Financial Analysis Essay - Questions And Solutions.

Question 1

You will be allocated an ASX listed company as the context for many of the questions in this assignment and the next. You can find your allocated company’s ASX ticker code via “View Grades”. You will need to collect real data for all questions except Question 3. Use DatAnalysis to collect company financial data and the RBA site for yield data. Reference all sources of data used.

Collect the company’s 5 year growth rate (CAGR) in operating revenue as at the end of the most recent financial year. (If the company has not been listed that long, use the 1 or 3 year rate – whichever is longer – as a proxy.) If this CAGR can be expected to continue, what is your prediction for operating revenue for the 2020/21 financial year?

Collect the company’s interest expense from the profit and loss statement for the year ending 30 June 2016 and divide this figure by average long-term debt in the balance sheet for the last two financial years. Use this as a very rough approximation of the quoted annual interest rate that the company would have to pay on new long-term debt. Now hypothetically assume that on 1 July 2016, the company took out a 20 year amortised loan of $800,000 to buy some equipment and that the rate of interest on that loan is fixed for the first 4 years at the rate you calculated above. The loan requires monthly payments, due on the last day of the month. How much interest will the company be able to claim as an annual tax deduction in the first financial year (1 July 2016 to 30 June 2017) and in the fourth financial year?

Assume that the company has just received a large amount of cash from selling assets and wants to use this cash to repay $2 million in debt maturing in three years. In the meantime, the necessary cash can be invested into one of the following investments: (1) a fund with a quoted fixed rate of 4.20% compounded semi-annually; (2) a fund with a quoted fixed rate of 4.14% compounded monthly; or (3) zero coupon bonds maturing in three years and currently trading at $88.45 per $100 face value. Which investment fund should be chosen: 1, 2 or 3? (Assume the investments have equivalent risk.) How much cash will be invested?

Hypothetically assume that on 27 January 2017 the company issued 10 year, semi-annual fixed coupon bonds at par, which are given a BB rating and have a spread of 325 basis points over the yield on an Australian government bond of equivalent maturity.

a) What is the yield on the company’s bonds?

b) How would the yield have been different if the company’s bonds had been shorter term? Explain with reference to data and to the relevant component(s) of market interest rates.

c) You have a pessimistic outlook for the Australian economy over the next year. Given this, what do you predict will happen to the spread on the company’s bonds over the next year and why? Ensure you mention the relevant component(s) of market interest rates in your answer.

d) What do you expect to happen to the price of the company’s 10 year bonds if your prediction in part c is correct? Illustrate your answer with a numerical example.

a) Use CAPM to estimate the required return on the company’s shares as at 30 June 2015. To do this, use the yield to maturity on that date of a 10-year Australian Treasury bond as a proxy for the risk-free rate, assume the market risk premium is 6.80% and use the company’s current beta (thus assuming the beta has not changed since mid-2015).

b) Assuming the market risk premium and beta has not changed from 5a), recalculate the required return on the company’s shares as at 30 June 2016. What has happened to the required return and why? In the absence of any other change, what does theory predict should have happened to share prices?

c) Explain would happen to the company’s required return if average risk aversion in the market fell.

Collect and evaluate the company’s FCF and ROIC for the two financial years ending 30 June 2015 and 30 June 2016. Assume that the company’s cost of capital (WACC) was the same as the required returns (costs of equity) you calculated in Question 5.1

Collect the company’s 5 year growth rate (CAGR) in operating revenue as at the end of the most recent financial year. (If the company has not been listed that long, use the 1 or 3 year rate – whichever is longer – as a proxy.) If this CAGR can be expected to continue, what is your prediction for operating revenue for the 2020/21 financial year?

The ASX listed company taken for completion for these assignments is Mantra Group Limited. Mantra group Limited is the Australian based company that deals in hotel and resort market. It has more than 20000 rooms operated in various properties across Australia, New Zealand and Indonesia (About Us, 2017).

The financial data for the company is presented from the year 2013 to 2016 therefore for this particular question, data for last three financial years has been taken to calculate the CAGR for the most recent period and answer the given question.

Formula to calculate the CAGR: = ((FV/PV) ^ (1/n)) – 1

CAGR for operating revenue for latest year (2016) for Mantra Group Limited is: 15.93 % (Calculated in Excel)

Prediction of operating revenue in year 2020/21if CAGR is expected to continue= $140,308.95 (It has been calculated using the formula in excel)

Formula to calculate the Future value using the CAGR is: FV (CAGR Rate, number of years, 0, Present Value) (Sutherland and Canwell, 2004)

Collect the company’s interest expense from the profit and loss statement for the year ending 30 June 2016 and divide this figure by average long-term debt in the balance sheet for the last two financial years. Use this as a very rough approximation of the quoted annual interest rate that the company would have to pay on new long-term debt. Now hypothetically assume that on 1 July 2016, the company took out a 20 year amortized loan of $800,000 to buy some equipment and that the rate of interest on that loan is fixed for the first 4 years at the rate you calculated above. The loan requires monthly payments, due on the last day of the month. How much interest will the company be able to claim as an annual tax deduction in the first financial year (1 July 2016 to 30 June 2017) and in the fourth financial year?

