How Individuals, Institutions, Governments and Business Acquire Financial Resources

Organizations or intermediaries that help the financial system operates efficiently and transfer funds from savers and investors to individuals, business and government that seek to spend or invest the funds.

It is basically the difference between the present value of cash inflows and the present value of cash outflows. NPV is used in capital budgeting to analyze the profitability of an investment or project. If the NPV of the project is positive, then the project should be accepted. However, if NPV of that project is negative, the project should probably be rejected because cash flows of that project will also be negative.

Calculations for Alice and Wonderland Limited:

The market weighted gearing of Alice Ltd £1 ordinary shares amounts 500 million GBP = owns 500 million shares. Market value of shares = 500-4 = £2000 million Market value of bonds = 5.7-93 = £530.1 million Market value of debt = £530.1 million Total value = 2700+530.1 = £3230.1 million Fraction debt = 530.1/3230.1 = 16.4% Fraction equity = 2700/3230.1 = 83.6%

It is a model which describes the relationship between risk and expected return and that is used in the pricing of risky securities. This model says that the expected return of a portfolio or of a security equals the rate on a risk-free security plus a risk premium. If this expected return does not match or beat the required return, then the investment should not be undertaken. The security market line plots the results of the CAPM for all different risks (betas)

Corporate assets are financed by two ways either by debt or by equity. WACC is the average of the costs of these sources of financing, each of which is calculated by its respective use in the given situation. By taking a calculated average, we can see how much interest the corporate has to pay for every penny a corporate finances in the project or in its business. WACC can be calculated as follow:

Revenues at year 0 = £183.6 million Revenue at year 1 = 183.6-1.05 = £192.78 million Revenue at year 2 = 192.78-1.05 = £202.4 million Revenue at year 3 = 202.4-1.05 = £ 212.52 million Revenue at year 4 = 212.52-1.05 = £223.146 million Revenue at year 5 = 223.146-1.05 = £234.3033 million Wonderland can secure a loan of £400 million at 8% fixed rate. Thus the company will pay an interest on the loan which is tax-free. Hence this must be excluded from the taxable income similar to capital allowance. Hence the company will pay £32 million as interest every year. The after tax realizable value of the non-current assets after five years of the project is given to be between £100 million and £200 million. This is assumed to be £150 million.

 

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