Corporate Finance

Group Project
Written By:
Alexander Gaprindashvili
Giorgi Gvimradze

Content:

Financial statements and financial ratios

Time value of money
Bond and stock valuation
Cost of capital and capital structure
Capital budgeting

Financial statements and financial ratios

GreenW Inc. is a small American company
specialized in producing electric bikes. Company has
70 million shares outstanding. In the beginning of
2002, GreenW Inc. issued 20 thousand, 10-year bond
with 10% coupon rate. Every year, Company spends
3-5% of its net revenues on research and
development.

Financial statements (All figures are given in thousands of US dollars):

Assets

2004

2005

2006

2007

2008

Cash and cash equivalents

5 000

23 027.41

22 500

4 800

23 360.45

Accounts receivable

3 500

3 255

4 027.25

5 250

6 500

15 400

16 255

14 442.50

17 310

15 780

55

28

30

47

70

23 955

42 535.41

40 999.75

27 407

45 710.45

Land

10 000

10 000

20 000

25 000

25 000

Buildings

25 000

23 750

34 562.50

31 797.50

29 253.70

Machinery and equipment

65 750

66 985

64 058.43

53 168.50

44 129.85

3 000

2 550

2 100

1 650

1 200

127 705

145 820.41

161 720.68

139 023

145 294

Inventories
Prepaid expenses and other
current assets

Total Current Assets

Other long-term assets

Total Assets

Liabilities and Equity

Accounts payable

2004

2005

2006

2007

2008

3 740

3 596

2 749.59

75

100

165

172

180

120

112

78

103

90

75

86

8 602

9 122

8 797.05

2 122.62

10 000

4 120.38

12 585

12 993

21 816.64

270

6 541

20 000

20 000

20 000

20 000

20 000

32 585

32 993

41 816.64

20 270

26 541

Common stock

70 000

70 000

70 000

70 000

70 000

Retained earnings

25 120

42 827.41

49 904.04

48 753

48 753

127 705

145 820.41

161 720.68

139 023

145 294

Salaries payable
Accrued expenses
Taxes payable
Dividends payable

Total
Long-term debt

Total Liabilities

Total Liabilities and

Equity

Income Statement

2004

2005

Net revenues

155 360

168 455

165 800

134 648.96

157 400.60

111 753

122 258.09

120 546.07

112 865.07

129 094.11

277

305

295

1 430

880

5 250

5 500

5 400

5 400

6 000

10 780

11 562.50

11 685.25

14 104.93

12 032.45

27 300

28 829.41

27 873.68

848.96

9 394.04

2 000

2 000

2 000

2 000

2 000

25 300

26 829.41

25 873.68

- 1 151.04

6 243

8 602

9 122

8 797.05

2 122.62

16 698

17 707.41

17 076.63

- 1 151.04

4 120.38

10 000

4 120.38

16 698

17 707.41

7 076.63

- 1 151.04

Cost of products sold

Selling, general and administrative
expenses
Research and development
Depreciation

EBIT
Interest paid

Taxable income

Taxes(34%)

Net income
Dividends declared
Addition to retained earnings

2006

2007

2008

Statement of Cash Flows

Net income
Depreciation

2005
17 707.41

2006

2007

2008

17 076.63

- 1 151.04

4 120.38

11 562.50

11 685.25

14 104.93

12 032.45

245

- 772.25

- 1 222.75

- 1 250

-825

1 782.50

- 2 867.50

1 530

Change in prepaid expenses

27

-2

-17

-23

Change in accounts payable

-144

- 846.41

- 2 674.59

25

- 60

-8

25

-13

-15

11

Change in taxes payable

520

- 324.95

- 8 797.05

2 122.62

Purchase of fixed assets

- 11 097.50

- 29 121.18

- 5 000

- 10 000

18 027.41

- 527.41

- 17 700

18 560.45

Change in accounts receivables

Change in inventories

Change in salaries payable

Change in accrued expenses

Payment of dividends

Net cash flow

Ratio

\ Year

2004

2005

2006

2007

2008

Current ratio

1.90

3.27

1.88

101.51

6.99

Quick ratio

0.68

2.02

1.22

37.40

4.58

Cash ratio

0.40

1.77

1.03

17.78

3.57

Inventory turnover

7.26

7.54

8.35

6.52

8.18

Days' sales in inventory

50.30

48.44

43.73

55.98

44.62

Receivable turnover

44.39

51.75

41.17

25.65

24.22

Days' sales in receivables

8.22

7.05

8.87

14.23

15.07

Total asset turnover

1.22

1.16

1.03

0.97

1.08

Total debt ratio

0.26

0.23

0.26

0.15

0.18

Debt-equity ratio

0.34

0.29

0.35

0.17

0.22

Times interest earned ratio

13.65

14.41

13.94

0.42

4.70

Profit-margin

0.11

0.11

0.10

- 0.01

0.03

Return on total assets

0.13

0.12

0.11

- 0.01

0.03

Return on equity

0.18

0.16

0.14

- 0.01

0.03

Earnings per share (EPS)

