Question 1)

Hill Ltd. is considering updating their systems, which will cost $100,000. The new system will be depreciated prime cost to zero over its 5-year life. It will probably be worth about $20,000 after 5 years.

The new machine will save $20,000 per year in operating costs. The tax rate is 30 per cent, and tax is paid in the year of income.

Hill Ltd. has several classes of outstanding bonds, and the average yield is 6%. Its beta is 1.3, historical market risk premium is 7.94%, and the treasury yield is 4%.

Please use the above information to answer questions A to F.

A)What is the required rate of return for Hill?

B)There is a put option on Hill shares with an exercise price of $30. If we expect the Hill share price to be $25 at the option expiry date in six months, what will be the pay-off from the put option?

C)If the risk-free rate was currently 2 per cent and the share return volatility (variance) of Hill's ordinary shares was 5.00 per cent per annum, what would be the traded price of the Hill put option?

D)If Hill's capital structure is 40% debt and 60% equity, what is Hill's cost of capital (WACC - Weighted Average Cost of Capital)? Explain your answer.

E)Should Hill Ltd purchase the new system? Show your analysis using the capital budgeting techniques you have learned in this unit and explain your answer.

F)If you hold $10,000 Hill shares, and plan to buy additional shares of ABC worth $5,000. The expected return for ABC is 5%. What is the expected return for your portfolio including both Hill and ABC? (Hint: use the required rate of return computed in A)