Question 1 (20 marks) ? Lectures 2 and 3: Time Value of Money and Interest Rates I and II

8 marks

Ted just won the lottery, and he must choose among three award options. He can elect to receive a lump sum today of $61m, to receive 10 payments of $9.5 million per year at the end of each year (the first payment occurs one year from now), or to receive 30 payments of $5.5 million per year at the end of each year (the first payment occurs one year from now).

If he thinks he can earn 7% annually, which should he choose? (3 marks)

If he thinks he can earn 9% annually, which is the best choice? (3 marks)

Explain how interest rates influence the award options. (2 mark)

7 marks

You borrow $50,000 repayable in monthly instalments over 10 years. The nominal interest rate is 12% per annum. After 3 years have passed, the lender increases the interest rate to 13.5% per annum and you are given the choice of either increasing the monthly repayment or extending the term of the loan.

What would be the new monthly repayment? (5 marks)

What would be the new loan term? (2 marks) (Note: students may use the following formula to solve for t)

and

.

5 marks

Mickey is planning to save $50,000 per quarter for 10 years. Savings will earn interest at an (nominal) interest rate of 12% per annum. Calculate the present value for this annuity if interest is compounded semi-annually. (Note: students may try to convert the semi-annual rate to an effective annual rate, then to a quarterly rate)

Question 2 (20 marks) ? Lecture 4: Valuing shares and bonds

8 marks

Consider two 12% (coupon rate) $100 (face value) government bonds that differ only in that one matures in 2 years? time and the other in 5 years? time. Both bonds pay coupon annually.

What will be the price of each bond, given the required yield is 10% per annum? (3 marks)

What will be the price of each bond, given the required yield is 14% per annum? (3 marks)

Explain the price movements in response to interest rate changes as evidenced by parts (i) and (ii). (2 marks)

6 marks

The required rate of return on the shares in the firms identified in parts (i) to (ii) is 15% per annum (discount rate). Calculate the current share price in each part.

The current dividend per share in Firm B is 80 cents. This dividend is expected to grow at 5% per annum indefinitely. (2 marks)

Current dividend per share in Firm C is 60 cents. The dividend has been growing at 12% per annum in recent years, a rate expected to be maintained for a further 3 years. It is envisaged that the growth rate will then decline to 5% per annum and remain at that level indefinitely. (4 marks)

6 marks

A major pension fund is interested in purchasing Ted?s stock. The pension fund manager has estimated Ted?s free cash flows for the next 4 years as follows: $3 million, $6 million, $10 million, and $15 million. After the 4th year, free cash flow is projected to grow at a constant 7%.

Ted?s WACC (discount rate) is 12%, the market value of its debt and preferred stock totals $60 million, and it has 10 million shares of common stock outstanding.

What is Ted?s enterprise value today? (4 marks)

What is an estimate of Ted?s price per share? (2 marks)

Question 3 (20 marks) ? Lectures 5 and 6: Net present value and other investment criteria and Capital Budgeting

You are evaluating a proposal to buy a new machine. The base price is $108,000, and shipping and installation costs would add another $12,500. The machine is depreciated using prime cost method (3 years useful life), and it would be sold after 3 years for $60,000. The machine would require a $5,500 increase in net operating working capital (in year 0) and this will be returned at the end of year 3. The pre-tax labour costs would decline by $44,000 per year. The marginal tax rate is 35% and the WACC is 12%.

What are the project?s annual cash flows during years 0, 1, 2 and 3? (12 marks)

Calculate NPV (6 marks) and advise whether this project should be accepted based on its NPV (2 marks).

Question 4 (20 marks) ? Lecture 8: Shareholder value and the cost of capital

4 marks

AJI Limited current share price is $20 and it has just paid a $1 dividend. As AJI is a mature firm, this $1 dividend is expected to grow at a rate of 4% per year. What is an estimate of the return shareholders of AJI Ltd expected to earn?

4 marks

AJI also has preference shares outstanding that pays $2 per share fixed dividend. If this stock is currently priced at $24, what is the return that preference shareholders expect to earn?

4 marks

AJI has issued a 5 year bond with a coupon rate of 11% and par value of $1,000. The price received by AJI was $1,200. What is AJI?s pre-tax cost of debt?

4 marks

AJI has 5m ordinary shares outstanding and 1m preference shares outstanding. Its liabilities have a book value of $20m. If AJI?s ordinary and preference shares are priced as in parts a) and b), what is the market value of the AJI?s assets?

4 marks

AJI faces a 30% tax rate. Given the information in parts a) ? d), and your answer to those problems, what is AJI?s WACC?

