2.1. HBHEnterprises is a large publicly listed company, specialised in manufacturing washing machines. The company is looking to set up a manufacturing plant to produce a new line of washing machines. This project will be a six-year project. The company bought a piece of land four years ago for $ 10 million in anticipation of using it for its proposed manufacturing plant. If the company sold the land today, it would receive $ 11.5 million after taxes. In six years, the land can be sold for $8 million after taxes and reclamation costs. HBH Enterprises wants to build a new manufacturing plant on this land. The plant will cost $350 million to build. The following market data on HBH's securities are current:

Debt

$250,000,000, 6.75% coupon bonds outstanding with 20 years to maturity redeemable at par, selling for 92 percent of par; the bonds have a $1000 par value each and make semi-annual coupon payments.

Equity

40,000,000ordinary shares, selling for $42.50 per share

Non-redeemable Preference shares

15,000,000 shares (par value $ 12 per share) with 5.5% dividends (after taxes), selling for $24 per share

The following information is relevant:

HBH Enterprises' tax rate is 28%

1. The company had been paying dividends on its ordinary shares consistently. Dividends paid during the past five years is as follows

Year (-4) ($) 2.25

Year (-3) ($) 2.35

Year (-2) ($) 2.81

Year (-1) ($) 2.95

Year (0) ($) 3.20

1. The project requires $ 11 million in initial net working capital investment in year 0 to become operational.
2. Work all solutions to the nearest two decimals.

Required:

1. Calculate the project's initial, (time 0) cash flows, taking into account all side effects.

(2 marks)

1. Compute the weighted average cost of capital (WACC) of HBH Enterprises. Show all workings and state the assumptions underlying your computations.

(12 marks)

1. Using the WACC computed in part (2) above and assuming the following, compute the project's Net Present Value (NPV), Internal Rate of Return (IRR) and the Profitability Index (PI)
2. The manufacturing plant has a ten-year tax life, and HBH Enterprises uses Diminishing value method depreciation for the plant at 20% per annum. At the end of the project, (i.e., at the end of year 6), the plant can be scrapped for $ 71 million.
3. The project will incur $310 million per annum in fixed costs
4. HBH Enterprises will manufacture 420,000 washing machines per year and expects to sell them at an average price of $ 2,500 per washing machine.
5. The variable production costs are $ 1,400 per washing machine.
6. At the end of year 6, the company will sell the land.

(16 marks)

