JUNE 2022 – Individual Assignment

STUDENT ID
PRESENTED TO
DATE
 Question 1

Calculating the Weighted Average Cost of Capital for Peace Corps is required.

Market Capitalisation of Equity = RMB 20 million

In the first step, Capital Asset Pricing Model (CAPM) is used to calculate the cost of equity
(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

As a result of Capital Rationing, the act of making investments that are feasible as well as
placing a few restrictions on new investments so that maximum returns are achieved is that a
company is unable to invest in all profitable projects because of a shortage of funds despite
the fact that all the projects have positive net present value. A company can use capital
rationing to limit the number of new projects and investments it is allowed to undertake by
restricting capital investment. By rationing capital, companies ensure that their limited
resources are allocated efficiently to maximize shareholder value (Mahr & Koscinski, 2022).
The goal of capital rationing is to prioritize projects based on the expected return on
investment. An organization may decide to only invest in projects with a higher expected
return than the cost of capital when it evaluates how many opportunities it can pursue and
what investments it can make. Additionally, a company may have difficulty raising equity or
debt capital. The company may not be able to borrow more money due to the current
economic conditions or because it does not have sufficient credit available. Capital rationing
can be characterized as either hard or soft capital rationing, depending on the situation.

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. When a company is forced to ration its capital due to a situation outside
its control, it is called hard rationing. A company may experience this if it cannot access the
necessary funding to pursue all of its desired investment opportunities (Mahr & Koscinski,
2022). If this is the case, the company may have to ration its capital in order to avoid
overextending itself financially. It is also possible to suffer hard rationing when a company
has to adhere to strict regulations that restrict its ability to invest. The lending practices of
banks, for example, are regulated strictly. Due to this, they may need to ration their capital to
prevent exceeding their lending limits

Rationing of soft capital, also referred to as internal rationing, refers to a rationing process
that involves the restriction of the availability of funds which is due to the firm's internal

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policies regarding the raising of funds for the prospective investments (Gompers & Lerner,
n.d.). In soft rationing, companies restrict their capital investments on their own accord to
meet certain financial goals by making deliberate restrictions on their capital investments. To
weather an economic downturn, management may ration capital, for instance, to conserve
cash. If a company is seeking to control its growth, it may also ration capital as part of its
overall financial strategy (Mahr & Koscinski, 2022).

Part b

In order to get the net present value, we discount the cash flows of each year and bring them
up to the present 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

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For Project B

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

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 3 80 0.7513 60.104

4 80 0.6830 54.64

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

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Funds should be allocated to the projects with the highest NPV if they are divisible

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 be accepted or rejected wholly, depending on whether they
are indivisible. In the previous example, only projects A & B could receive funds.

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

IRRs greater than required rates of return should be accepted as projects. It should be rejected
if the IRR is lower than the required rate of return.

Question 4

Equity or debt can be used to finance a company's long-term needs. As opposed to equity
financing, which is the process of raising money from investors who are entitled to a share of
your business' profits in return, debt financing is the process of borrowing money from
lenders to run your business. Depending on the type of loan you are seeking, the debt

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financing can be divided into two types: long-term and short-term loans (Ward, 2021). Unlike
equity financing, debt financing involves borrowing money to run your business, unlike
equity financing, which involves raising money from investors who in return receive a share
of your profits. In general, debt financing can be done in the following ways:

 Loans from Bank – As one of the most popular and common methods of financing a
debt, taking a loan from the bank is the most common and popular method. The loans
are usually obtained for a fixed period of time, with a fixed rate of interest and are to
be repaid on a regular basis in accordance with the schedule of repayments presented
to the borrower. It is crucial for any business to have a loan that fits its needs, whether
it's for a long-term, a short-term or a medium-term. Loans are secured by collateral,
which is the security against which the loan is made.

 Overdraft facility – Overdraft facilities are provided by the banks to those businesses
who have good creditworthiness by allowing them an additional credit limit, along
with the normal credit limit, on their overdraft account (Ghangurde, 2021). Overdrafts
are essentially facilities offered by banks that allow account holders to borrow up to a
certain amount once their account balance reaches zero, through which they can
borrow up to a certain amount. A lender may charge interest on the borrowed amount
or impose an overdraft fee on the borrowed amount, and the money lent must be
repaid within a set time frame that is set by the lender.

 Bonds – Overdraft facilities are provided by the banks to those businesses who have
good creditworthiness by allowing them an additional credit limit, along with the
normal credit limit, on their overdraft account.
Whenever companies sell shares to investors to raise capital, this is called equity financing,
and it is a form of capital raising (BDC, n.d.). There is a major benefit to a business in
receiving equity financing, which is the fact that the money received does not have to be
repaid. A share of the company's funds will not be returned to shareholders in the event that
the company fails. As a result of this benefit, the business must give them a certain share of
ownership in the company in exchange for this benefit-and this may also entail a certain
amount of decision-making power. There is also a percentage of the business's profits that are
shared with equity investors from the earnings after tax (EAT) of the business. Equity
financing can be arranged in a number of different ways, including;

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  Issue of equity shares - There are two basic ways in which funds are raised: either by
issuing equity shares during the Initial Public Offering, or by issuing more equity
shares later on. Investors expect, however, a higher return due to the higher level of
risk that is associated with these investments.
 Retained Earnings – This can be done by giving the company access to its retained
earnings, which are a portion of the company's earnings that are kept for investment
purposes rather than being paid out as dividends to the company's shareholders.

 Venture Capitalist – The fastest growing investments are those that are invested in by
these investors. A financing type such as this is often called "Private Financing"
(Finn, 1976) and is referred to as just that.

Taking into account the above mentioned financing options, a small business faces many
challenges. Here is a short list of a few of them:

 A prospecting investor search can be quite time consuming and involves a

significant amount of effort on the part of the investor.
 It is important to keep in mind that the owner can only exert a limited control over
the operation of the business because other investors may have a stake in the
business as well.
 Debt financing involves a high level of risk in the event of non-repayment of the
loan, which may result in legal action or confiscation of the property if the loan is
not repaid.
 There is a possibility that the lender will have to sell the security against which the
debt was obtained if the instalments are not paid on time.

A small business can choose from the following financing options when it comes to financing
their operations:

 Retained Earnings – An owner can plough back their retained earnings in order to
finance the business operations of the business in order to maximize their profits.
 Owners Capital – In order to make investments, owners can use their own capital,
which is their personal savings, as a means of investing.
 Taking out loans from friends and family (Kotey, 1999) is another way to borrow
money.

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References

Bdc. (n.d.). Equity financing.

https://www.bdc.ca/en/articles-tools/entrepreneur-toolkit/templates-business-guides/
glossary/equity-financing

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

Ghangurde, A. (2021, November 15). Overdraft facility – Meaning, features & how to apply
overdraft facility. https://www.dripcapital.com/resources/blog/what-is-an-overdraft

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

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

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

Mahr, N., & Koscinski, M. (2022, April 29). Capital rationing types and examples.
Study.com. https://study.com/learn/lesson/capital-rationing-types-examples.html

Ward, S. (2021, March 17). What is debt financing? The balance.

https://www.thebalancemoney.com/debt-financing-2947067

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