a) Brad is planning to start a project of his dreams in five years from now. He will need $70,000 to start the project. With a target to save that amount, he has decided to invest an equal sum once a year for five years at the beginning of each period. If his investments will earn 7% interest per year, how much must he invest today to start the saving plan?
b) You have determined you can afford to pay $400 per month toward purchasing a new convertible sports car. You see an advertisement in the paper for a bank loan at the rate of 14% pa and you want to make monthly payments over the next 5 years. How much can you borrow now to buy the sports car?
c) In March 1963 issue number 39 of Tales of Suspense was issued. The original price for that issue was $0.12. By March 1995, the value of this comic book had risen to $2,500 as a collectors’ item. What annual rate of interest would you have earned if you had bought the comic book in 1963 and sold it in 1995?
d) Mrs Penny, who is 35 years old, has just inherited $18,000 and decides to use the windfall towards her retirement. She places the money in a bank which promises a return of 7% per year until her planned retirement in 25 years. How much will she have at retirement with interest compound annually and semi-annually?
e) A bond with par value of $1,000 pays 9% semi-annually interest and has 11 years to maturity. The market requires an interest rate of 8.4% on bonds of this risk. What is this bond's price?
f) What would be the maximum an investor should pay for the common stock of a firm that has no growth opportunities but pays a dividend of $1.48 per year? The next dividend will be paid in exactly 1 year. The required rate of return is 11.5%.
g) A share you are interested in paid a dividend of $1 last year. The anticipated growth rate in dividends and earnings is 16% for the next 2 years before settling down to a constant 6% growth rate. The discount rate is 10%. Calculate the expected price of the share.
h) Calculate the YTM on a bond priced at $986.50 which has 4 years to maturity, a 9% annual coupon rate, and a return of $1,000 at maturity
Based on the well-maintained 14% WACC of the company, Good Projects Company accepts projects providing an internal rate of return (IRR) greater than 14%. The company is evaluating a nine-year project that requires $1.638 million in initial investment and provides $280,000 in annual net cash inflows.
a) What is the IRR of the project? Should the project be accepted? (Justify your answer)
b) Assuming the annual net cash inflows continue to be $280,000, how many additional years should the flows continue in order to make the project acceptable (that is, to have an IRR of 14%)?
c) With the given project life (9 years) and initial investment, what is the minimum annual net cash inflows in order to make the project acceptable
The Future Vision Corporation is considering replacing one of its laser machines with a new, high-precision machine. The existing machine presently has a book value of $120,000 and could be sold for $50,000 now, but for $5,000 only after six years. The existing machine is being depreciated on a simplified straight line basis down to a salvage value of zero over the next six years, generating depreciation of $20,000 per year. The replacement machine would cost $330,000 and have an expected life of six years, after which it could be sold for $60,000. Because of increasing perfection in its operations, the new machine would produce cash benefits of $92,000 per year before depreciation and taxes. Assuming simplified straight line depreciation and that the replacement machine is being depreciated down to zero for tax purposes; a 34% marginal tax rate, a required rate of return of 14.5% and the required payback period is 3 years.
a) Prepare a table to illustrate your cash flows
b) Write a detailed report (with supporting calculations) outlining whether the new machine should be purchased
(a) Systematic beta coefficients of firm-P and firm-Q are 0.80 and 1.30 respectively. Calculated realised returns by a portfolio manager from firm-P and firm-Q are 11.25% and 16.10% respectively. Market risk premium is 8% and the risk-free rate of return is 5.5%.
i. Find the expected rate of returns from firm-P and firm-Q stocks as per CAPM.
ii. Identify the under-priced and/or overpriced stocks.
(b) An investment advisor made the following statements to a client
Statement 1: It is preferable to invest in a portfolio of shares rather than placing all resources in one share
Statement 2: It is advisable to allocate a percentage of the investment funds in 10-year Government Bonds with the remaining percentage of the funds invested in a portfolio of shares that tracks the performance of the Australian All Ordinaries Index (an index of shares listed on the Australian Stock Exchange)
In support of this advice the advisor had these statistical records
♦ Portfolio of shares representative of the All Ordinaries Index o Mean Value of Return 11.0%
o Standard Deviation 12.7%
♦ A share in Company X
o Mean Value of Return 9.7% o Standard Deviation 14.6%
♦ 10 Year Bond Rate
o Mean Value of Return 5.0%
♦ Average Covariance between a share in Company X and the All Ordinaries Index is 0.0133
(i) Select appropriate statistics from above to outline with reasons a justification to support Statement 1.
(ii) In support of Statement 2 the advisor asks you to indicate the rate of return and standard deviation of risk that an investor would accept if 40 per cent (40%) of funds were invested in Government bonds and 60 per cent (60%) of funds were invested in the All Ordinaries Index.
(iii) The management of Company X wish to ascertain the required rate of return on their ordinary shares
Calculate the Required rate of return for Company X if the current Beta for Company X is 0.8246
MACC Ltd, a B2B air frame company, is planning to tender for the opportunity to supply special wings to a major aircraft manufacturer. The company finance manager is unsure of the required rate of return to use in the calculations. She has offered you a free trip to Gold Coast if you could provide information on the appropriate ‘discount rate’. To help you with your calculations, she has tabled the following extracts from the company’s latest Financial Statements
Selected financial data as at 31 December 2014:
Ordinary shares Issue price $5.00 each, fully paid $ 30,000,000
10% Preference shares Issue price $3.00 each, fully paid $ 15,000,000
Retained Earnings $ 21,500,000
Reserves $ 7,500,000
Accounts Payable $ 2,500,000
Loan $ 5,000,000
Debentures $ 40,000,000
Bank Overdraft $ 12,000,000
40,000 debentures have been issued with a coupon rate of 9.0% p.a. paid semi-annually. The debentures mature in 7 years’ time. Similar debentures have a yield to maturity of 11% pa.
The bank overdraft carries an interest rate of 9%. Interest is charged quarterly.
The loan carries 7% interest rate compounding monthly.
The current dividend paid is 70 cents per share. This dividend is expected to grow indefinitely at 5% per annum.
The expected return on MACC Ltd ordinary shares is 16%.
The risk free rate of interest is 4%.
The current market price of the Preference Shares is $2.80.
The company tax rate is 30%.
(a) Calculate the weighted average cost of capital. Show all workings. Use 4 decimal places for workings and 2 decimal places for final answer.
(b) Write a detailed report commenting on the following statement
“The cost of capital depends primarily on the use of the funds, not the source”
Ross et al - Fundamentals of Corporate Finance
Modigliani and Miller develop a theory describing a firm’s optimal capital structure, ranging from a basic model assuming no corporate taxes, to an intermediate model including corporate taxes, and ultimately a model providing for costs of financial distress.
a) Describe the optimal capital structure for a company in each of the following circumstances, and sketch appropriate diagrams to illustrate each case.
i) No corporate tax
ii) Corporate tax
b) Draw a diagram to explain the effect of financial distress costs on firm value. Show all labels on the diagram.
Shares of DryCry Ltd are currently selling for $3.60 per share and there are 12 million shares outstanding. The company has announced a renounceable rights offering to obtain $12 million of equity financing. In maintaining its current 30% debt-equity ratio, the company is also raising $3.60 million in debt. The subscription price for the rights is set at $2.50 per share.
a) How many shares are required to buy one new share?
b) What is the value of the right?
c) What is the theoretical ex-rights share price?
d) If you hold shares in DryCry Ltd, will you gain or lose by the rights issue? Support your answer with calculations in the events of exercising and selling the rights. Assume that you have enough cash to exercise the rights.