Question 2 (15 marks, 7.5 marks each)

a. Dianne Anderson is the owner and CEO of Anderson Bus Lines which have taken over

several additional new routes which will commence at the end of Year 1. Dianne has

invested heavily in new coaches for her firm and as a result expects to be cash flow

negative for a few years whilst the new routes are established. She has presented the

following table of expected cash flows and has asked you to provide a valuation for

her company at different stages on its future timeline.

Year Cash Flows

0 -1,000,000

1 -250,000

2 0

3 250,000

4 750,000

5 1,500,000

6 2,500,000

7 3,000,000

Dianne has a required return of 15% per annum.

Required: Calculate the value of Anderson Bus Lines as at Year 0, Year 2 and Year 7.

b. Lee Cutting, a mortgage broker, has accumulated trailing commissions from loans she

issued which will generate positive cash flows of $200,000 at the end of each of the next 10

years. She has been approached by a competitor who wishes to purchase her debt book.

(i) Given that other investments of equivalent risk earn 7.5% per annum, calculate the

present value of these cash flows to Lee. (Show all calculations supporting your answers).

(ii) Lee is concerned that given currently high inflation she may need to increase her annual

required rate of return to 10%. Re-calculate the present value of the cash flows using 10% as

the required return.

(iii) Briefly explain the difference between the values calculated at (i) and (ii).

(Show all calculations supporting your answers).