Essay Instructions: ADVANCED FINANCIAL MANAGEMENT (MBA ASSIGNMENT)
CORE BOOKS TO USE:
Brealey, R., Myers, S., and Allen, F. (2008) Principles of Corporate Finance, 9th edition, McGraw-Hill.
Hillier, D., Ross, S., Westerfield, R., and Jaffe, J. (2005) Corporate Finance, 7th edition, McGraw-Hill.
PART A: OPTIONS
?When you have the option of deciding when to invest, it is usually optimal to invest when the NPV is substantially greater than zero.?
Required: I
With reference to above, discuss how VOLATILITY and DIVIDENDS of the stock affect the optimal time to exercise a CALL in an option to delay an investment opportunity.
(400 Words)
YourCompany Plc is considering a new project at a cost of ?13 million. The project may begin today or in exactly one year. You expect the project to generate ?2,000,000 in free cash flow the first year if you begin the project today. Free cash flow is expected to grow at a rate of 3% per year. The risk-free rate is 4%. The appropriate cost of investment is 11%. The standard deviation of the project?s value is 30%.
Required: II
Applying suitable models (Black-Scholes Model) discuss whether you should begin the project today or wait one year?
(500 Words)
The Black-Scholes model introduced standard options pricing method which is very useful among users in financial market and companies. However, the model disagrees with reality in a number of ways. Hence, proper use requires understanding its limitations.
Required: III
With reference to above, explain Black and Scholes model and its limitations reviewing published journal articles.
(400 Words)
PART B: INVESTMENT ANALYSIS
MyCompany Plc is a company currently engaged in manufacturing of toys. It wishes to diversify into the manufacturing of Mobile phones.
The Investment details:
The company?s equity beta is 1.07 and is currently debt to equity ratio of 30:70; however the company?s gearing will change as a result of new project.
Firms involved in mobile phones have an average equity of 1.12 and an average debt to equity ratio of 40:60.
Assume that the debt is risk free, that the risk free rate is 8% and that the expected return from the market portfolio is 20%.
The new project will involve the purchase of new machinery for a cost of ?1,200,000 (net of issue costs), which will produce annual cash inflows of ?650,000 for 3 years. At the end of this time it will have no scrap value.
Corporation tax is payable in the same year at a rate of 33%. The machine will attract writing down allowances of 25% p.a. on a reducing balance basis, with a balancing allowance at the end of the project life when the machine is scrapped.
The financing details:
The new investment will be financed as follows:
Debentures (redeemable in 3 years time) : 45%
Rights issue of equity : 55%
The issue costs are 4% on the gross equity issued and 2% on the gross debt issued.
Required: I
Estimate the Adjusted Present Value for MyCompany Plc based on information given above.
(600 Words)
Advantages of Adjusted Present Value (APV) technique were identified a long time ago in S.C. Myers, ?Interactions of Corporate Financing and Investment Decisions ? Implications for Capital Budgeting,? Journal of Finance 29 (March 1974). Pp.1-25. The Harvard Business Review has published a popular account of APV in T.A. Luehrman, ?Using APV: A better tool for valuing Operations,? Harvard Business Review 75 (May-June 1997), pp 145-154.
Required: II
Reviewing relevant literature discuss various advantages of APV as a method of evaluating a capital investment decision. You may also like to comment circumstances under which APV might be a better method of evaluating a capital investment than Net Present Value.
(400 Words)
