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University of South Australia SCHOOL OF COMMERCE Business Finance (BANK 2007), SP5, 2017 On Campus and Off Campus Students Assignment (Part B) Topics 4-7 To be completed and submitted individually Due Date: 11 pm (SA Time) Sunday 15 October 2017 Instructions 1. This assignment contains FOUR Questions. 2. Your answers for this assignment are to be type written in a new Microsoft word document. 3. Read the Assignment Instructions that can be accessed from the Course Outline. 4. Marks will not be given for any calculation type of questions without showing full calculations. 5. Ensure you keep a copy of your assignment. Please include your name, student ID number and page numbers in the footer of your document before saving and submitting this file via Gradebook on the learnonline course website. 6. The report must have 1.5 line spacing with margins of two (2) centimetres. Marks will be deducted for both bad grammar and poor spelling. General report formatting requirements of any good report will be expected. It is important that you document how you arrived at your answer, particularly detailing calculator key strokes used for your calculations. For some problems it is beneficial to draw a timeline to identify the amount and timing of cash flows. 7. Most of the marks for each question will be given for the process used to arrive at your answer. Therefore, if you just provide an answer that is wrong and there are no supporting details as to how you arrived at that answer, you won't get any marks. But if you have detailed your process (which may have been correct but you made some error with your calculations) then you have the opportunity to get some marks for the question. If you provided a correct formula but the workings are wrong, you won't get marks for just providing a correct formula. 8. Ignore inflation in your answers and where possible interest rates should be calculated as percentages to 4 decimal places (e.g. 1.2678%). 9. You must ensure that your assignment answers are your own work. The Academic Integrity section of the Course Outline Booklet details the various University policies that will apply to academic misconduct. Please refresh yourself with what is meant by Academic Integrity and Misconduct. a. Ensure that you have properly acknowledged the work of others that enabled you to complete your assignment. A finance assignment that mostly comprises calculations is no different from a written (e.g. essay) assignment. b. You must acknowledge by a reference and/or bibliography all texts and sources that provided you with the formulae etc. to do your calculations. This includes directly copying material, closely paraphrasing, submitting another student's work in whole or in part or using another person's ideas, work or research without acknowledgement. The final assignment marks will be deducted if no references or inadequate references have been provided. (UniSA, 2016) c. You must complete your own work. Working with friends and peers is a good way to learn, but the communication of the findings, results and explanation must be your own work, and be independently done. Question 1 [13 marks] a) Doolittle Ltd has recorded the following end-of-year share prices: Price Month 2009 $8.89 2010 $8.21 2011 $7.45 2012 $8.45 2013 $9.06 2014 $9.91 2015 $10.80 2016 $12.45 *Note: The company paid no dividends in these years. i. Calculate the yearly returns for this share. (2 marks) ii. Calculate the standard deviation of returns for the company's shares. (3 marks) b) Fortissimo Group has estimated the potential returns that may be achieved from a project, together with the likelihood of such returns occurring, detailed in the table below: Possible Returns -5% 3% 8% 21% Probability of Occurrence 15% 30% 40% 15% Fortissimo Group has also estimated that the risk of this project, measured with Beta, is 0.6. The market portfolio that they have chosen has returned an average of 9% per annum over the past 5 years. The current risk free rate is 2%. i. Calculate the expected return and the standard deviation of returns for this investment. (5 marks) ii. Identify whether Fortissimo Group should invest in this project. Provide a reason for your decision. (3 marks) 2|P a g e Question 2 [15 marks] Pacific Coconuts Ltd. is an investment company that is considering expanding their business, and as such, is reviewing their current financing mix and the costs of their sources of finance. The latest balance sheet for the company shows: Long-term debt Bonds: Par $100, annual coupon 9% p.a., 6 years to maturity $ 3,000,000 Equity Preference shares (500,000 shares outstanding, 40 cents per share dividend) Ordinary shares (10,000,000 shares issued) Total 2,000,000 10,000,000 15,000,000 The company's debt (bonds) currently sell for $104.62, while the preference shares currently sell for $3.89 Pacific Coconuts wishes to re-estimate the value of their shares based on historical cost of equity and dividend growth values. Historically, the cost of equity averages 15% p.a., while the growth of dividends is estimated at 4% per year and is expected to continue to do so in the future. Pacific Coconuts has recently paid a dividend of 15 cents. The company's tax rate is 30%. (a) Using current market and expected (calculated) values, determine the market value proportions of debt, preference shares and ordinary equity comprising Pacific Coconuts capital structure. (5 marks) (b) Calculate the after-tax costs of capital for each source of finance. (3 marks) (c) Determine the after-tax weighted average cost of capital for the company. (3 marks) (d) Using your knowledge of the costs of finance capital, identify what you expect to happen to the weighted average cost of capital if additional costs are incurred in the securing new equity finance? If you need you can show the expectation numerically using the answers from (a) - (c). (4 marks) 3|P a g e Question 3 [10 marks] a) As an economic advisor to the government, you have been asked to investigate the costs, from various providers, associated with the installation of water salinity and catchment devices along the MurrayDarling river system. There are currently three designs on the market that offer a suitable solution. Experts in the water management industry indicate that 100,000 devices will be required to cover the river system. The three choices that you have identified have the following characteristics: Water Technologies Natural Resources Murray Life (WT) (NR) (ML) Initial Outlay (IO) $9,000,000 $23,000,000 $15,000,000 Annual Maintenance (CF) $4,500,000 $3,000,000 $4,000,000 Life of system 6 years 12 years 8 years A flat rate of 10% is estimated as the risk in both of these projects. Assuming that the government (the eventual buyer of these devices) is not capitally constrained, provide detailed calculations indicating which system you would advise the government to purchase (round to whole dollar values) (10 marks) 4|P a g e Question 4 [12 marks] a) Using your own words describe the efficient markets hypothesis. In describing this hypothesis discuss the extent of the incorporation of information into prices. (MAX 200 words). (4 marks) b) What is the implication of the efficient markets hypothesis for finance managers and their decision making process? (4 marks) c) You wish to expand your bond portfolio and have the following information regarding a possible bond investment: Par: $1,000 Maturity: 4 years Coupon: 9% per annum Yield to Maturity: 10% p.a. If the current market value of the bond is $982.10 would you buy the bond? Why or why not? (4 marks) 5|P a g e