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FIN205 – Business Finance

Question

Answered

Use the information below for parts a & b.
Currently the risk-free rate equals 3% and the expected return on the market portfolio
is 8%. A financial analyst provides you with the following information:
Share
Beta
Expected Return
A
1.50
14%
B
0.60
8%
C
1.20
9%
D
1.80
10%
a. Indicate whether each share is overpriced, underpriced, or correctly priced.
(Marks: 2)
b. Show how a smart investor could construct a portfolio of shares A and B that would outperform share D.
(Marks: 3)
Use the information below for parts c – e.
Assume the cost of capital is 12%. Sharpe Manufacturing is considering the following projects:
c. Rank the projects based on NPV.
(Marks: 1)
d. Which of the projects would Sharpe Manufacturing accept using the payback method if its policy is to accept all projects with a payback period of 2.75 years or less?
(Marks: 2)
e. What are the internal rate of return and profitability index of Projects A, B and C?
(Marks: 2)
Question 2 (Total Marks: 10)
Interest rates in Australia are currently at an all-time low. A few days earlier (in August 2017) Sam found her dream home. It’s priced at $700,000. Sam plans to pay 10% of the house price from her savings. For the remaining 90% of the house price she has been offered a home loan at a very attractive annual interest rate of 3.5% by Star Bank. Sam can choose between a 20 or 25-year loan. She has to repay the loan through equal annual installments over the term of the loan. Her first installment of repayment will be in August 2018.
a. Assuming the interest rate remains constant over the entire loan term calculate Sam’s annual repayments for a 20-year loan and compare it with the repayments for a 25-year loan.
(Marks: 2)
b. Calculate and compare the total interest paid for a 20-year and 25-year loan.
(Marks: 2)
c. Everything else remaining the same what is the relationship between the loan term and
(i) annual repayments (ii) total interest paid? Provide a brief explanation for your answer.
(Marks: 2)
Interest rates seldom remain constant over the entire loan term. Suppose Sam’s home loan interest rate is fixed for the first 3 years. After 3 years, i.e., from August 2020, Sam will have to pay an annual interest rate of 6% for the remaining term of her home loan.
d. Calculate the annual loan repayments for Sam from August 2021 onwards if she had taken a 20-year loan originally. How does this compare with her repayments for a 25-year loan.

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Tellus molestie nunc non blandit massa enim nec dui. Tellus molestie nunc non blandit massa enim nec dui. Ac tortor vitae purus faucibus ornare suspendisse sed nisi. Pharetra et ultrices neque ornare aenean euismod. Pretium viverra suspendisse potenti nullam ac tortor vitae. Morbi quis commodo odio aenean sed. At consectetur lorem donec massa sapien faucibus et. Nisi quis eleifend quam adipiscing vitae proin sagittis nisl rhoncus. Duis at tellus at urna condimentum mattis pellentesque. Vivamus at augue eget arcu dictum varius duis at. Justo donec enim diam vulputate ut. Blandit libero volutpat sed cras ornare arcu. Ac felis donec et odio pellentesque diam volutpat commodo. Convallis a cras semper auctor neque. Tempus iaculis urna id volutpat lacus. Tortor consequat id porta nibh.

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BE314 Financial modelling

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