Calculation of Annual Interest Rate

Formula= Interest Expense for year 2016 / Average Long term Debt

= 7000 / ((105000+125000)/2) (Datanalysis, 2017)

= 6.08%

Pmt No.	Payment Date	Beginning Balance	Scheduled Payment	Extra Payment	Total Payment	Principal	Interest	Ending Balance	Cumulative Interest
1	7/30/2016	$      800,000.00	$       5,768.43	$             -	$       5,768.43	$       1,715.10	$      4,053.33	$  798,284.90	$     4,053.33
2	8/30/2016	798,284.90	5,768.43	-	5,768.43	1,723.79	4,044.64	796,561.11	8,097.98
3	9/30/2016	796,561.11	5,768.43	-	5,768.43	1,732.52	4,035.91	794,828.59	12,133.89
4	10/30/2016	794,828.59	5,768.43	-	5,768.43	1,741.30	4,027.13	793,087.29	16,161.02
5	11/30/2016	793,087.29	5,768.43	-	5,768.43	1,750.12	4,018.31	791,337.17	20,179.33
6	12/30/2016	791,337.17	5,768.43	-	5,768.43	1,758.99	4,009.44	789,578.18	24,188.77
7	1/30/2017	789,578.18	5,768.43	-	5,768.43	1,767.90	4,000.53	787,810.28	28,189.30
8	3/2/2017	787,810.28	5,768.43	-	5,768.43	1,776.86	3,991.57	786,033.42	32,180.87
9	3/30/2017	786,033.42	5,768.43	-	5,768.43	1,785.86	3,982.57	784,247.55	36,163.44
10	4/30/2017	784,247.55	5,768.43	-	5,768.43	1,794.91	3,973.52	782,452.64	40,136.96
11	5/30/2017	782,452.64	5,768.43	-	5,768.43	1,804.00	3,964.43	780,648.64	44,101.39
12	6/30/2017	780,648.64	5,768.43	-	5,768.43	1,813.15	3,955.29	778,835.49	48,056.67
13	7/30/2017	778,835.49	5,768.43	-	5,768.43	1,822.33	3,946.10	777,013.16	52,002.77
14	8/30/2017	777,013.16	5,768.43	-	5,768.43	1,831.56	3,936.87	775,181.60	55,939.64
15	9/30/2017	775,181.60	5,768.43	-	5,768.43	1,840.84	3,927.59	773,340.75	59,867.23
16	10/30/2017	773,340.75	5,768.43	-	5,768.43	1,850.17	3,918.26	771,490.58	63,785.49
17	11/30/2017	771,490.58	5,768.43	-	5,768.43	1,859.55	3,908.89	769,631.03	67,694.37
18	12/30/2017	769,631.03	5,768.43	-	5,768.43	1,868.97	3,899.46	767,762.07	71,593.84
19	1/30/2018	767,762.07	5,768.43	-	5,768.43	1,878.44	3,889.99	765,883.63	75,483.83
20	3/2/2018	765,883.63	5,768.43	-	5,768.43	1,887.95	3,880.48	763,995.68	79,364.31
21	3/30/2018	763,995.68	5,768.43	-	5,768.43	1,897.52	3,870.91	762,098.15	83,235.22
22	4/30/2018	762,098.15	5,768.43	-	5,768.43	1,907.13	3,861.30	760,191.02	87,096.52
23	5/30/2018	760,191.02	5,768.43	-	5,768.43	1,916.80	3,851.63	758,274.22	90,948.15
24	6/30/2018	758,274.22	5,768.43	-	5,768.43	1,926.51	3,841.92	756,347.71	94,790.07
25	7/30/2018	756,347.71	5,768.43	-	5,768.43	1,936.27	3,832.16	754,411.44	98,622.24
26	8/30/2018	754,411.44	5,768.43	-	5,768.43	1,946.08	3,822.35	752,465.36	102,444.59
27	9/30/2018	752,465.36	5,768.43	-	5,768.43	1,955.94	3,812.49	750,509.42	106,257.08
28	10/30/2018	750,509.42	5,768.43	-	5,768.43	1,965.85	3,802.58	748,543.57	110,059.66
29	11/30/2018	748,543.57	5,768.43	-	5,768.43	1,975.81	3,792.62	746,567.76	113,852.28
30	12/30/2018	746,567.76	5,768.43	-	5,768.43	1,985.82	3,782.61	744,581.94	117,634.89
31	1/30/2019	744,581.94	5,768.43	-	5,768.43	1,995.88	3,772.55	742,586.06	121,407.44
32	3/2/2019	742,586.06	5,768.43	-	5,768.43	2,006.00	3,762.44	740,580.06	125,169.87
33	3/30/2019	740,580.06	5,768.43	-	5,768.43	2,016.16	3,752.27	738,563.90	128,922.15
34	4/30/2019	738,563.90	5,768.43	-	5,768.43	2,026.37	3,742.06	736,537.53	132,664.20
35	5/30/2019	736,537.53	5,768.43	-	5,768.43	2,036.64	3,731.79	734,500.89	136,395.99
36	6/30/2019	734,500.89	5,768.43	-	5,768.43	2,046.96	3,721.47	732,453.93	140,117.46
37	7/30/2019	732,453.93	5,768.43	-	5,768.43	2,057.33	3,711.10	730,396.59	143,828.56
38	8/30/2019	730,396.59	5,768.43	-	5,768.43	2,067.76	3,700.68	728,328.84	147,529.24
39	9/30/2019	728,328.84	5,768.43	-	5,768.43	2,078.23	3,690.20	726,250.61	151,219.44
40	10/30/2019	726,250.61	5,768.43	-	5,768.43	2,088.76	3,679.67	724,161.84	154,899.11
41	11/30/2019	724,161.84	5,768.43	-	5,768.43	2,099.34	3,669.09	722,062.50	158,568.20
42	12/30/2019	722,062.50	5,768.43	-	5,768.43	2,109.98	3,658.45	719,952.52	162,226.65
43	1/30/2020	719,952.52	5,768.43	-	5,768.43	2,120.67	3,647.76	717,831.85	165,874.41
44	3/1/2020	717,831.85	5,768.43	-	5,768.43	2,131.42	3,637.01	715,700.43	169,511.42
45	3/30/2020	715,700.43	5,768.43	-	5,768.43	2,142.22	3,626.22	713,558.21	173,137.64
46	4/30/2020	713,558.21	5,768.43	-	5,768.43	2,153.07	3,615.36	711,405.14	176,753.00
47	5/30/2020	711,405.14	5,768.43	-	5,768.43	2,163.98	3,604.45	709,241.16	180,357.45
48	6/30/2020	709,241.16	5,768.43	-	5,768.43	2,174.94	3,593.49	707,066.22	183,950.94

