Intermediate Finance
Case Study
Read the following case study and answer the questions that follow:
Congratulations ! you have been nominated as a candidate for an assistant financial analyst position. Among the selection criteria is the following case study that you have to solve using the knowledge you have obtained during the semester. A good financial analyst is a a detective who must differentiate between good evidence from bad. Much of the challenges is knowing what tool of analysis to use in the first place.
You are required to rank the projects and recommend the four best that the company should accept. No other project characteristics are deciding factors in the selection, except that management has determined that projects 7 and 8 are mutually exclusive.
All projects require the same initial investment, $2,000,000. Moreover, all are believed to be of the same risk class. To simulate your analysis, consider the following questions:
1. What is the weighted average cost of capital of this company ?
2. Can you rank the projects simply by inspecting the cash flows?
3. What criteria might you use to rank the projects?
4. Which quantitative ranking methods are better? Why?
5. What is the ranking you found by using different methods? Does this ranking differ from the ranking obtained by simple inspection of the cash flows?
6. Use a sensitivity analysis for the top ranked project only and show changes for NPV (pessimistic 25% less forecasted cash flows, optimistic 35 % more cash flows)
The following information is given as well :
Debt10,000 shares of 6.5% coupon bonds are outstanding, $1,000 face value, 20 years to maturity, selling for 95 % of face value. The bonds make semiannual payments
COMMON STOCK 250,000 shares outstanding , selling for $60 per share, the beta is 1.05
Preferred stock 10,000 shares of 5% preferred stock outstanding, $100 par value, currently selling for $93 per share.
Market 8% market risk premium and 4.5 % risk free rate
Corporate tax rate = 35%
Project1
Project2
Project3
Project4
Project5
Project6
Project7
Project8
Initial Investment
$ 2,000,000
$ 2,000,000
$
2,000,000
$ 2,000,000
$
2,000,000
$
2,000,000
$ 2,000,000
$ 2,000,000
Year
1
$ 330,000
$ 1,666,000
$ 160,000
$ 280,000
$2,200,000
$ 1,200,000
$ (350,000)
2
$ 330,000
$ 334,000
$ 200,000
$ 280,000
$ 900,000
$ (60,000)
3
$ 330,000
$ 165,000
$ 350,000
$ 280,000
$ 300,000
$ 60,000
4
$ 330,000
$ 395,000
$ 280,000
$ 90,000
$ 350,000
5
$ 330,000
$ 432,000
$ 280,000
$ 70,000
$ 700,000
6
$ 330,000
$ 440,000
$ 280,000
$4,000,000
$ 1,200,000
7
$ 330,000
$ 442,000
$ 280,000
$ 2,250,000
8
$ 1,000,000
$ 444,000
$ 280,000
9
$ 446,000
$ 280,000
$ 2,000,000
10
$ 5,000,000
$ 448,000
$ 280,000
11
$ 450,000
$ 280,000
12
$ 451,000
$ 280,000
13
$ 451,000
$ 280,000
14
$ 452,000
$ 280,000
15
$
9,000,000
$
(2,000,000)
$ 280,000
