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School of Economics, Finance and Marketing
Master of Finance
BAFI 1059 – Corporate Finance
Semester 1 – 2020
• This assignment is marked out of 100 and contributes 40% to the overall assessments.
Due Date
• Your report must be submitted via Turnitin/Canvas by 11:00 PM (Melbourne time) on the due date Sunday 31st May 2020.
• Late submissions where special consideration has not been granted will be penalised. Please go through the course guide to understand the implications.
Submission Instructions
1) Go to the following link to download RMIT’s Assignment Cover Sheet, fill in your details and attach it to the front page of your Word document.
2) Save a PDF version of your document with file name saved in the following format:
BAFI1059_Project_Group_Number.pdf (e.g., BAFI1059_Project_Group_11.pdf). Your assigned group number is listed on Canvas under the People tab.
3) Upload the PDF file to the Turnitin/Canvas submission link.
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The objective of this exercise is to enhance students’ understanding of some of the main issues in corporate finance and related business decision-making process. In this project students are required to prepare a business report based on a case study. Details about the case study and its requirements are set out below.
It is 31th December 2019.
Your team of four people form a financial analysis team at Aussie Finance Consulting (AFC), a renowned financial institution. The executive management of AFC has assigned you a task to carry out a special project for its client Yarra Digital Limited (YDL), which requires preparing a business report. This report will be presented to AFC executive management and also to the senior management of YDL.
YDL is a Victorian pay television company—operating in cable television, direct broadcast satellite television, and IPTV streaming services. It was formed in 1999 through a joint venture established between Yarra Broadcasting Corporation and Ultra Digital Network Limited, with Yarra Broadcasting Corporation being the 65% and Ultra Digital Network the 35% shareholders respectively. They provide a full range of television services to corporate and government customers including pay TV, data networks and mobility services through a range of carriers offering choice, control and cost reduction.
YDL has been in the business for 20 years now. It is well established and profitably running business thus far. YDL has recently undertaken a market study which costed them $50,000. Findings of the study indicate that it is critical for YDL to upgrade their infrastructure to meet the demand of its customers. They plan to do the upgrade systematically in stages gradually over next few years. They also need to plan their finances to fund the upgrade plan.
For the upgrade, they need some critical hardware components. The management has identified two options: (1) In-house production which requires the company to establish their own production facility; and (2) Outsourcing which implies external procurement of the necessary hardware.
After a careful analysis, the management has worked out the following details for the two options:
Option 1: In-house production
The purchase and installation of the machinery shall cost $3,500,000 and has an economic life of twelve years. The machinery is expected to depreciate to zero on a straight-line basis over its economic life. However, the company expects to keep their in-house production for only seven years. At the end of Year 7, the machinery can be sold at an estimated market value of $1,700,000. Currently YDL has a warehouse which generates a rental income of $200,000 each
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year. To save on investment costs, the management intends to convert this warehouse into a factory for manufacturing various hardware components. The conversion cost is estimated to be $140,000 and treated as a capital expense. YDL also requires training its staff on the new machinery immediately after the installation. Training fees are expected to be $10,000 and fully tax-deductable. Annual maintenance cost of the machinery is $160,000. The collective cost of the hardware components to be manufactured is estimated to be $1,800,000 in Year – 1 with an expected increase of 4% per annum in the following years. YDL also needs to invest in necessary development software and maintain the licenses. The negotiated licensing fee for the software is estimated to be $57,000 per year. Finally, the management estimates that they shall need additional net working capital of $30,000 at the beginning of the production with an expected increase of 3% per annum in the following years.
Option 2: Outsourcing
Alternatively, YDL can contract with a firm named Innovative Equipment Limited (IEL) which is specialised in manufacturing the required hardware. Based on the types and expected number of units YDL would need, IEL management has quoted a total cost of $3,100,000 in Year 1 which will continue to grow at 6% per annum to keep up with the rising cost and forecasted growth in the number of the required units. IEL, however, has offered this rate on a condition of a five-year contract. Also, IEL requires that YDL pays 50% of the expected cost for a year in advance at the beginning of that year. From the accounting perspective, equipment that are procured from IEL may be classified as cost of goods sold in the books of YDL. Hence, they will be treated as operating expense for the business. Furthermore, as in Option 1 YDL still needs the warehouse to store the hardware.
You are required to analyse the two given options and make recommendations to YDL about the option they should choose.
