Q1. A mid-sized manufacturing company is considering two major investment projects to expand its operations. Project A requires a higher proportion of debt financing, while Project B relies more on equity and preference shares. The finance manager is aware that each source of funds has a different cost and risk profile. The company’s board expects a thorough evaluation of both projects, taking into account the impact of the financing mix on the overall cost of capital and the firm’s value. The manager must recommend which project to pursue, ensuring the decision aligns with the company’s wealth maximization objective. Based on the scenario, how should the finance manager of a mid-sized manufacturing firm apply the concept of weighted average cost of capital (WACC) to evaluate two competing investment projects, given that each project requires a different mix of debt, equity, and preference shares? What steps should be taken to ensure the most cost-effective financing decision is made? (10 Marks)

Q2.

A firm is considering restructuring its capital structure to minimize its Weighted Average Cost of Capital (WACC). The current structure is as follows:

The firm is considering increasing its debt to 400 lakhs by redeeming preference shares and using the proceeds plus an additional Rs.200 lakhs to issue new debt at a post-tax cost of 8%. However, the increased leverage will raise the cost of equity to

 17%. The cost of preference shares is eliminated. Calculate:

 1. The current WACC.

 2. The new WACC after restructuring.

 3. Should the firm proceed with the restructuring? Justify your answer with calculations and a discussion of the trade-offs involved. (10 Marks)

Q3 (A)

A firm is considering two mutually exclusive projects, each with a 3-year life. Project X requires an initial investment of Rs.50,00,000 and generates cash flows of Rs.25,00,000, Rs.20,00,000, and Rs.15,00,000. Project Y requires Rs.50,00,000 and generates Rs.10,00,000, Rs.20,00,000, and Rs.40,00,000. The cost of capital is 10%. If the firm faces capital rationing and can only invest in one project, but also has the option to delay either project by one year (with no change in cash flows), which project should it select and when? Show all calculations using NPV and justify your answer. (5 Marks)

Q3 (B)

A company is considering two financing plans for a new project requiring Rs.5,00,00,000. Plan X: 100% equity; Plan Y: 60% equity and 40% 10-year debt at 9% interest. The project is expected to generate an EBIT of Rs.1,20,00,000 per year. The corporate tax rate is 25%. The cost of equity is 14% for Plan X and 16% for Plan Y (due to increased financial risk). Calculate the expected Earnings Per Share (EPS) under both plans, assuming shares are issued at Rs.100 each. Which plan offers higher EPS, and what does this imply about the effect of leverage? Show all calculations. (5 Marks)