BBA Limited is a levered firm having a debt-equity ratio of 1:3. It has financed its capital via debt of ₹25,00,000 and 50,000 shares outstanding. The interest rate on debt is 8%, whereas shareholders require a return of 10%. The firm wants to make an investment decision. It wants to choose between two projects - Project X and Project Y. Both Projects will last 5 years but will provide different cashflows. Year Year (t)= 0 Year (t)= 1 Year (t)= 2 Year (t)= 3 Year (t)= 4 Year (t)= 5 Cashflows CF0 CF1 CF2 CF3 CF4 CF5 Project X -1,00,000 50,000 60,000 50,000 40,000 50,000 Project Y -1,50,000 30,000 50,000 60,000 70,000
BBA Limited is a levered firm having a debt-equity ratio of 1:3. It has financed its capital via debt of ₹25,00,000 and 50,000 shares outstanding. The interest rate on debt is 8%, whereas shareholders require a return of 10%. The firm wants to make an investment decision. It wants to choose between two projects - Project X and Project Y. Both Projects will last 5 years but will provide different cashflows. Year Year (t)= 0 Year (t)= 1 Year (t)= 2 Year (t)= 3 Year (t)= 4 Year (t)= 5 Cashflows CF0 CF1 CF2 CF3 CF4 CF5 Project X -1,00,000 50,000 60,000 50,000 40,000 50,000 Project Y -1,50,000 30,000 50,000 60,000 70,000
Chapter11: Capital Budgeting Decisions
Section: Chapter Questions
Problem 8TP: Fenton, Inc., has established a new strategic plan that calls for new capital investment. The...
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BBA Limited is a levered firm having a debt-equity ratio of 1:3. It has financed its capital via debt of ₹25,00,000 and 50,000 shares outstanding. The interest rate on debt is 8%, whereas shareholders require a return of 10%. The firm wants to make an investment decision. It wants to choose between two projects - Project X and Project Y. Both Projects will last 5 years but will provide different cashflows.
Year Year (t)= 0 Year (t)= 1 Year (t)= 2 Year (t)= 3 Year (t)= 4 Year (t)= 5
Cashflows CF0 CF1 CF2 CF3 CF4 CF5
Project X -1,00,000 50,000 60,000 50,000 40,000 50,000
Project Y -1,50,000 30,000 50,000 60,000 70,000 80,000
The CFO had to decide which Project would need to be approved. He discussed the different approaches with the CEO and they agreed that the decision should be based on the Net Present Value approach. They also agreed that the Project will be funded in the same debt-equity ratio of 1:3. The bank has confirmed that it will charge the same interest rate as the existing debt on new debt issuance.
1. What is BBA Limited’s weighted average cost of capital before it executes the project?
2. Which project should the CFO choose?
3. What is the total market value of the firm after completing the project?
4. What is the number of shares to be issued to raise new equity?
5. What will be the share price after taking up the project?
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