For the purpose of the analysis, you have already assembled the following information:
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Balance Sheet of YDL as of 31 December 2019
Cash at bank
$ 700,000
Accounts receivable
$ 550,000
$ 1,700,000
Marketable securities
$ 6,670,000
Plant, machinery and equipment
$ 150,500,000
Intangible assets
$ 40,000,000
Land and building
$ 30,000,000
$ 230,120,000
Accounts payable
$ 300,000
Bank overdraft
$ 670,000
Commercial bills (due 30th Jun 2020)
$ 3,000,000
3.75% Coupon bonds (due Dec 2029 issued @$100 each)
$ 150,000,000
Shareholders’ Fund
Common stock 33,500,000 @ $2.209 each
$ 74,000,000
Retain earnings
$ 2,150,000
Liabilities + Shareholders’ Fund
$ 230,120,000
End-of-month stock prices for the market (All Ordinaries Index) and YDL adjusted for all corporate actions such as dividends and stock splits over the previous five years are provided in the file: BAFI1059_S1_2020_Project_Data.xlsx
Additional Information:
• The applicable interest rate on bank overdraft is 5.5% per annum and has monthly compounding.
• The commercial bills are currently yielding 4.5% per annum with quarterly compounding. They will mature on 30th June 2020 however, will be replaced by newer issues on that date.
• The bonds are currently priced at $102 each and pay coupons semi-annually on 30th June, and 31st December.
• The coupon payment due to be paid on 31th December 2019 has been paid.
• The applicable company tax rate is 30% and the proportion of tax collected from the company and is claimed by shareholders is 0.50.
• The current yield on Australian Government 10-year bonds is 1.40% per annum.
• The expected market return including franking premium is 9.25% per annum.
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You are required to advise the company on the following:
a) Capital Budgeting Decision (30 marks)
(i) Which of the two options should YDL pursue?
Steps in part (a):
The first part of the analysis requires you to work out the Weighted Average Cost of Capital (WACC) for YDL with the help of the given information and given data.
(15 marks)
Secondly, evaluate the two options using NPV analysis and clearly identify which of the two alternatives is better for YDL.
(15 marks)
b) Capital Structuring Decision (15 marks)
In the next phase, YDL aims at expanding business beyond Victoria and cover all the major cities in Australia. YDL needs to raise more capital for the purpose. However, the executives worry about the high level of debt in the current capital structure and are debating if they should raise sufficient money through common stock only. They intend to use new capital for both (a) further expansion and (b) repaying debt. Doing so will eventually convert the company into an all-equity company.
(i) Calculate the required rate of return on capital if YDL were to become an all-equity firm.
(7.5 marks)
(ii) In the light of Modigliani & Miller propositions in the perfect world but with corporate taxes, discuss your findings in both the possible scenarios about:
– WACC / Cost of capital, and
– Cost of equity.
Essentially you need to report (no more than 250 words) if your workings validate the arguments forwarded in the Modigliani & Miller theory.
(5 marks)
(iii) Give your opinion if YDL should convert into an all-equity firm and explain why? (no more than 250 words)
(5 marks)
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c) Dividend Policy Decision (15 marks)
Another aspect that YDL executives are perplexed about is the dividend policy they should adopt.
(i) Give your advice with reasoning to the YDL executives if they should pursue dividend distribution or retention as their dividend policy. (no more than 250 words)
(15 marks)
d) Evaluating Leasing Possibility (15 marks)
Instead of purchasing the machinery, your team, being experienced consultants, wishes to propose to YDL that they have another option which is leasing it. Coincidently, your other client, New Leasing Limited (NLL), may be a suitable lessor. On discussions, the executives at NLL have asked you to prepare a lease quotation that could be forwarded to YDL for consideration. For the purpose, NLL has provided the following information:
• NLL can get a 5% discount on the purchase and installation price of the machinery.
• They expect the life of the machinery to be twelve years with no salvage value after that. YDL may use this machinery for seven years, and NLL is confident that it can be leased to others after that.
• NLL uses the straight-line method for calculating depreciation.
• As the owner of the machinery, NLL is responsible for its annual maintenance cost.
• NLL’s applicable tax rate is 30%.
(i) If the NLL’s after-tax required rate of return is 12% per annum, what will be the minimum annual lease payment that NLL would charge? Consider that NLL requires lease payments to be made annually in advance.
(8 marks)
(ii) Calculate the maximum annual lease payment that would make leasing a viable option for YDL?
(7 marks)
e) Business Report Overall Quality (10 marks)
The assignment is to be presented as a business report to both AFC and YDL executive management. This report needs:
• Page numbering
• Informative heading and sub-headings
• Numbered sections
• Executive summary
• Table of contents
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• Reference list
Your report is to be submitted as a PDF version of your work.
The report must use a font/fonts suitable for business communication.
The reference style to be used is Harvard style referencing (author-date).
Your main report will have word limit of 3,000 words approximately excluding appendix and will be professionally presented. A concise, relevant and visually appealing paper is essential for business communication.
f) Micro-credential: (12.5 marks)
Complete the Promoting U micro-credential. You may access this through this Canvas site by clicking ‘Modules’ on the left-hand sidebar and navigating to the Creds module.
