CaseStudyAssignment

BUS302:FinancialManagement

Abstract

This case study aims to acquaint students with the application of cost of capital and capital budgetingtechniques to choose among alternative financial proposals. This case is based on the Bangladeshicontextandintroducesthe conceptofclimatefinance.

Introduction

YourclassmateSafwanaAhmedjuststartedworkingforABCGroup,awell-establishedbusinessconglomerate, as an Assistant Manager reporting to the company's Finance Manager. She recently got anassignmentfromherbossto conducta feasibilitystudytoopenanewline ofbusinessinthe transportationindustry of Bangladesh. During BBA, Safwana majored in Marketing. She almost forgot about the financetopics. She is seeking your help to conduct the project analysis. You agreed to help your friend to suggestthebesttransportation service.

Background

ABCisexploringinvestmentopportunitiesintheroadtransportservicesector.TheinitialplanistoconnectDhaka and Khulna, expecting an increased inflow of tourists to visit Sundarban. But, they need to learnabout the road transportation sector. They are considering two alternatives: fuel based buses (requiringinitialinvestmentof10crore)and electricbuses(requiringinitial investmentof 18 crore).

Despite contributing only 0.4 percent to global greenhouse gas (GHG) emissions, Bangladesh is highlyvulnerable to climate change in terms of rising temperature, loss in agriculture, and frequent naturaldisasters, among others. The country has committed to reducing GHG footprint by 21.8 percent by 2030.Inlinewiththecountry'scommitment,ABCGroupisaligningitsgoaltobeanenvironmentallyandsociallyresponsible company and focusing on green investment. Hence, they are actively considering financiallyviablegreen investment opportunities.

TheProjectOptions

Thefollowingtablesummarizes theafter-tax cash flowsassociatedwith twoinvestmentalternatives.

	Year1	Year2	Year3	Year4	Year5
Net Cash Flow(FuelBasedBuses)	5 crore +1011201	5 crore +1011065	4 crore +3011024	3 crore +3011040	3 crore +1011149
Net Cash Flow(ElectricBuses)	5 crore +1011149	5 crore +3011040	5 crore +3011024	5 crore +1011065	5 crore +1011201

The firm needs to decide now which project it should invest and thus, it needs to apply different capitalbudgetingtools.

FinancialData

Several capital budgeting tools need a discount rate. The company's financial manager identified that thefirm's WACC is the appropriate discount rate for evaluating the projects by applying capital budgetingtools.But, its WACCisnotyet calculated.

So, now the firm is interested in measuring its overall cost of capital. The firm is in the 25% tax bracket.The firm follows a 40% debt ratio and wants to maintain it for the new venture. For the equity portion, thefirmplanstoissuepreferredstocksto raisehalfoftheequitycapitalandissuenew commonstockstoraisetheremaininghalf.Thecurrentinvestigation hasgatheredthefollowingdata:

Debt:The firm can collect the required loan from XYZ Bank at 10% interest rate. However, the interestratewould be 6% if thefirmchoosestogo forgreen financing.

Preferred stock:The firm can sell 10% (annual dividend) preferred stock at BDT 100 per share. The costof issuing and selling the preferred stock is expected to be BDT 2.5 per share. An unlimited amount ofpreferredstockcan besold undertheseterms.

Common stock (New issue):The firm's common stock sells for BDT 80 per share. The firm expects topaycashdividendsofBDT6persharenextyear.Thefirm'sdividendshavebeengrowingatanannualrateof6%, whichis expectedtocontinue. Floatation costsareexpected toamount to BDT3 per share.

Requirements:

1. CalculateWACC andnetpresentvalue foreachalternative.
2. Whichalternativeshouldbechosenconsideringfinancialviabilityandwhy?(Assumethatthealternativesaremutuallyexclusive).
3. Wouldyouranswerin2changeconsideringenvironmentalsustainability. Support youranswer.

Report:

• Showthe details of thecomputations.

Answer rating: 100% (QA)

Solution WACC Calculation The Weighted Average Cost of Capital WACC is the appropriate discount rate for evaluating the projects by applying capital budgeting tools The WACC is calculated as follows W... View the full answer