Module 4 – Case
Capital Budgeting and Capital Structure

Assignment Overview

Questions 1 and 2 for this assignment are computational in nature and  require the use of Microsoft Excel. Questions 3 and 4 are conceptual in  nature and do not require computations. Make sure to thoroughly review  the required background readings and work through both the concepts and  the computational examples. The videos on computing NPV and IRR using  Excel along with the sample spreadsheet should also help. If you are  unable to figure out how to make the computations in Excel, then you can  get partial credit by computing the answers using a calculator and  thoroughly explaining your steps. For conceptual questions, make sure to  thoroughly explain the reasoning for your answers and to use references  from the required background readings.

Case Assignment
Submit your answers to the following questions in a Word document,  and also submit an Excel file with your computations for Questions 1 and  2:

The table below gives the initial investment (the negative numbers  at “Year 0”) for two projects. Compute the payback period, the NPV, and  the IRR using Excel. Then rank the two projects based on each of these  three criteria, and discuss which projects should be funded based on  your computations.


The ACME Umbrella Company is deciding between two different umbrella  factories. Both factories will cost $500,000 to get started. However,  the cash flows for each factory will depend on whether the next five  years are rainier than average or sunnier than average. Factory A will  have cash flows of $130,000 per year for the next five years if the  weather is sunnier than average. But if it is rainier than average the  cash flows will be $150,000 per year for the next five years. Factory B  will have cash flows of $100,000 per year for the next five years if it  is sunnier than average, but if it is rainier than average it will have  cash flows of $200,000 per year. ACME has a cost of capital of 9%. Based  on this information, calculate the following:

Firm Cost of Capital:
11%YearProject AProject B0-100,000-150,000125,00030,000225,00030,000325,00090,000425,00020,000525,00020,000625,00020,000

Calculate the NPV for both factories and for both scenarios (rainy  versus sunny). What is the range of NPV for each factory based on your  scenario analysis?
Based on your answer to a) above, do you think ACME should use the  same discount rate of 9% for each factory? Or should they use a  risk-adjusted discount rate (RADR)? If so, which factory should have a  higher RADR? Explain your answer with references to the background  readings.
Your neighbor Freewheeling Franklin has a very successful new  internet-based technology company. While his company has great cash  flow, you see Mr. Franklin has a collection of five expensive sports  cars in his newly built garage. You also see him throwing some  extravagant parties every weekend where he serves expensive champagne.  Based on the required background readings such as Ross, et al. (2013).,  explain how you would handle the following situations:

Mr. Franklin asks you for a loan to help expand his business and  offers you an interest rate considerably higher than you would get from  leaving your money in the bank. As a lender, what measures might you  take to make sure you get your money back and Mr. Franklin won’t waste  the money?
Mr. Franklin asks you to buy one-third of his company, and wants to  use the money from selling this portion of the company to expand his  business. As a shareholder, what steps might you take to make sure he  spends his profits and the investment money you gave him wisely?
Suppose you own a new business and after a few rough years you now  are making a solid profit of $150,000 per year and have built up some  savings as well. While your business is successful, you realize that in  order to expand and remain competitive you are going to have to raise a  lot of money to invest in some new machinery and new stores. You have to  decide between using your savings to finance your expansions and  machinery upgrades, taking out a bank loan, or selling a portion of your  equity to new investors. Explain the pros and cons of each of these  three options in this situation, and make references to the required  background readings such as Ross, et al. (2013).


Module 3 – SLP
Risk, Return, and Stock Valuation
For your Module 3 SLP, we will go back to looking at information about the stock price and stock returns of your four companies. Look up the following information about your four companies on Yahoo Finance,, Morningstar, or a similar page:

The current stock prices
The stock prices five years ago
The dividend yield for each stock
The beta for each stock
Look up the current three-month treasury bill rate on Fidelity’s Fixed Income page

Now do the following calculations with this information:

Calculate the average annual capital gain or loss (stock price change) over the last five years. Calculate the percentage change from five years ago, and divide by five. For example, if the stock price increased from 50 to 100 in five years, the percentage increase would be 100% and the average annual gain would be 20% (100 divided by 5). Which of these companies has the highest or lowest capital gain?
Now estimate the average total return, which is the capital gain plus dividends. If the dividend yield is 2%, then the average total return would be 22% in the example above. Which of these four companies has the highest or lowest total return? Does the order change?
Finally, calculate the Treynor Ratio. First, take the total return for each of your four companies and subtract the three-month treasury bill rate (the “risk-free rate”). Then divide this by the beta of each company. This ratio is a measure of the risk-adjusted return of each stock. The higher the return, the higher the Treynor Ratio. But the higher the beta (which is a measure of risk), the lower the Treynor Ratio. Which of your companies has the highest or lowest risk-adjusted return? Does the order change from what you found in 1) and 2) above?

Submit a one-page memo in Word summarizing your findings, and include an Excel file with your data and calculations. 

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