FIN722 GDB 1 Solution and Discussion

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Short Questions
Following are few short questions covering some topics from pre-mid content of this course. Main purpose of this activity is to help students in preparation for their mid-term examinations. While attempting this assignment, need to keep following points in your mind:
 Mark will be awarded only if answer is correct
 So each question carries only 1 mark and thus total marks of this activity are 5.
 Although working does not carry any mark, however, working will help you to understand
the complete concept and may ultimately be fruitful in your preparation for mid-term.
 It is strongly recommended to consult the video lectures and PPTs for successfully
attempting this activity
Important Note: It is appreciable to upload the solution file on VULMS of the course against assignment # 1 till December 5, 2019. However, you will also be provided with 1 day grace period i.e. in case you missed to upload the solution till due date, you can avail grace day and can upload the solution file till December 6, 2019.
Following are the questions:
Q1: What will be cost of equity if a company has paid a dividend of Rs. 4 at constant growth rate of 4% while stock’s current price is Rs. 60?
Q2: Output level is 8,000 units with variable cost of Rs. 6 per unit and total fixed cost Rs. 60,000. If sale price is Rs. 9 per unit then what will be the profit / loss?
Q3: Suppose a portfolio consists of three projects A, B & C where each project requires an initial investment of Rs. 65,000. If present value of cash flows of projects A, B & C is Rs. 80,000, Rs. 73,000 and Rs. 82,000 then what will be ranking of each project based upon profitability index criterion?
Q4: There are two states of economy, Boom & Recession. Probability of occurrence of Boom is 45% while Recession is 55%. Suppose stock A expected return in Boom (state of economy) is 12% while in Recession is 7%. Stock B expected return in Boom (state of economy) is 20% while in Recession is 3%.
If an investor invests 70% in stock A and 30% in stock B then what is the total expected return of the portfolio?

Q5: A capital structure consists of 10% preferred stock, 55% common equity and 40% debt. Company’s preferred stock is currently selling for Rs. 55 per share and paying dividend of Rs. 4. If cost of common equity is 15% and after tax cost of debt is 6% then what will be WACC?

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Solution of Graded Activity for Pre Mid

Lecture # 9
Q1: What will be cost of equity if a company has paid a dividend of Rs. 4 at constant growth rate of 4% while stock’s current price is Rs. 60?
ke = ( D1 / P0 ) + g Where
D1 (Expected div.)= D0 (1+g)
ke = (4*1.04/60)+0.04 ke = 0.0693 + 0.04
ke = 0.1093 or 10.93%

Lecture # 12
Q2: Output level is 8,000 units with variable cost of Rs. 6 per unit and total fixed cost Rs. 60,000. If sale price is Rs. 9 per unit then what will be the profit / loss?
Total cost = Total FC + Total VC
Total cost = 60,000 + (6*8,000)
Total cost = 60,000 + 48,000 = Rs. 108,000
Total revenue = Sale price * Output level Total revenue = 9 * 8,000 = Rs. 72,000
Profit / loss = Total revenue – total cost = 72,000 – 108,000 = Rs. -36,000 There is a loss of Rs. 36,000

Lecture # 14
Q3. Suppose a portfolio consists of three projects A, B & C where each project requires an initial investment of Rs. 65,000. If present value of cash flows of projects A, B & C is Rs. 80,000, Rs. 73,000 and Rs. 82,000 then what will be ranking of each project based upon profitability index criterion?

	Projects	Initial Investment (Rs.)	PV of cash flows (Rs.)	PI = (PV/Initial Investment)	Ranking
A	65,000	80,000	1.23	2
B	65,000	73,000	1.12	3
C	65,000	82,000	1.26	1

Lecture # 15

Q4: There are two states of economy, Boom & Recession. Probability of occurrence of Boom is 45% while Recession is 55%. Suppose stock A expected return in Boom (state of economy) is 12% while in Recession is 7%. Stock B expected return in Boom (state of economy) is 20% while in Recession is 3%.
If an investor invests 70% in stock A and 30% in stock B then what is the total expected return of the portfolio?

Total Expected return (Stock A) = 0.120.45 + 0.070.55
Total Expected return (Stock A) = 5.4% + 3.85% = 9.25%

Total Expected return (Stock B) = 0.200.45 + 0.030.55
Total Expected return (Stock B) = 9% + 1.65% = 10.65%

Total Expected Return (portfolio) = 0.70 * 0.0925 + 0.30*0.1065
Total Expected Return (portfolio) = 0.06475 + 0.03195 = 0.0967 or 9.67%

Lecture # 18:

Q5: A capital structure consists of 10% preferred stock, 55% common equity and 40% debt. Company’s preferred stock is currently selling for Rs. 55 per share and paying dividend of Rs. 4. If cost of common equity is 15% and after tax cost of debt is 6% then what will be WACC?
Cost of preferred stock (Kps) = D / P
Kps = 4/55 = 7.27%
WACC=Wce * Kce + Wps * Kps + Wd Kd (1-T)
WACC= 0.550.15 + 0.100.0727+ 0.400.06 WACC= 0.0825 + 0.00727+ 0.024 = 0.1138 or 11.38%
Note: A solution with weightage of 5% of preferred stock will also be considered correct WACC=Wce * Kce + Wps * Kps + Wd Kd (1-T)
WACC= 0.550.15 + 0.0.050.0727+ 0.40*0.06
WACC= 0.0825 + 0.003635+ 0.024 = 0.1101 or 11.01%