Question 5 (20 marks) ? Lecture 7: Risk and Return:

Your grandfather is planning to invest $25,000 into the following stocks:

Rio Tinto Ltd

Cathay Pacific Airlines

The table below shows the closing prices between 2008 and 2014.

	Rio Tinto Ltd (RIO.AX)	Cathay Pacific Airlines (0293.HK)
December 2008	$29.97	$8.72
December 2009	$74.89	$14.48
December 2010	$85.47	$21.45
December 2011	$60.3	$13.32
December 2012	$66.01	$14.22
December 2013	$68.18	$16.4
December 2014	$58	$16.9

The monthly data is collected from Yahoo Finance on 1st of November 2015.

4 marks

For each stock, show the annual stock returns.

4 marks

Based on the annual stock returns, calculate the average stock returns and standard deviation for each stock.

4 marks

Calculate the covariance and correlation of annual stock returns between these stocks.

4 marks

The risk-free rate is 2.06% per annum. Calculate the Sharpe ratio for Rio Tinto Ltd and Cathay Pacific Airlines. Which stock is performing better? Explain your answer.

4 marks

Suppose grandfather invests 60% in Rio Tinto and 40% in Cathay Pacific Airlines, calculate the expected return and standard deviation for this portfolio. Is this portfolio perform better than the individual stock?

