FIN80005 Corporate Financial Management – Individual
Assignment
Semester 1, 2018
The objective of this assignment is to encourage students to use Excel spread sheets to aid in
solving a capital budgeting problem. Topics 4 – 8 are particularly relevant for this assignment.
Weight: 20% of total assessment
Due dates: Due in the corresponding classes in the week beginning May 14. You must contact
your lecturer directly and make alternative arrangements should you not be able to submit
your assignment in class. In addition, the electronic version must be submitted via Turnitin on
Blackboard prior to your class in the week beginning May 14.
Late submissions: Late assignments cannot be accepted unless a time extension has been requested
from, and approved by, the Unit Convenor. Such requests must be made in writing via
email.
Format: This assignment is a problem solving exercise, using Excel spreadsheets, with discussion
of findings. It should be written in a report format. The length of the report is 1000 – 1,500
words. Report writing resources are provided under Assessments on Blackboard.
1
Company background
Branson ltd is a public listed tour company that is based in Melbourne. One of its main
operating businesses is to provide tourists with hot-air balloon flights over the city. As their
current balloons are due to be retired, they must decide whether to replace them with a large or
small model. New balloons have an expected life of 8 years, after which salvage values are $50,000
for the large balloons and $30,000 for the small balloons. Market research has estimated that
there is a 50% probability that demand will be high throughout the useful life of the balloons, a
25% probability that demand will be high in the first four years and low in the final four years,
and a 25% probability that demand will be low throughout the useful life of the balloons.
The large model is expected to cost $800,000, with an extra installation and shipping costs
of $50,000. The small model is expected to cost $500,000, with an additional installation and
shipping costs of $30,000. The company accounting’s policy is to depreciate using the reducing
balance approach of 20% per annum.1 There is also an initial increase in net working capital
of $50,000 for the large model, and $30,000 for the small model. The net working capital is
recoverable at the end of their useful life.
In the event of high demand, the company expects a yearly operating revenue of $650,000 for
the large model, and a yearly operating revenue of $300,000 for the small model. If the demand
is low, yearly operating revenue is forecasted to be $300,000 for the large model and $150,000
for the small model. Annual variable and fixed costs associated with operating these balloons
are expected to be $300,000 for the large model and $120,000 for the small model. In addition,
if the large model is preferred over the small model, the company needs to rent an additional
warehouse to store the large balloons. A new warehouse’s rental cost is expected to be $50,000
per year. At any given time in the first four years, there is also an option to cease operation and
thus selling the large balloons for $400,000 and the small balloons for $80,000 if the business is
not profitable.
The company requires you to calculate an appropriate discount rate using the company’s
weighted average cost of capital. The company’s capital structure has remained fairly stable,
with a debt-to-equity ratio of 1.5. The company has no plan to adjust its capital structure in
1 As discussed in Topic 5, ignore residual value in the calculation of yearly depreciation.
2
the future. Given that the company is listed on the stock exchange, you are able to obtain the
historical returns over the last 20 years for the company, the market portfolio and the risk-free
rate as tabulated in Table 1. The company debentures have a face value of $1000 and a coupon
rate of 10%. They mature in 5 years time. Similar debentures are currently yielding 12%. The
company tax rate is 30%.
Table 1 Historical yearly returns for Branson ltd, market and risk-free bond
Year Branson Market Risk-free
1998 5.64% 10.43% 5.49%
1999 23.13% 13.81% 6.01%
2000 19.55% 12.77% 6.31%
2001 10.08% 7.65% 5.62%
2002 -19.35% -10.64% 5.84%
2003 25.01% 14.61% 5.37%
2004 29.21% 29.48% 5.59%
2005 28.41% 23.83% 5.34%
2006 22.29% 20.93% 5.59%
2007 -5.68% 1.73% 5.99%
2008 -68.09% -33.58% 5.82%
2009 48.21% 33.84% 5.04%
2010 12.39% 8.03% 5.37%
2011 -6.54% -6.43% 4.88%
2012 15.28% 18.56% 3.38%
2013 -1.12% 10.38% 3.70%
2014 17.98% 11.67% 3.66%
2015 -15.44% -6.43% 2.71%
2016 26.23% 16.29% 2.34%
2017 0.20% 5.70% 2.72%
Required
You are to prepare spreadsheets, to present to the CEO, showing the various cash flows based
on the different scenarios. Use Excel to prepare a full analysis, evaluating whether or not the
company should proceed with the purchase of large or small balloons, taking into consideration
of the various scenarios. Show all formulae, adjacent to the corresponding calculated amounts in
the spread sheet. You should also clearly state any assumptions (if any) made in your analysis.
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