2.2. What are the pros and cons of using risk-adjusted costs of capital for individual investments?

Bachelor of Business (Incorporating Graduate Diploma and Graduate Certificate in Business) Managerial Finance (ACCT 706) Semester Two, 2017 Assignment # 2 Due Date: Week 8, 21/09/2017, 12.00 noon Weighting: 25% of the final grade Type: Individual Assignment Length: Approximately 2,000 - 3,000 words excluding appendices Submission : Students are expected to submit a hard copy of the assignment along with Arion generated barcoded assignment cover sheet in the drop box located in WF building Level 1 (City campus) & MB building Level 1(South campus). All assignments should be submitted via Turnitin, and a Turnitin report should accompany the assignment (Please note: Turnitin submission should precede physical submission and only the hard copy will be marked). The penalty for late submissions: 10% of the mark obtained for each 24-hour delay including weekends. Page 1 of 4 QUESTION 1: VALUATION OF SHARES (30 MARKS) Peter and Sandy own a medium-sized manufacturing firm, Max Security Ltd in Auckland. The company manufactures and installs security alarms for commercial and home security. Max Security Ltd has experienced rapid growth because of the new technology that improves the company's monitoring efficiency. The company is owned equally by Peter and Sandy holding 250,000 shares each. If either wishes to sell the shares, the shares have to be offered first to the other shareholder at a discounted price. In 2017, Peter and Sandy have decided to value their holdings in the company for financial planning purposes. To accomplish this, they have gathered the following information about their main competitors. EPS (Cents) Hub Security Ltd Reliable Security Plus Kiwi Monitoring Ltd Industry Average -0.20 0.31 0.16 0.24 DPS (Cents) Share Price ($) 0.04 0.14 0.16 0.18 3.25 2.90 12.10 7.05 ROE (%) 9.5 10.5 10.25 10.5 Required rate (%) 7.75 9.25 9.00 8.75 Last year, Max Security Ltd had an EPS of $0.35, and Peter and Sandy were paid a dividend of $52,500 each. The company also had a return on equity of 18%. Peter and Sandy believe a required rate of return of 14% for the company is appropriate. Required: 1. Calculate the share price of the company assuming the company continues its current growth rate (growth rate should be inferred from the data given) into the infinite period (adjust to 2 decimal places). (7 marks) 2. To verify their calculations, Peter and Sandy have hired Richard Hill, a consultant. Richard was previously an equity analyst, and he has a good understanding of the security Industry. Richard has examined the company's financial statements as well as those of its competitors. Although Max Security Ltd currently has a technological advantage, Richard's research indicates that Max Security's competitors are investigating other methods to improve efficiency. Given this, Richard believes that Max Security's technological advantage will last for only five years. After that period, the company's growth is likely to slow down to the industry average, and so the industry average required return will be a more appropriate rate for valuation. Under Richard's assumptions, what is the estimated share price? (12 marks) 3. What is the current industry average price-earnings ratio (PER)? Using Richard's estimation in part (2) above, calculate Max Security's price-earnings ratio. Comment on FOUR differences in PERs and explain why these differences may exist? (6 marks) Price - earnings ratio is the price the market places on 1$ of a firm's earnings. 4. After discussion with Richard, Peter and Sandy agree that they would like to increase the value of the company's equity. Like many business owners, they want to retain control of the company and do not want to sell shares to outside investors. They also feel that the company's debt is at a manageable level and do not want to borrow more money. What steps can they take to increase the share price? - justify each of your suggestions. (5 marks) Page 2 of 4 QUESTION 2: WEIGHTED AVERAGE COST OF CAPITAL (35 Marks) 2.1. HBH Enterprises is a large publicly listed company, specialised in manufacturing washing machines. The company is looking to set up a manufacturing plant to produce a new line of washing machines. This project will be a six-year project. The company bought a piece of land four years ago for $ 10 million in anticipation of using it for its proposed manufacturing plant. If the company sold the land today, it would receive $ 11.5 million after taxes. In six years, the land can be sold for $8 million after taxes and reclamation costs. HBH Enterprises wants to build a new manufacturing plant on this land. The plant will cost $350 million to build. The following market data on HBH's securities are current: Debt $250,000,000, 6.75% coupon bonds outstanding with 20 years to maturity redeemable at par, selling for 92 percent of par; the bonds have a $1000 par value each and make semi-annual coupon payments. Equity Non-redeemable Preference shares 40,000,000ordinary shares, selling for $42.50 per share 15,000,000 shares (par value $ 12 per share) with 5.5% dividends (after taxes), selling for $24 per share The following information is relevant: HBH Enterprises' tax rate is 28% The company had been paying dividends on its ordinary shares consistently. Dividends paid during the past five years is as follows Year (-4) ($) Year (-3) ($) Year (-2) ($) Year (-1) ($) Year (0) ($) 2.25 2.35 2.81 2.95 3.20 The project requires $ 11 million in initial net working capital investment in year 0 to become operational. Work all solutions to the nearest two decimals. Required: 1. Calculate the project's initial, (time 0) cash flows, taking into account all side effects. (2 marks) 2. Compute the weighted average cost of capital (WACC) of HBH Enterprises. Show all workings and state the assumptions underlying your computations. (12 marks) 3. Using the WACC computed in part (2) above and assuming the following, compute the project's Net Present Value (NPV), Internal Rate of Return (IRR) and the Profitability Index (PI) a. The manufacturing plant has a ten-year tax life, and HBH Enterprises uses Diminishing value method depreciation for the plant at 20% per annum. At the end of the project, (i.e., at the end of year 6), the plant can be scrapped for $ 71 million. b. The project will incur $310 million per annum in fixed costs c. HBH Enterprises will manufacture 420,000 washing machines per year and expects to sell them at an average price of $ 2,500 per washing machine. d. The variable production costs are $ 1,400 per washing machine. e. At the end of year 6, the company will sell the land. (16 marks) 2.2. What are the pros and cons of using risk-adjusted costs of capital for individual investments? (5 marks) QUESTION 3: PORTFOLIO ANALYSIS Page 3 of 4 (35 Marks) Amanda Nguyen is considering investing in four different two-factor portfolios. She can obtain the weekly returns of securities A, B, C and D for the period from August 2012 to August 2017 ( The attached file (Stock returns Aug 2012-Aug 2017) gives 260 weekly returns for four securities along with the returns of the NZX all share index for the period from August 2012 to August 2017). In any of the possible two-factor portfolios, the weight of each security in the portfolio will be 50%. The four possible portfolio combinations are A&B; B&C; A&C; C&D; A&D and B&D. Required: a) Determine, using the appropriate Excel function (see f x) the average weekly return, the standard deviation, and variance for each of the companies. (Use the 260 weekly returns data in the calculations and use the Excel functions identified as \"Variance P\" and \"Standard Deviation P.\") (4 marks) b) Determine, using the appropriate Excel function the covariance between securities A&B; B&C; A&C; C&D; A&D and B&D. (Use the 260 weekly returns data in the calculations and use the Excel function \"COVARIANCE P.\") (4 marks) c) Calculate using the two-factor portfolio equations, the portfolio returns and risks (both standard deviation and variance) for the following portfolios: a. A and B b. B and C c. A and C d. C and D e. A and D f. B and D (6 marks) d) By computing the ratio of ( Rp p ) select the best investment that Amanda should undertake, assuming she is risk averse. Explain the rationale that you have used in making this choice. (4 marks) e) Draw a portfolio graph (showing Risk on the X-axis and Return on the Y-axis) for the investment portfolio that you have recommended in (d) above for a range of investment weights that Amanda could choose from (i.e., Amanda could invest 0% in one company and 100% in the other or 5% in one company and 95% in the other and so on). Determine from the portfolio graph, the minimum risk that Amanda could obtain for this portfolio and the respective weightings that should be invested in each of the securities in the portfolio. (6 marks) f) Determine the betas for Securities A, B, C and D by regressing the returns of each of the companies on the returns for the NZX ALL Share Index (the first column in the spreadsheet). Security A is in construction industry, securities B and D are in Health care sector, and security C is in entertainment sector, (Regression Calculation: Go to Data Analysis - far right under Data- and choose regression. If Data Analysis does not appear it must be added, it will be available in Excel. Go to Options under File and choose Add-ins and then Data Analysis the company returns constitute the Y input and the index returns the X input. Alternatively, the \"slope\" found in f(x) also represents Beta). a. Explain what the values of the betas (the slope coefficients in the regression) indicate and discuss the factors that might explain the differences in the values of the betas of the three companies. (8 marks) b. Should Amanda decide to invest in all the four companies in equal proportions? Compute the return and risk of the portfolio? (3 marks) ***END*** Page 4 of 4