$ 0.24

$ 0.25

$ 0.24

- $ 0.02

$ 0.06

Price-earning ratio

62.88

67.20

102.48

- 729.77

271.82

Liabilities ratio

0.63

0.65

1.09

0.01

0.33

Return on current assets

0.70

0.42

0.42

- 0.04

0.09

Assets ratio

0.23

0.41

0.34

0.25

0.46

GreenW Inc.
Year

2004

2005

2006

2007

2008

Price of stock

$ 15

$ 17

$ 25

$ 12

$ 16

Percentage Change of Balance Sheet Items

2005

2006

2007

2008

360.55%

- 2.29%

- 78.67%

386.68%

- 7%

23.73%

30.36%

23.81%

5.36%

- 10.99%

19.85%

- 8.84%

- 49.09%

7.14%

56.67%

48.94%

77.56%

- 3.61%

- 33.15%

66.78%

0%

100%

25%

0%

- 5%

45.53%

- 8%

- 8%

Machinery and equipment

1.88%

- 4.37%

- 17%

- 17%

Other long-term assets

- 15%

- 17.65%

- 21.43%

- 27.27%

Total Assets

14.19%

10.90%

- 14.04%

4.51%

Accounts payable

- 3.85%

- 23.54%

- 97.27%

33.33%

Salaries payable

4.24%

4.65%

- 33.33%

- 6.67%

Accrued expenses

32.05%

- 12.62%

- 16.67%

14.67%

Taxes payable

6.05%

- 3.56%

- 100%

- 100%

3.24%

67.91%

- 98.76%

2 322.59%

Long-term debt

0%

0%

0%

0%

Total Liabilities

1.25%

26.74%

- 51.53%

30.94%

Common stock

0%

0%

0%

0%

Retained earnings

70.49%

16.52%

- 2.31%

0%

Total Liabilities and Equity

14.19%

10.90%

- 14.04%

4.51%

Cash and cash equivalents

Accounts receivable
Inventories
Prepaid expenses and other current assets
Total Current Assets
Land
Buildings

Dividends payable
Total Current Liabilities

Time value of money

Exercise 1
In 2006, company purchased a piece of
land for 10 000 thousand. However, there
was alternative - another piece of land for
14 000 thousand to be paid after 2 years.
Did the financial manager make correct
decision if banks pay 16 % compounded
semi annually?

Solution
2 years and 16 % compounded semi annually
means that we have 4 periods and 8 % of
discount rate. Let's calculate present value of
alternative:

PV=FV/(1+r)t=14 000/(1+0.08)4 =10290

10 290 > 10 000, the decision was correct

Time value of money

Exercise 2
In the beginning of 2005, company purchased
fixed assets and paid 11 097.50 thousand in
cash. This portion of assets generated 1 800,
2 500, - 200 and 1 200 thousand net income in
2005, 2006, 2007, and 2008 respectively.
According to forecast, it will generate 3 500
thousand a year during next 7 years beginning
from 2009. Was the decision correct? Banks pay
16 % compounded semi annually.

Solution
Discount rate per period= 8%
PV=FV/(1+r)t
Year
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015

year No
1
2
3
4
5
6
7
8
9
10
11

Discounting
Period
2
4
6
8
10
12
14
16
18
20
22

PVIF
0,8573
0,7350
0,6302
0,5403
0,4632
0,3971
0,3405
0,2919
0,2502
0,2145
0,1839

Cash flow
1 800,00
2 500,00
-200,00
1 200,00
3 500,00
3 500,00
3 500,00
3 500,00
3 500,00
3 500,00
3 500,00

Total
11 397.51 > 11 097.50, the decision was correct

PV of cash
flow
1 543,14
1 837,50
-126,04
648,36
1 621,20
1 389,85
1 191,75
1 021,65
875,70
750,75
643,65
11 397,51

Time value of money

Exercise 3
At the end of 2007, company purchased another
piece of land for 5 000 thousand. Company
plans to sell it for 7 500 thousand after 4 years.
Brokerage fees are estimated to be 20
thousand. Was the decision correct if banks pay
8 % compounded quarterly?

Solution
Net future cash flow = 7 500 - 20 = 7 480
We have 4X4=16 periods and 2 % discount
rate
PVIF = 0.7284
PV of the decision=0.7284X7 480 = 5448.43

5 448.43>5 000=> decision was correct

Time value of money

Exercise 4
In 2008, company had a possibility to pay 3 500
thousand of accounts payable after 3 months
plus 5 % of original sum. But company did not
use this opportunity and paid accounts payable
immediately after receiving the invoice. Was the
decision correct if banks pay 24 % compounded
monthly?

