Question 1           Finance Question代写

Finance Question代写 Large investment projects in big corporations may fail to deliver their estimated cash flows for a series of reasons.

Finance Question代写
Finance Question代写

B)       Finance Question代写

Large investment projects in big corporations may fail to deliver their estimated cash flows for a series of reasons. Taking the example of an investment project which is appraised using the net present value (NPV) method.

To deploy the NPV method, first, the company has to forecast the estimated cash flow of the project, which can be problematic.

The estimation of cash flow for the project is tricky because no one can predict the future, thus every cash flow estimated can be off the real value realized in the future. Second, even if the estimated value of cash flow is close enough to the real value in the future, cash flow estimation is usually predicted under some kind of assumption of economic macro-environment (such as good time and bad time).

However, macro-economy conditions change at every moment can it is impossible to take into account every possible outcomes of economy situations, which make the estimation biased. Third, even if every possible economy outcome is precisely predicted, it is difficult to attach the possibility to each condition, which also leads to biased estimation of cash flow estimation. While for simplicity, in appraisal, the analysts may say that there are two possible economy outcomes (good and bad) with a possibility of fifty percentage each and the cash flow under each outcome can be well forecasted. Finance Question代写

The project is profitable according to appraisal. In reality, the possibility forecast, the possible conditions forecast of economy outcomes and the cash flow forecast can all be defective, leading to misleading conclusions, which is especially true for long-lasting projects with projection periods over several years.

Second, when applying the NPV method, a discount rate is used. However, in reality, the discount rate is difficult to estimated.Finance Question代写

First, for a public listed company, the return of the stock is usually taken as the discount rate/required return of a given project. However, this method has some disadvantages. First, the calculation of stock return is based on historical data, which can be off to its real value. Second, stock return is usually obtained by using some kind of pricing model, such as CAPM or APT model. However, these pricing models have their own demerits and the applicability of these pricing models are still being argued in academic circle. Thus, the defects of pricing model, which is used to derive the stock return, can leads to inaccurate estimation of stock return.

Moreover, even if the stock return can be accurately calculated at the beginning of the appraisal, it does not necessarily represent the real required return of a project. For example, during the life of the project, risk preference of investors can change, economic conditions may change, operating conditions of the company may change, which will finally lead to changes in the required return. As a result, required return in different stages of the project may be different, requiring adjustment in the discount rate used to calculated the net present value of the project. However, all this information is almost unlikely to be foreseen at the time of investment appraisal.Finance Question代写

Despite NPV method, other investment appraisal techniques have similar shortcomings, which can lead to misleading appraisal of large investment projects.

Failed capital project affects key stakeholders and shareholder value differently. Failed capital projects adversely affect key stakeholders. For a creditor, failed capital project may impact their interests in terms of interest and principals. Should a project fail and negatively affect the company’s solvency ability, creditors may not be able to collect interest payments and even the principal. For a shareholder, failed capital project has even worse impacts. If a company’s solvency is impacted due to failed capital projects, shareholders interests can be negatively impacted in both aspects.Finance Question代写

On one hand, failed projects bring negative prospects on company’s future profitability, leading to stock price decrease. Shareholders suffer loss due to price fall in stocks. On the other hand, shareholders are ranked behind creditors should a bankruptcy happen and the company is in liquidation. In such conditions, company’s assets are firstly paid to creditors before allocated to shareholders. If nothing left after paying the creditors, shareholders will suffer great loss. Other stakeholders are also negatively impacted.

For example, the management and the employees of the company will suffer economic losses due to the failed project. In an extreme situation where failed project leads to bankruptcy, the management losses bonus and the employees lose jobs. Similarly, customers and suppliers of the company are negatively impacted: customers would lose future access to the products of the company and the suppliers lose one customer.

As far as the government, it loses one source of tax revenue or gets reduced tax revenue from the company and thus is also adversely influenced. However, the competitor of the company can benefit from the failure of the company and take the chance to take the original market share of the company.