The unique URL is required for submission in this assignment. Please include the link in the last section of the assessment along with the student’s detail. Your teacher will use this link to verify you have completed the assessment. Use the instructions linked on the credential launch page in Canvas to claim your badge and to get your unique URL.
In order to qualify for a badge you will need to achieve the stated requirements for the credential. Please refer to the credential launch page for more details including marking turnaround times on submission-type assessments. Badges may take up to 24 hours to be issued.
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General Instructions
Essential Contents:
Your report needs to set out the following at it least:
• An executive summary
• A table showing the calculation of YDL’s WACC using market data / CAPM
• A selection of NPV spreadsheets used in the NPV analysis of both the Options: 1 & 2
• A recommendation to YDL’s management as to which option it should adopt
• Calculation of YDL’s WACC when financing is all-equity
• Calculation of NLL’s lease quotation for YDL
• Discussion about Modigliani & Miller propositions, and your opinion about capital structure and dividend policy
• A list of references
• Appropriate appendices.
Regarding the WACC calculations, whilst you need to present your final work in a table in the main body of your report, all subsidiary calculations need to be provided in an appendix. You need to provide detailed steps (e.g. formulae) that lead to the final answers. Correct final answers alone will not earn full marks. Also, annotate your appendix so that the examiners can understand your work.
Refer to the tutorial/additional questions for the topics – Capital Budgeting, Cost of Capital and Leasing to present your calculations.
Please round off your values to 4 decimal places for interest rates and two decimal places for amounts, e.g. 0.0659 or 6.59%, and $10,369.78
All assessment of numerical work is marked consequentially. So, you will be awarded marks for all correct calculations and procedures.
Marking Rubric
Marking rubrics are provided on the next pages.
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High Distinction
Capital Budgeting Decision
WACC and NPV calculations are mostly accurate. All workings are shown.
Presented in an easy to follow layout.
Recommendation for the option is consistent with the findings.
WACC and NPV calculations have minor inaccuracies. All workings are shown.
Presented in an easy to follow layout.
Recommendation for the option is consistent with the findings.
WACC and NPV calculations have some errors. All workings are shown.
Difficult to follow the calculations.
Recommendation is not clear or not consistent with the findings.
WACC and NPV calculations are mostly inaccurate. All workings are shown.
Difficult to follow the calculations or presentation or flow of information.
Recommendation not provided or not consistent with the findings.
WACC and NPV calculations are mostly inaccurate or incomplete. Workings are not shown.
Difficult to follow the calculations or presentation or flow of information.
Recommendation not provided.
30.0 pts
Capital Structuring Decision
Calculations on unlevered cost of capital are mostly accurate.
Discussion is provided and demonstrate a mastery of the relevant theory.
Capital structure recommendation is consistent with the findings.
Calculations on unlevered cost of capital have minor inaccuracies.
Discussion is provided and demonstrate a good understanding of the relevant theory.
Capital structure recommendation is consistent with the findings.
Calculations on unlevered cost of capital have some errors.
Discussion is provided, and a reasonable understanding of the relevant theory is shown.
Capital structure recommendation is not clear or not consistent with the findings.
Calculations on unlevered cost of capital are mostly inaccurate.
Discussion is provided but show poor understanding of the relevant theory.
Recommendation is not provided or not consistent with the findings.
Calculations on unlevered cost of capital are mostly accurate or incomplete.
No discussion is provided.
Recommendation not provided.
17.5 pts
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Dividend Policy Decision
Correctly commenting on the current situation. Advise the policy consistent with the reasonings.
Commenting on the current situation. Advise the policy consistent with the reasonings.
Advise the policy consistent with the reasonings.
Advise but no reasoning or inconsistent reasoning.
No advice or reasoning provided.
15.0 pts
Leasing calculations are mostly accurate.
Correctly mention the viability conditions for leasing options.
Leasing calculations have minor inaccuracies.
Correctly mention the viability conditions for leasing options.
Leasing calculations have some errors.
Correctly mention the viability conditions for leasing options.
Leasing quotation calculations is mostly inaccurate.
Failed to mention the viability conditions for leasing option.
Leasing calculations mostly inaccurate or incomplete.
Failed to mention the viability conditions for leasing options.
15.0 pts
Report Writing Quality
Writing and presentation is business like, precise and elegant. Consistently use correct grammar with rare spelling errors.
Writing and presentation is business like and precise. Few grammatical or spelling errors.
Writing and presentation is precise and business like. Some grammatical or spelling errors.
Writing and presentation lacks professionalism or does not use an appropriate business style. Many errors in spelling and grammar.
Poor communication, spelling and grammar characterise the work.
10.0 pts
Micro-credential completion
Evidence of badge presented in assessment
No evidence of badge presented in assessment.
12.5 pts
Total points

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