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You have just joined the staff of Eureka Publishing Company, a current affairs journal, as a business and finance reporter. The business editor has commissioned a series of articles that will span several weeks of the publication and she has asked you to provide advice on the following questions.
1. What difference would it make to the sum repayable after two years (as a single lump sum) if the amount of $5,000 is borrowed at 12% p.a. compounded (a) annually or (b) monthly? How much interest is payable in each case? 2. In Australia, legislation has been introduced to require lenders to show borrowers the 'true' rate of interest on their loans rather than just the 'nominal' rate. Explain how these interest-rate concepts differ and give an example based on the loan in question 1above. 3. If money is paid in equal, periodic instalments, it is known as an annuity. What is the difference between an annuity due and an ordinary annuity? 4. The average Australian housing loan for a first home buyer is $240,000 and it is borrowed typically for a period of 25 years. Currently, interest rates are quite low, about 7% p.a. for housing finance. What would happen to the typical borrower's annual commitments if the starting rate increased to 9% p.a.? 5. Many people, including Australians, are having trouble putting aside enough money for their retirement. If statisticians think we need at least $200,000 saved by retirement age, which occurs on average after 30 years, how much has to be put aside at the end of each year if the average interest rate is 6% p.a.? 6. Some company shares pay interest perpetually. These are called preference shares. If First International Company's shares are paying a dividend of $2 per share, and currently investors require a return of 10% p.a. on those shares, how much should an investor be willing to pay for one of these preference shares? 7. If the Australian government wants to raise more money to finance its public expenditure programs, it can issue treasury bonds to raise that money from investors. (a) If these bonds come in multiples of $1,000 maturity value per bond, what would be the market price of a five-year bond that pays $40 interest every half-year if the current market rate required by investors is 8% p.a. (compounded half-yearly)? (b) What would happen to the value of the bond if current market interest rates rose to 10% p.a.? (c) What would happen to the value of the bond if current market interest rates fell to 6% p.a.?
(1 X 7 = 7 Marks)
Part 2 (Maximum word limit for the report is 300 words)
Ballarat Kitchen Equipment (BKE) has recently investigated possible sources of long term debt funds. Now the owners have a specific proposal to borrow $500,000 for a period of five years to finance new kitchen equipment for their stores and to refit the shopfront area in the first outlet they opened back in 2006.The firm's bank has offered this amount as a term loan repayable by equal annual instalments of $131,899, payable at the end of each year. A second lender has offered to finance the
renovations with a loan that is repayable in a single lump- sum of $842,529.A third lender has offered to lend the money if BKE issues a 'bond' that is repayable via interest payments of $25,000 at the end of each half-year, with the principal amount being repayable at maturity in five years’ time. The owners of BKE see no difference in the risks attached to these alternatives and they do not see any particular taxation implications, so they intend to choose the finance that offers the lowest interest rate. Therefore the financial management problem confronting BKE is to determine the respective interest rates of the alternative borrowings. Provide a brief report on this.
(1 X 3 =3 Marks)
Part 3 Word limit 1400+/- 100 (15 Marks)
The following two quotations show there is an increasing interest among finance researchers on how the Chief Executive Officer’s (CEO) reputation can influence corporate capital investment and its market value.
Carefully review the two documents (provided via Moodle) and discuss the importance of CEO reputation for capital investment and company value. It is essential to give examples to enhance your answer. You are expected to provide at least two other research articles in your reference list, in addition to the two articles made available to you.
Quotation 1: “There is substantial literature that examines the wealth effects of corporate capital investments. This literature primarily analyzes the effects of firm characteristics such as size, market-to-book ratios and leverage on the stock price reaction surrounding capital investments. In general, these studies document considerable heterogeneity in the stock price reaction around the announcements of corporate capital investments and much of this heterogeneity cannot be explained by firm-level characteristics, even after controlling for industry effects. Many researchers attribute these valuation effects to the signalling of new information about the announcing firm's future cash flow prospects (McConnell and Muscarella, 1985; Woolridge and Snow, 1990; Chan et al., 1995; Chen and Ho, 1997; Vogt, 1997). However, there is little research on factors that affect the credibility of such information signals. In this study, we posit that CEO reputation is an important determinant of the credibility of information signals relating to announcements of capital investments. Therefore, the primary research question in this paper is whether CEO reputation matters for corporate capital investments. Specifically, we examine the role of CEO reputation on the wealth effects associated with corporate capital investments. Thus, the primary
contribution of this paper is to explicitly consider a managerial human capital dimension in explaining the economic effect of corporate capital investments.” (Jian and Lee, 2011, p.929).
Source: Jian, M and Lee K.W (2011), ‘Does CEO reputation matter for capital investments?’, Journal of Corporate Finance, 17, pp. 929–946.
Quotation 2: “The past several years have not been easy for big business and its leaders: CEOs. Research has found that respect for corporate leaders and large multinationals has declined. Between the global financial crisis, spread of worldwide protest movements such as Occupy, backlash against executive compensation, and even employee revolts, CEOs have faced numerous threats to their reputation and those of the companies they run.
Despite this erosion in positive perceptions of CEOs, Weber Shandwick’s research continues to find that CEO reputation is a fundamental driver of corporate reputation, and is unwavering in its contribution to market value. Our newest research, reported herein, finds that global executives estimate that nearly one half of a company’s market value is attributable to its CEO. CEO reputation continues to be a premium form of currency and wealth in an economy where companies trade on their reputations every day. As Michael Fertik, founder and CEO of reputation.com, says, “Reputation is the new oil”.” (Weber Shandwick, 2015, p.2).
Source: Weber Shandwick engaging always (2015) ‘The CEO Reputation Premium: Gaining Advantage in the Engagement Era’, March, pp.2-24. Online version accessed 20/3/2016. https://www.webershandwick.com/news/ article/the-ceo-reputation-premium-a-neweraof-engagement.
NB: 1) Understanding the notions in articles is more important than an entanglement with the advanced math in many articles; and 2) Do not plagiarise the article content – instead cite, or better yet, paraphrase it and always give full references. This shows that your opinions are informed opinions.
Plagiarism, Cheating & Collusion Plagiarism, cheating or collusion is regarded as a serious
1.a) Amount repayable if Interest compounded annually would be 5000*1.12*1.12 or 6,272 dollars. Hence interest payable is 1272 dollars
b) Amount repayable if interest compounded monthly would be 5000*1.1^24 or 6348.68 dollars. Hence interest payable is 1348.68 dollars
2) The interest rate quoted on any borrowing is known as the nominal rate. For the loan in the given scenario it is 12%/ It becomes a handy exercise to be able to directly compare the interest rate for a particular type of loan between time periods to do this the real interest rate is calculated by removing the rate of inflation from the nominal rate.
The nominal interest rate can be shown algebraically as:
n = r + i + (i x r)
n = nominal interest rate
r = real interest rate
i = inflation rate.
Rearranging we get r=n-i/1-I
For the above example we get real interest rate as 8.333 if we assume the inflation to be at 4%.
3)Annuity is a series of equal periodic instalments. They might be
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