Failed capital project changes the future strategy of investment capital.Finance Question代写

For debt capitals, it will require higher interest payment because the failure of the projects make it riskier to lend money to the company. On one hand, failed projects weaken the cash flow and debt capital may worry about the interest payment ability of the company. On the other hand, big projects failures may leave the company in a situation with high debt-ratio, making the company seek higher return projects in the future, which is also accompanied by greater risks.

For equity capitals, it will require higher returns due to increased risks caused by the failed projects. If the company is looking for new stock issuance for further investment, investors would raise their required return because historical failure increases the standard deviation/risk of investing in the company. Meanwhile, new  stick issuance has the effect of dilution, which poses a downward pressure on the stock price, making it less profitable.

C)          Finance Question代写

CAPM is based on a series of assumptions, which is targeted to homogenize the characteristics of investors with different initial wealth and risk preference. By making these assumptions, CAPM presents a formula which gives the expected return through risk-free rate, beta and risk premium:

Finance Question代写
Finance Question代写

The advantages of CAPM are that the formula of CAPM is, simple to use and easy to understand. It depicts the relationship between returns and risks, so that investors can understand the difficult concept of risk more easily. However, there are also disadvantages of CAPM, which are mainly caused due to its strict assumptions.

First, CAPM’s assumptions assumes that investors are rational when making investment decisions:

they focus only on future returns and risks (standard deviations). However, in fact, such assumptions are not met under all conditions. For example, some recent researches of behavior finance propose the concept of ‘bounded rationality’ to describe that people are not rational under all conditions. Instead, investors can be irrational due to various reasons, such as incomplete information, sentiment influence and so on. In the real world, investors make mistakes and adjust their own decisions accordingly.

Therefore, the rational person assumption in the CAPM model is not sound under all conditions. Another instance is that when investors are particularly disgusted with losses, even small ones, they will use higher expected returns to compensate for losses, that is, excessive risk premiums. Excessive risk premiums show that investors not just focused on the value of the stocks they currently hold. Instead, they can more focus on losses and profits.

Attitudes to risk are also affected by previous losses and. If losses happen, investors will be more cautious in choosing securities to compensate for losses. Conversely, if investors have previously achieved returns that exceed investors’ expectations, they will boldly choose high-risk securities to invest in, because even if there is loss in this condition, they can make it up using past returns.

Second, CAPM that there are no transaction costs and no taxes.Finance Question代写

However, transaction costs and tax burdens always exist, and they also can have a considerable impact on the stock and preference of investors. Due to the fact that dividends and capital gains taxes are levied with different standards and transaction costs exist, investors in the stock market will hold different portfolios simultaneously instead of holding assets with the same proportion.

When considering the difference between dividend tax burden and capital gains tax, it can be expected that uneven tax burden will cause investors in the stock market to have different investment preferences. Different investment preferences will not only affect the return on investment, but also bring additional non-systematic risk costs. Therefore, the assumption of no transaction costs and no tax burden is also untenable.

Third, CAPM also assumes that investors can borrow funds at the same risk-free rate.   Finance Question代写

However, in reality, investors cannot find real risk-free securities. Even if we believe that the default risk of government bonds is minimal, we cannot deny that price changes caused by interest rate fluctuations in the capital market are also the main risks of investing in government bonds, namely, the market risk. On the other hand, under normal circumstances, the interest rate for borrowing funds will be higher than the interest rate for lending rate.

Besides, CAPM assumes that investors’ expectations are the same, and they have the same understanding in terms of standard deviation, expected rate of return, and covariance of securities. However, individuals will have different expectations for the same asset as is analyzed before. Moreover, CAPM assumes that assets in the securities market are infinitely divisible. In popular terms, investors can buy any part of any stock, so that investors can be free to distribute his assets in any proportion. However, in addition, this is unlikely because there is minimum quantity trading requirement in the market. For example, investors cannot by half of a stock share.Finance Question代写

Despite its disadvantages, CAPM is widely used in reality.

