Question

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Answer 1

Part (a) and (b)

Please see the table below. Please be guided by the second column titled “Linkage” to understand the mathematics. The last two rows highlighted in yellow contain your answer. All financials are in $.

Parameter	Linkage	Option A	Option B
Cost	A	178,000	187,000
Equity funded proportion	B	40%	40%
Equity required	C = A x B	71,200	74,800
Net income	D	3,500,000	3,500,000
Part (a): Residual dividend	E = D - C	3,322,000	3,313,000
Part (b): Dividend payout ratio	F = E / D	94.91%	94.66%

For part (c), (d) and (e), i am first providing the answers. Details workings along with the snapshot is available towards the end of the solution.

Part (c)

Based on payback period, the company should choose option B (shown as option 2) in the table below, as it has payback period of 3.31 years less than the cutoff value of 3.5 years.

Part (d)

Based on NPV, the company should choose option B (shown as option 2) in the table below, as it has higher NPV than option A.

Part (e)

Considering both the methods, the company should choose option B. This has higher NPV and meets the payback criterion of the firm as well.

Please see the table below. The rows highlighted in yellow is your answer. Figures in parenthesis, if any, mean negative values. All financials are in $. Adjacent cells in blue contain the formula in excel I have used to get the final output.

dd

AQ AS AR AT AU AV AW 186 Year 187 Option 1 188 Cash flows 189 Cumulative cash flows 1 3 2 4 40,000 (138,000) 52,000 (86,000) (178,000) (178,000) 55,000 57,000 43,500 69,500 (31,000) 26,000 190 Payback period =AU186-AU189/AV188 3.54 191 Discount rate 192 NPV 193 194 Option 2 195 Cash flows 196 Cumulative cash flows 197 Payback period 198 Discount rate 199 NPV 8% =NPV(AR191,AS188:AW188)+AR188 18,781.50 (187,000) (187,000) 47,000 64,000 59,000 54,000 34,000 (76,000) (17,000) (140,000) =AU186-AU196/AV195 37,000 71,000 3.31 8% 21,055.75 =NPV(AR198,AS195:AW195)+AR195