number of other
problems. Following is a list of some of them:

 The search for the right prospecting investor can take up a lot of time and effort, and
can take a lot of effort.
 Although the owner retains some control over the operation of the business, it is
possible that the owner may need to share ownership with other investors so that the
business may operate as a joint venture.
 If the creditor fails to repay the loan, legal action or confiscation could be taken in
case of non-repayment of the loan, which is a high risk associated with debt financing.
 Unless the instalments are paid on time, the lender may choose to sell the security
against which the debt was obtained if the payments are not made on time.

Small businesses have a variety of financing options available to them:

 Retained Earnings – In certain situations, the owners of a company can invest the
retained earnings in financing the business operations of the company.
 Owners Capital – t is possible for owners to invest their own capital for the purpose
of making investments and that is derived from their own personal savings.
 Kotey (1999) make the point that borrowing from family and friends is a very
common practice.

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References

Accounting Tools. (2022, May 21). Capital rationing definition.

https://www.accountingtools.com/articles/capital-rationing.html

British Business Bank (n.d.). What is equity financing? https://www.british-business-

bank.co.uk/finance-hub/what-is-equity-finance/

Finance Management (n.d.). Types of capital rationing – Hard and soft.

https://efinancemanagement.com/investment-decisions/types-of-capital-rationing-hard-
and-soft

Finn, F. (1976). Capital Rationing and Market Discount Rates: Some Common
Fallacies. Australian Journal Of Management, 1(2), 37-49. doi:
10.1177/031289627600100203

Gompers, P., & Lerner, J. Equity Financing. Handbook Of Entrepreneurship Research, 267-

298. doi: 10.1007/0-387-24519-7_12

Kagan, J. (2022, March 9). Overdraft explained: fees, protection, and types. Investopedia.
https://www.investopedia.com/terms/o/overdraft.asp

Kotey, B. (1999). Debt Financing and Factors Internal to the Business. International Small
Business Journal: Researching Entrepreneurship, 17(3), 11-29. doi:
10.1177/0266242699173001

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