Cost of capital weighted avareage cost cash flow marginal cost

Cost of capital Cost of capital The relationship between risk and return to investors determines when and where to invest. To the risk averse investors, they prefer low returns with lower risks while the risk takers would invest in high-risk securities with high returns (Chandra, 2008). In most cases, probability of getting high returns is associated with high risks. This relationship also makes the investor be aware of their risk tolerance which improves on the investment approach. The relationship further explains that the risk takers will always ignore the risk involved and concentrate on returns on the investment.
Annual Discount Rate
13%
Initial investment
-20000
-20000
1st year Return
10000
0.885
8850
2nd year Return
8000
0.783
6264
3rd year Return
9000
0.693
6237
4th year
8600
0.613
5271.8
Net Present Value(NPV)
6662.8
Calculation of IRR
Cash inflows
10000
8000
9000
8600
total=35600
35600/4=8900
20000/8900=2.2472
Year
cash flow
22% PVIF
Present value
1
10000
1.22
12200
2
8000
1.488
11904
3
9000
1.816
16344
4
8600
2.215
19049
Present value of inflows
59497
PVIF 12%
1
10000
1.12
11200
2
8000
1.254
10032
3
9000
1.405
12645
4
8600
1.574
13536.4
Present value of inflows
47413.4
59497
22%
59497
22%
47413.4
12%
40000
Cost
12083.6
19497
22%+19497/12083.6(10%)=22%+1.61351(10%)=22%+16.13%=38.13%
3).Weighted average cost of capital refers to the average rate return a firm expects to reward its investors through bonds or equity. The weighted average cost of capital entails the entire rate of return that is utilized by the firm to determine viability of a company. The weights of both equity and debt financing are combined to determine weighted average cost of capital.
Weighted average cost of capital= (weight of equity *cost of equity) + (weight of debt * cost of debt)
Weighted average cost of equity= (0.45*0.6) + (0.2*1.06) = 0.482 =48.2%
Weighted average cost of debt = (0.35*0.09) = 0.0315 =3.15%
Weighted average cost of capital = 48.2 + 3.15 = 51.35
=51.35%
4).
5).Project X
Initial investment -20000
Year Cash flow PVIF at discount rate 14%
1 10000 0.877 8770
2 8000 0.769 6152
3 9000 0.675 6075
4 8600 0.592 5091.2 +
NPV 6088.2
Project Y
Initial investment -40000
Year cash flow PVIF at discount rate of 14%
1 20000 0.877 17540
2 13000 0.769 9997
3 14000 0.675 9450
4 16000 0.592 9472 +
NPV 6459
Profitability index=PV of future cash flows
Initial investment
Project X=26088.2 Project Y=46459
20000 40000
=1.30441 =1.16148
Using the net present value, project y is more viable than x since it yields higher returns. This is contrary to profitability index approach which indicates that project x is more viable than y with a higher ratio of 1.3044.
6).
a). E(X) = x1p1 + x2p2 + x3p3 + . . . + xnpn.
= (30*0.10) + (50*0.20) + (75*0.40) + (90*0.30)
=70
b). Standard deviation is a measure of the amount of variation of values from the average.
Standard deviation =Square root of the expected value
Therefore square root of 70
=8.3666
This value is high which indicates that the data points are spread out over a large range.
References
Chandra, P. (2008). Financial management: Theory and practice. New Delhi: Tata McGraw-Hill Pub.