Annual Tax Deduction for interest for first financial year (1 July 2016 to 30 June 2017) = $44,101.39

Annual Tax Deduction for interest for forth financial year (1 July 2019 to 30 June 2020) = $43,833.48

Assume that the company has just received a large amount of cash from selling assets and wants to use this cash to repay $2 million in debt maturing in three years. In the meantime, the necessary cash can be invested into one of the following investments: (1) a fund with a quoted fixed rate of 4.20% compounded semi-annually; (2) a fund with a quoted fixed rate of 4.14% compounded monthly; or (3) zero coupon bonds maturing in three years and currently trading at $88.45 per $100 face value. Which investment fund should be chosen: 1, 2 or 3? (Assume the investments have equivalent risk.) How much cash will be invested?

Question 2

Formula to calculate the present value = P = A/ (1+(r/t)) nt 

Present Value to be invested to get $2 million future value in

Option1:
	Future value	$                 200,000.00
	Rate of Interest	4.20%
	Compounded	Semi annually
	Present Value to be invested	$                 176,553.18
Option 2:
	Future value	$                 200,000.00
	Rate of Interest	4.14%
	Compounded	Monthly
	Present Value to be invested	$                 176,678.40

Option 3:
Zero Coupon Bonds
Maturity Value	$                          100.00
Current Trading Price	$                            88.45
Future Value	$                 200,000.00
Present Value	$                 176,900.00

As per the solution, option 1 must be exercised as it require least amount to be invested. Amount to be invested is equal to $ 176,553.18

Hypothetically assume that on 27 January 2017 the company issued 10 year, semi-annual fixed coupon bonds at par, which are given a BB rating and have a spread of 325 basis points over the yield on an Australian government bond of equivalent maturity.

1. What is the yield on the company’s bonds?
2. How would the yield have been different if the company’s bonds had been shorter term? Explain with reference to data and to the relevant component(s) of market interest rates?
3. You have a pessimistic outlook for the Australian economy over the next year. Given this do you predict will happen to the spread on the company’s bonds over the next year and why? Ensure you mention the relevant component(s) of market interest rates in your answer?
4. What do you expect to happen to the price of the company’s 10 year bonds if your prediction in part c is correct? Illustrate your answer with a numerical example.

