a)This is a two period certainty model problem.

Assume that Jack Black has a sole income from Wildcat Ltd in which he owns 10% of the ordinary share capital.

In its financial year 2016-17 just ended, Wildcat Ltd reported net profits after tax of $500,000, and announced its net profits after tax expectation for the next financial year, 2017-18, to be 20% higher than this years figure. The company operates with a dividend payout ratio of 60%, which it plans to continue, and will pay the annual dividend for 2016-17 in mid-May 2017, and the dividend for 2017-18 in mid-May, 2018.

In mid-May, 2017, Jack wishes to spend $40,000. How much can he consume in mid-May, 2018 if the capital market offers an interest rate of 8% per year?

b)This question relates to the Capital Asset Pricing Model (CAPM)

Fresh Fysh Ltd owns shares in four different companies, as set out below, and -based on their current share prices expects the following returns.

Company NameExpected Return (%)Beta

Prawn Ltd10.8%0.5

Salmon Ltd13.0%0.8

Shark Ltd15.6%1.2

Trout Ltd17.4%1.7

The risk free rate of interest is currently 6% and the market risk premium is 8%.

i)Based on the CAPM, which of the above shares are undervalued, overvalued or correctly valued on the share market? Show all calculations and reasons for your answers.

ii)Using the above information, draw a Security Market Line graph, and plot all securities on the chart.

QUESTION 2. [(4 + 6) + (4 + 6) = 20 Marks]

a)This question relates to the time value of money and deferred perpetuities.

Property Developers Ltd returns nothing to the owners in the first 3 years. At the end of the following 2 years, the returns are $120,000 and $220,000 respectively.

After that, the return is $300,000 a year in perpetuity. The required return is 10 per cent per annum. All returns are received at the end of each year.

i)What is the present value of the constant income flows at the beginning of the sixth year?

ii)What is the present value now of the whole income stream?

b)This question relates to loan repayments and loan terms.

Three years ago, Linda Green borrowed $600,000 to buy a furniture business. The loan from BMX Bank required equal monthly repayments over 10 years, and carried.an interest rate of 7.2% per annum, compounded monthly.

Today, after making the last monthly payment for the third year, the bank tells Lisa that the interest rate will be increased immediately to 9.6% per annum, compounded monthly, in line with market rates. It also tells her that, with the rise in rates, she has two alternatives. She can increase her monthly repayment (so as to pay off the loan by the originally agreed date), or she can keep paying the same monthly repayment as now, but this will mean that she must extend the term of the loan.

You are required to calculate:

i)The new monthly repayment if Linda accepts the first alternative.

ii)The extra period added to the term of the loan if Linda adopts the second alternative.

QUESTION 3. [(8 + 4) + (8 + 4) = 24 marks]

a)This question relates to annual equivalent costs (AEC)

William Gray is proposing to manufacture a new type of surfboard. He has two alternative proposals- Plan A (a three year plan) and Plan B (a four year plan) - under consideration.

Under Plan A, the initial manufacturing costs are $100,000 immediately, followed by servicing costs of $3,000 a year at the end of each of the next three years.

Under Plan B, the initial manufacturing costs are $90,000 immediately, followed by servicing costs of $8,000 a year at the end of Year 1, $9,000 at the end of Year 2, and $10,000 at the end of each of Years 3 and 4.

The discount rate is 9 per cent per annum. Ignore depreciation and taxes.

You are required to:

i)Calculate the annual equivalent costs (AEC) of each Plan

ii)Which Plan would you recommend to William Gray? Give reasons for your recommendation.

b)This question relates to the valuation of bonds.

Bradley White, a retired school teacher, has two 8 per cent per annum $100,000 Australian Government bonds that mature on 15 May 2020 and 15 May 2024 respectively. At the date of the last half-yearly interest payment, viz.,15 November, 2016, both bonds were selling at par.

Since then, interest yields on bonds have risen by 2% per annum, compounded half-yearly. Sarah now intends to sell the bonds and put a deposit on a country property.

i)Calculate the price she will receive from each bond if she sells on 15 May, 2017 at the new yield, immediately after receiving the interest payments due that day.

ii)Explain the relative price movements in the two bonds, as evidenced in your answer to i) above.

QUESTION 4. [30 + 4 = 34 marks].

This question relates to capital budgeting.

Canberra Systems Ltd is considering the purchase of new technology costing $500,000, which it will fully finance with a fixed interest loan of 10% per annum, with the principal repaid at the end of 4 years.

The new technology will permit the company to reduce itsto reduce its labour costs by $190,000 a year for 4 years, and the technology may be depreciated for tax purposes by the straight-line method to zero over the 4 years. The company thinks that it can sell the technology at the end of 4 years for $20,000.

The technology will need to be stored in a building, currently being rented out for $30,000 a year under a lease agreement with 4 yearly rental payments to run, the next one being due at the end of one year. Under the lease agreement, Canberra Systems Ltd can cancel the lease by paying the tenant (now) compensation equal to one years rental payment plus 10%, but this amount is not deductible for income tax purposes.

This is not the first time that the company has considered this purchase. Twelve months ago, the company engaged Amazing Consultants, at a fee of $27,000 paid in advance, to conduct a feasibility study on savings strategies and the company made the above recommendations. At the time, the company did not proceed with the recommended strategy, but is now reconsidering the proposal.

The company further estimates that it will have to spend $15,000 in 2 years time overhauling the technology.It will also require additions to current assets of $35,000 at the beginning of the project, which will be fully recoverable at the end of the fourth year.

Canberra Systems Ltds cost of capital is 12%. The tax rate is 30%. Tax is paid in the year in which earnings are received.

REQUIRED:

(a)Calculate the net present value, that is, the net benefit or net loss in present value terms of the proposed purchase and the resultant incremental cash flows.

(b)Should the company purchase the technology? State clearly why or why not.