First, CAPM can be used in portfolio selection. CAPM can be used to calculate the β coefficients of different securities investment portfolios; to calculate the risk-return ratio of each securities portfolio; to calculate and compare the return rate of each investment portfolio. Investors can use CAPM to calculate the return on their own securities portfolio and compare it to the expected minimum return in detail for decision making.

Second, CAPM can be used to calculate the risk-adjusted discount rate. According to CAPM, expected return is positively correlated with risks. Thus, the risk aversion degree of investors determines the specific required return. Then, the risk adjusted return can be used for project selection. The principle is that calculating the net present value of high-risk projects based on a higher risk-adjusted discount rate, and then formulate a plan based on the rules of the net present value method.

The theoretical basis of this method is that when making a project investment decision, the minimum return required by investors is the discount rate or the cost of capital. In project investment, risk is always proportional to the required return. Moreover, CAPM can be used to calculate the cost of equity in financing decisions. Generally speaking, the expected return on a company’s stock is the cost of equity capital. In the CAPM model: the cost of capital of common stock can be calculated by using risk-free rate of return, beta coefficient and the market risk premium.

Question 2               Finance Question代写

a)

The cost of debt, , namely the promissory notes, satisfies the following equation:

Finance Question代写
Finance Question代写

 

 

 

 

 

 

 

 

 

 

 

 

b)

The cost of equity, :

Finance Question代写
Finance Question代写

 

 

 

 

 

 

 

 

c)

The weighted average cost of capital, :

Finance Question代写
Finance Question代写

 

 

 

 

 

 

 

 

 

 

d)        Finance Question代写

The addition investment cost of USD 1.6 million incurred at the end of year 1 will fully depreciated on a straight line basis over the life of the project (by the year of 5) with no scrap value at the end.

1
1
year Revenue Variable costs Fixed costs Revenue before tax Tax

(34%)

Cash flow after tax Depreciation Free cash flow
0 -1.0 -1.0
1 -1.6 -1.6
2 7 3 1.8 2.2 0.748 1.452 0.4 1.052
3 7 3 1.8 2.2 0.748 1.452 0.4 1.052
4 7 3 1.8 2.2 0.748 1.452 0.4 1.052
5 7 3 1.8 2.2 0.748 1.452 0.4 1.052

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Present value of the cash flow at year 1 (the beginning of year 1 is denoted as 0 in the table above) if outcome from the pilot run is positive:

2
2

The positive present value of cash flow is 0.58 USD millions.

e)

Project’s cash flow (in USD millions):

year Revenue Variable costs Fixed costs Revenue before tax Tax

(34%)

Cash flow after tax
0 -1.0
2 4.05 1.735 1.8 0.515 0.1751 0.3399
3 4.05 1.735 1.8 0.515 0.1751 0.3399
4 4.05 1.735 1.8 0.515 0.1751 0.3399
5 4.05 1.735 1.8 0.515 0.1751 0.3399

 

 

 

 

 

 

 

 

 

 

 

Present value of the cash flow at year 1 (the beginning of year 1 is denoted as 0 in the table above) if outcome from the pilot run is positive:

3
3

Question 3          Finance Question代写

a)

4
4

b)

5
5 
6
6

c)

Finance Question代写
Finance Question代写

The equally-weighted portfolio has an average return of the project RoboTrain and RoboMaind but the standard deviation is lower the two projects. By diversifying in two projects, the specific risk (or in more generalized words, unsystematic risk) of Transbot can be lowered.

d)

Finance Question代写
Finance Question代写

Since the required return of Transbot (15.97%) is greater than the return of the two projects (14.64% and 15.55%), it is not recommended for the CFO to proceed with these investments, as the return from these two investments can not live up to the required return of the company.

It is appropriate to use the firm’s hurdle rate as benchmark comparison when making decisions because hurdle rate is viable from the aspect of net present value (NPV). When using the NPV rule to determine the feasibility of a project, future cash flows are discounted by some ‘rate’. The ‘rate’ represents the required return of the project. If the expected return is greater (less) than the required return, the project be approved/refused under NPV rule. In this context, the required return is the hurdle rate.Finance Question代写

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