END of Assignment

Unit: FNCE2000 - Introduction to Finance Principles Semester 1/Trimester 1A 2016 Locations: Bentley, CTI, Miri, Singapore and Sydney campuses Assessment: Group assignment Assessment value: 20% Due date: To be submitted by 5pm on Friday 20th of May 2016 (week 12 as per unit outline) IMPORTANT INSTRUCTIONS: This group assignment is due by above date and time. Form a group with 3 - 4 group members. Each group should have a minimum of 3 students and a maximum of 4 students. Show all working to demonstrate you have understood how to solve each problem. If you use a financial calculator, state the sequence of steps to solve the problem. Please present your answers in at least 2 decimal places. Students are to submit their assignments onto Blackboard. The assignment must be typed (Word or PDF). Answer must be legible. If the marker cannot follow or read your answers, marks cannot be rewarded. Answer all sections. Your assignment should meet the following requirements A copy of the assignment has been retained by each of the group member Declaration below is complete Declaration Except where I have indicated, the work I am submitting in this assignment is my own work and has not been submitted for assessment in another unit or course. I admit that the work contributed among the group members is adequately fair. I warrant that any diskettes and/or computer files submitted as part of this assignment have been checked for viruses and reported clean. Student ID Family Name Given Name Signature of student Name of your tutor 1. 2. 3. 4. All form of plagiarism, cheating and unauthorised collusion are regarded seriously by the University and could result in penalties including failure in the course and possible exclusion from the University. If you are in doubt, please contact your lecturer, unit coordinator or your course coordinator. Question 1 (20 marks) - Lectures 2 and 3: Time Value of Money and Interest Rates I and II Page 1 of 6 a) 8 marks Ted just won the lottery, and he must choose among three award options. He can elect to receive a lump sum today of $61m, to receive 10 payments of $9.5 million per year at the end of each year (the first payment occurs one year from now), or to receive 30 payments of $5.5 million per year at the end of each year (the first payment occurs one year from now). i. ii. iii. If he thinks he can earn 7% annually, which should he choose? (3 marks) If he thinks he can earn 9% annually, which is the best choice? (3 marks) Explain how interest rates influence the award options. (2 mark) b) 7 marks You borrow $50,000 repayable in monthly instalments over 10 years. The nominal interest rate is 12% per annum. After 3 years have passed, the lender increases the interest rate to 13.5% per annum and you are given the choice of either increasing the monthly repayment or extending the term of the loan. i. What would be the new monthly repayment? (5 marks) ii. What would be the new loan term? (2 marks) (Note: students may use the following formula to solve for t) C ) CPr log ( 1+ r) log ( t= t=number of period ; C= payment ; P=Present value ; and r=interest rate . c) 5 marks Mickey is planning to save $50,000 per quarter for 10 years. Savings will earn interest at an (nominal) interest rate of 12% per annum. Calculate the present value for this annuity if interest is compounded semi-annually. (Note: students may try to convert the semi-annual rate to an effective annual rate, then to a quarterly rate) Page 2 of 6 Question 2 (20 marks) - Lecture 4: Valuing shares and bonds a) 8 marks Consider two 12% (coupon rate) $100 (face value) government bonds that differ only in that one matures in 2 years' time and the other in 5 years' time. Both bonds pay coupon annually. i. What will be the price of each bond, given the required yield is 10% per annum? (3 marks) ii. What will be the price of each bond, given the required yield is 14% per annum? (3 marks) iii. Explain the price movements in response to interest rate changes as evidenced by parts (i) and (ii). (2 marks) b) 6 marks The required rate of return on the shares in the firms identified in parts (i) to (ii) is 15% per annum (discount rate). Calculate the current share price in each part. i. The current dividend per share in Firm B is 80 cents. This dividend is expected to grow at 5% per annum indefinitely. (2 marks) ii. Current dividend per share in Firm C is 60 cents. The dividend has been growing at 12% per annum in recent years, a rate expected to be maintained for a further 3 years. It is envisaged that the growth rate will then decline to 5% per annum and remain at that level indefinitely. (4 marks) c) 6 marks A major pension fund is interested in purchasing Ted's stock. The pension fund manager has estimated Ted's free cash flows for the next 4 years as follows: $3 million, $6 million, $10 million, and $15 million. After the 4 th year, free cash flow is projected to grow at a constant 7%. Ted's WACC (discount rate) is 12%, the market value of its debt and preferred stock totals $60 million, and it has 10 million shares of common stock outstanding. i. ii. What is Ted's enterprise value today? (4 marks) What is an estimate of Ted's price per share? (2 marks) Page 3 of 6 Question 3 (20 marks) - Lectures 5 and 6: Net present value and other investment criteria and Capital Budgeting You are evaluating a proposal to buy a new machine. The base price is $108,000, and shipping and installation costs would add another $12,500. The machine is depreciated using prime cost method (3 years useful life), and it would be sold after 3 years for $60,000. The machine would require a $5,500 increase in net operating working capital (in year 0) and this will be returned at the end of year 3. The pre-tax labour costs would decline by $44,000 per year. The marginal tax rate is 35% and the WACC is 12%. i. ii. What are the project's annual cash flows during years 0, 1, 2 and 3? (12 marks) Calculate NPV (6 marks) and advise whether this project should be accepted based on its NPV (2 marks). Page 4 of 6 Question 4 (20 marks) - Lecture 8: Shareholder value and the cost of capital a) 4 marks AJI Limited current share price is $20 and it has just paid a $1 dividend. As AJI is a mature firm, this $1 dividend is expected to grow at a rate of 4% per year. What is an estimate of the return shareholders of AJI Ltd expected to earn? b) 4 marks AJI also has preference shares outstanding that pays $2 per share fixed dividend. If this stock is currently priced at $24, what is the return that preference shareholders expect to earn? c) 4 marks AJI has issued a 5 year bond with a coupon rate of 11% and par value of $1,000. The price received by AJI was $1,200. What is AJI's pre-tax cost of debt? d) 4 marks AJI has 5m ordinary shares outstanding and 1m preference shares outstanding. Its liabilities have a book value of $20m. If AJI's ordinary and preference shares are priced as in parts a) and b), what is the market value of the AJI's assets? e) 4 marks AJI faces a 30% tax rate. Given the information in parts a) - d), and your answer to those problems, what is AJI's WACC? Page 5 of 6 Question 5 (20 marks) - Lecture 7: Risk and Return: Your grandfather is planning to invest $25,000 into the following stocks: Rio Tinto Ltd Cathay Pacific Airlines The table below shows the closing prices between 2008 and 2014. December 2008 December 2009 December 2010 December 2011 December 2012 December 2013 December 2014 Rio Tinto Ltd (RIO.AX) $29.97 $74.89 $85.47 $60.3 $66.01 $68.18 $58 Cathay Pacific Airlines (0293.HK) $8.72 $14.48 $21.45 $13.32 $14.22 $16.4 $16.9 The monthly data is collected from Yahoo Finance on 1st of November 2015. a) 4 marks For each stock, show the annual stock returns. b) 4 marks Based on the annual stock returns, calculate the average stock returns and standard deviation for each stock. c) 4 marks Calculate the covariance and correlation of annual stock returns between these stocks. d) 4 marks The risk-free rate is 2.06% per annum. Calculate the Sharpe ratio for Rio Tinto Ltd and Cathay Pacific Airlines. Which stock is performing better? Explain your answer. e) 4 marks Suppose grandfather invests 60% in Rio Tinto and 40% in Cathay Pacific Airlines, calculate the expected return and standard deviation for this portfolio. Is this portfolio perform better than the individual stock? END of Assignment Page 6 of 6