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CFA Formulas > Corporate Finance Questions > Flashcards

Corporate Finance Questions Flashcards

1
Q

NPV Analysis
Q. Which should be accepted

Company X
Cash flow
-2k / 1k / 800 / 600 / 200

Company Y
Cash flow
-2k / 200 / 600 / 800 / 1.2k

Cost of Capital - 10%

A

NPV = Cap invested - PV of Cashflows
X NPV =157.63
Y NPV = 98.35

Accept Both

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2
Q

IRR Example
Q. Which should be accepted

Company X
Cash flow
-2k / 1k / 800 / 600 / 200

Company Y
Cash flow
-2k / 200 / 600 / 800 / 1.2k

Required Rate of Return - 10%

A

Use Calculator
Company X - 14.48
Company Y - 11.79

Accept both projects as IRR is greater than required return

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3
Q

Q. Calculate the payback period for the following Cashflows

Company X
Cash flow
-2k / 1k / 800 / 600 / 200

Company Y
Cash flow
-2k / 200 / 600 / 800 / 1.2k

A

Steps:
Calculate cumulative Cashflows
Divide the residual to break even by the next cashflow
Add the residual to years past

Company X
2 years + (200/600) = 2.33 yrs

Company Y
3 years + (400/1200) = 3.33

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4
Q

Discounted Payback Period
Q. Are these investments attractive, firms’ maximum payback period is 4 years

Company X
Cash flow
-2k / 1k / 800 / 600 / 200

Company Y
Cash flow
-2k / 200 / 600 / 800 / 1.2k

Cost of Capital - 10%

A

Steps
Discount cashflows
Calculate cumulative discounted cashflows
Divided residual to breakeven by next cashflow

Company X
DCF - 910 / 661 / 451 / 137
2+ (429/451) = 2.95

Company Y
DCF - 182 / 496 / 601 / 820
3+(721/820) = 3.88

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5
Q

Profitability Index

Q. What is the PI of both these companies

NPV Analysis
Q. Which should be accepted

Company X
Cash flow
-2k / 1k / 800 / 600 / 200

Company Y
Cash flow
-2k / 200 / 600 / 800 / 1.2k

Cost of Capital - 10%

A

Steps
NPV ÷ Cap invested
Company X - 2,158/ 2,000 = 1.079
Company Y - 2098/ 2000 = 1.049

If independent, accept if greater than 1

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6
Q

Crossover Rate
Q. What is the crossover rate of project A/B

Project A: -550 / 150 / 300 /450
Project B: -300/ 50 / 200 / 300

A

Steps
Subtract cashflows and calculate IRR
New cashflow: -250 / 100 / 100 / 150
IRR -17.5

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7
Q

Relationship between NPV and Stock Price

Company X
Investment: 500 mil
PV of Cashflows: 750 mil
Shares O/S: 100 mil
Stock Price: 45

A

Steps
NPV = Value creation
250 mil of value will be realised
250/100 = 2.5 euro per share
New price 47.5

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8
Q

Computing WACC

Q. What is the WACC

Company X
Target Cap Structure: Wd .45 / Wps .05 / Wcc .5

Before tax cost of debt 8%
Cost of Equity 12%
Preferred Stock 8.4%
Marginal Tax 40%

A

Steps
Adjust debt liability to compensate for tax
Multiply by various ratios

.45×(.08)(.6) + .05×.084 + .5× .12
= 8.6%

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9
Q

Determining target capital structure weights

Market Val of firms cap structure is
Debt - 8 mil
P.stock - 2 mil
C.stock - 10 mil
Total cap - 20 mil

A

Market Val of firms cap structure is
Debt - 40%
P.stock - 10%
C.stock - 50%
Total cap - 100%

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10
Q

Cost of Debt
Q. What is cost of capital

Company X
New debt issued @ 8%
Marginal Tax Rate - 40%

A

Step
Multiply pre tax cost of debt by 1-tax rate
.08*.6 = 4.8

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11
Q

Cost of Preferred Stock

Company X
Preferred Stock Divi - €8
Market Value - €100

A

Steps
Divi / Market value
8/100 = 8%

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12
Q

CAPM to estimate Kce

RFR - 6%
Rmkt - 11%
Beta - 1.1

Q. Estimate cost of equity

A

Steps
Risk free + beta multiplied by implied risk
6+1.1*(11-6) = 11.5%

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13
Q

Estimating Kce using Dividend Discount Model

Company X
Stock - €21
Next year divi - €1
Expected ROE - 12%
Earnings to be paid - 40%

Q. What is the cost of equity

A

Steps
Find Growth Rate
Use dividend approach to calc cost of equity

G = ROE * Retention
g = .12 * (1-.4) = 7.2%

(1/21)+ 7.2% = 12%

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14
Q

Estimating Kce with bond yields + risk premium

Company X
Interest on long term debt - 8%
Risk Premium - 5%

Q. What is the cost of equity

A

Steps
Add premium to existing long term debt cost

8%+5% = 13%

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15
Q

Cost of Capital For a Project

Company X
Scenario: Considering entering a food dist business
D/E - 2
Tax rate - 40%
Debt Yield - 14%

Company Y - Comp
D/E - 1.5
Tax Rate - 30%
Beta - .9
Risk Free Rate - 5%
Expected Return on portfolio - 12%

Q. Cal Company Y Asset Beta
Q. Cal Project equity beta
Q. WACC

A

Steps
Need to multiply beta by discount to deleverage your beta

BAsset = .9[(1/1+(1-.3)(1.5)] = .439

Need to now re-lever beta to reflect companies structure

B Project = .439(1+(1-.4)(2) = .966

Calculate project cost of equity
.5+.966(.12-.05) = 11.766

Calculate WACC

Weight of Debt = D/(D+E) = .67
Weight of Equity = 33

(.67)(.14)(1-.4) = 5.62% Debt
(33)(11.766) = 3.9%
WACC = 9.52%

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16
Q

Country Risk Premium

Company X
Scenario - Looking to invest in 3rd Sub Credit Country

Project Beta - 1.25
Exp Return - 10.4
Risk Free - 4.2
Country Risk Pre- 5.53

Q. Cal cost of equity of this project

A

Steps
Modify CAPM

.042 + 1.25(10.4 - 4.2)+.0553
= 18.86%

CFA Formulas (2 decks)

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