Solution

Expected future cash outflow:

3 500X105% = 3 675

Bank deposit:
period - 3, DR- 24/12 = 2 %, FVIF = 1.0612
Expected future cash inflow :
3 500X1.0612 = 3 714.2

The decision was not correct, company could put cash

into bank account and thus, gain 3 714.2 - 3 675 = 39.2
thousand

Bond + Stock Valuation

Exercise 1.Bond valuation
Bond valuation In the beginning of 2002,
company issued 20 000, 10-year bond with 10%
coupon rate. In the beginning of 2008, market
rate was 7%. In the beginning of 2009,
bondholders changed contract in order to
receive coupons semi-annually with the same
annual coupon rate. Suppose a person
purchased the bond In the beginning of 2008.
What should be maximum market rate in beg.
2009 if the person plans to gain by reselling
bond (in integer)?

Solution
Maturity date - end of 2011
Price (beg.2008) = 1 000X0.7629 + 100X3.3872 =1101.62
In 2009 with semiannual coupon rate, we have 6 period
and semiannual coupon payment of 50 $

Price = 1 000/(1+r)6+50X[1-1/(1+r)6]/r
When r = 4%, price = 1 000X0.7903 + 50X5.2421 =1052.41
When r = 3%, price = 1 000X0.8375 + 50X5.4172 = 1108.36
Thus, we can conclude that r should be at most 3%=>
market rate should be maximum 6%

Bond + Stock Valuation

Exercise 2.Stock valuation
Company's dividend for a share of stock at the
end of 2009 is $ 0.50. During the next three
years, the dividend will grow at 100% per year
(owing to unique technology company plans to
patent, g = 100%). After that, growth (g') will be
equal to 10% per year during three years. And
finally, after these two stages constant growth
(g") will be equal 5% per year. Let's calculate
value of the stock if required returns R, R', and
R" are 20%, 15% and 10% respectively.

Solution
Dividends

8
7
6,5
6

5% constant growth rate

5
4,5
4
3,5
3
2,5
2
1,5
1
0,5

10% growth rate

100% growth rate

2009

2010
1

2011
2

2012
3

2013
4

2014
5

2015
6

2016
7

2017
8

2018 2019 2020 2021 2022 2023 2024 2025

10
11
12
13
14
15
16
17
End of year

Discount rate 20%

Discount rate 15%

Discount rate 10%

Solution
D1 = 0.50
P7 = D7(1+g")/(R"-g") = D7(1+0.05)/(0.10 - 0.05) = D7X1.05/0.05
3

D7 = D1X(1+1) X(1+0.10) = 0.5X8X 1.3310

5,324

Present value(P7) = P7/[(1+0.15) X(1+0.20) ] =

42,54

P7 = 5.324X1.05/0.05

111,804
3

Present value(D7) = D7/[(1+0.15) X(1+0.20) ] =

2,03

Present value(D6) = D6/[1+0.20) X(1+0.15) ] = D1X[(1+1) X(1+0.10) ]/[(1+0.20) X(1+0.15) ] =

Present value(D5) = D5/[1+0.20) X(1+0.15) ] = D1X[(1+1) X(1+0.10) ]/[(1+0.20) X(1+0.15) ] =
Present value(D4) = D4/(1+0.20)
Present value(D3) = D3/(1+0.20)
Present value(D2) = D2/(1+0.20)

3
2
1

= D1X(1+1) /(1+0.20) =
= D1X(1+1) /(1+0.20) =
= D1X(1+1) /(1+0.20) =

Value of stock

2,31
1,39
0,83

53,44

2,12
2,21

Cost of Capital and Capital Structure

Exercise 1. Cost of capital
Suppose company's debt has a market value of
20 million and equity has a market value of 80
million. The cost of debt before tax is 12 %.
Unlevered beta is equal to 0.95, risk free rate is
2.7%, market premium is currently 8 %. If
WACC=11%, what is combined tax rate?

Solution

WACC =0.2X12(1-T)+0.8X[2.7+0.95X
(1+(1-T)X(2/8))X8]
11 = 0.2X12(1-T)+0.8X[2.7+0.95X
(1+(1-T)X(2/8))X8]
T = 0.2959 = 29.59%

Cost of Capital and Capital Structure

Exercise 2. Finding of optimal capital structure
Suppose that combined tax rate is 30 %. The
cost of debt (before tax) will be 5% for the 0%
debt and will increase by 8% for every 5 % debt
added to the capital structure, but after 45 %
cost of debt will remain constant. Unlevered beta
is equal to 1.15, risk free rate is 4%, market
premium is 10%. Let's find optimal capital
structure.

Solution
% Debt

R(D) - BT R(D) - AT % Equity

BL

R(E)

WACC

5,00

3,50

100

1,15

15,50

15,50

5
10

5,40
5,83

3,78
4,08

95
90

1,19
1,24

15,92
16,39

15,32
15,16

15

6,30

4,41

85

1,29

16,92

15,04

20

6,80

4,76

80

1,35

17,51

14,96

25

7,35

5,14

75

1,42

18,18

14,92

30

7,93

5,55

70

1,50

18,95

14,93

35

8,57

6,00

65

1,58

19,83

14,99

40

9,25

6,48

60

1,69

20,87

15,11

45

10,00

7,00

55

1,81

22,09

15,30

50

10,00

7,00

50

1,96

23,55

15,28

55

10,00

7,00

45

2,13

25,34

15,25

60

10,00

7,00

40

2,36

27,58

15,23

65

10,00

7,00

35

2,65

30,45

15,21

70

10,00

7,00

30

3,03

34,28

15,19

75

10,00

7,00

25

3,57

39,65

15,16

80

10,00

7,00

20

4,37

47,70

15,14

85

10,00

7,00

15

5,71

61,12

15,12

90

10,00

7,00

10

8,40

87,95

15,10

Minimum

OPT. CS

Tax rate
BU
RF
M. premium
OPT

14,92

Optimal capital structure is 25% debt and 75% equity

0,30
1,15
4,00
10,00

Solution
15,60
15,50
15,40

WACC,%

15,30
15,20
15,10
15,00
14,90
14,80
14,70
14,60
0

10 15 20 25 30 35 40 45 50 55 60 65 70 75 80 85 90
% Debt

Capital Budgeting
Company has an opportunity to purchase plant
for $ 100. All necessary data are given in the
table on the next slide. Calculate NPV, PI, IRR
and MIRR of the project.

Capital Budgeting
Project Life
Plant useful life
Cost of plant
Plant value at the end of seventh year
Depreciation method
Revenues in year 1
Revenue growth rate
Extra revenues

7
10
$100M
$35M
Straight-Line
$20M
8%
$10M in year 5

Annual expenses (excl. depreciation)

$3M

Expenses growth rate

10%

Extra expenses

$4M in year 7

Combined tax rate

30%

% Debt

25%

Cost of debt (before tax)

12%

Beta unlevered
RF

0,98

RM

15%

2%

Solution
1

20,00

21,60

23,33

25,19

27,21

29,39

31,74 Cash inflow (revenues)

10,00

Cash inflow (extra revenues in year 5)

35,00 Cash inflow (plant value at the end of year 7)

20,00

21,60

23,33

25,19

37,21

29,39

3,00

3,30

3,63

3,99

4,39

4,83

66,74 Total cash inflows

5,31 Cash outflow (expenses)
4,00 Cash outflow (extra expenses in year 7)

17,00

18,30

19,70

21,20

32,82

24,56

57,42 EBIT

5,10

5,49

5,91

6,36

9,85

7,37

17,23 Taxes

11,90

12,81

13,79

14,84

22,97

17,19

40,20 Cash inflows after taxes

10,00

10,00

10,00

10,00

10,00

10,00

10,00 Depreciation (cost of plant/plant useful life)

3,00

3,00

3,00

3,00

3,00

3,00

14,90

15,81

16,79

17,84

25,97

20,19

3,00 Depreciation*Tax rate

43,20 Adjustment of depreciation*tax rate effect
30,00 Plant book value at the end of year 7 (100 - 7X10 = 30)
5,00 Capital gain in year 7 by reselling plant
1,50 Tax on capital gain

14,90

15,81

16,79

BL = 0.98X(1+(1-0.30)X(25/75))= 1,21
RE=2+1.21X13 =
17,73 %
WACC=0.25X12X0.70+0.75X17.73 =

17,84

25,97

15,40

20,19

41,70 Final cash inflows after all adjustments

Solution
NPV = - 100+14.90/(1+0.154)+15.81/(1+0.154)2+
16.79/(1+0.154)3+17.84/(1+0.154)4+25.97/(1+0.1
54)5+20.19/(1+0.154)6+41.70/(1+0.154)7 = -17.69

PI=(100-17.69)/100=0.82
r = 10%, NPV = 0.33
r = 11%, NPV = -3.42 => 10%<IRR<11%

Solution
Calculate project's MIRR at 5 % discount rate
6
5
4
3
2
14,90
15,81
16,79
17,84
25,97

1
20,19

0
41,70
172.74/100 = 1.7274
41,70
21,20
28,63
20,65
20,41
20,18
19,97
172,74

9%<MIRR<10%