1. a)Yield on the company is yield on Australian Government Bond + spread of 325 basis points

Yield on Australian Government Bond for 10 Years as on 27 January 2017 = 2.73 % (Reserve Bank of Australia, 2017)

Yield on company Bond= 2.73% + 3.25% = 5.98%

2. b)In case bond has been issued for shorter period than yield on the Australian Government Bond will change as the change in period of bonds. For example if bonds have been issued for 5 years instead for 10 years than the yield on the Australian Government will be 2.21% (Reserve Bank of Australia, 2017) and yield on company bond after adding the spread will be 5.46%. Yield on company bond has been reduced due to change in yield of Australian Government bond (Richelson and Richelson, 2011).
3. c)The spread of company’s bond will increase due to positive change in market condition in future time period. Risk will minimize due to pessimistic outlook for the Australian economy and due to this market return will increase that helps in increase of spread of company bond.
4. d)Price of the company’s 10 year bond will increase due to change in spread of company’s bond (Richelson and Richelson, 2011).

a) Use CAPM to estimate the required return on the company’s shares as at 30 June 2015. To do this, use the yield to maturity on that date of a 10-year Australian Treasury bond as a proxy for the risk-free rate, assume the market risk premium is 6.80% and use the company’s current beta (thus assuming the beta has not changed since mid-2015).

b) Assuming the market risk premium and beta has not changed from 5a), recalculate the required return on the company’s shares as at 30 June 2016. What has happened to the required return and why? In the absence of any other change, what does theory predict should have happened to share prices?

c) Explain would happen to the company’s required return if average risk aversion in the market fell.

5 a) Formula to calculate the required rate of return:

CAPM: risk free rate of return + beta (expected market return –risk free of return)

Required rate of return on the company’s shares as at 30 June 2015

Risk free rate of return 30 June 2015 = yield to maturity on the same date of 10 year Australian Treasury bond

= 2.98% (Source: Reserve Bank of Australia, 2017)

Expected market risk premium = 6.80%

Beta of the Mantra Group Limited: 1.68 (Source: Yahoo Finance, 2017)

Required rate of return on company shares= 2.98 + 1.68 *6.80 = 14.404%

5b) In this question beta and market risk premium has not been changed and there has been changed only in the risk free rate due to change in period of time

Risk free rate as on 30 June 2016: 2.12% (Source: Reserve Bank of Australia, 2017)

Required rate of return = 2.12 + 1.68*6.80 = 13.544%

Required rate of return reduced from 14.404% to 13.544% due to change in risk free rate of return. Risk free rate of return is taken as the 10 year yield to maturity on Australian treasury bonds and yield changes frequently due to change in market risk.

5 c) When the average risk aversion in the market decreases the slope of SML will decrease, so will the market risk premium. Therefore, there will be decrease in company required rate of return.

Collect and evaluate the company’s FCF and ROIC for the two financial years ending 30 June 2015 and 30 June 2016. Assume that the company’s cost of capital (WACC) was the same as the required returns (costs of equity) you calculated in Question 5?

Free cash flow of Mantra Group Limited as on 30 June 2015 = $ 43,512,000 (The wall Street Journal, 2017)

Free cash flow of Mantra Group Limited as on 30 June 2016 = $ 40,376,000 (The wall Street Journal, 2017)

Return on Invested Capital of Mantra Group Limited as on 30 June 2015 = 9.61% (Datanalysis, 2017)

Return on Invested Capital of Mantra Group Limited as on 30 June 2016 = 7.87% (Datanalysis, 2017)

Return on invested capital (ROIC) is calculated as percentage and it is expressed as annual percentage. It must be compared to the company’s WACC to determine whether company is calculating the value or not. WACC of the Mantra Group Limited is 14.404% in year 2015 and 13.544% in year 2016. In case if ROIC is greater than the WACC than value is being created, if not than value is destroyed. In the case of Mantra Group Limited Value is being destroyed as ROIC is less than the WACC in both the years.

References

About Us. 2017. Mantra Group Limited. [Online]. Available at: https://www.mantragroup.com.au/About-Us.aspx [Assessed on: 30 June, 2017].

Datanalysis. 2017. [Online]. Available at: https://financials.morningstar.com/ratios/r.html?t=MTR&region=aus&culture=en-US [Assessed on: 30 June, 2017].

Reserve Bank of Australia. 2017. [Online]. Available at: https://search.rba.gov.au/search?q=bond+yield+2016&btnG=&client=RBA4&proxystylesheet=RBA4&sort=date%3AD%3AL%3Ad1&wc=200&wc_mc=1&oe=UTF-8&ie=UTF-8&ud=1&exclude_apps=1&site=RBA-all  [Assessed on: 30 June, 2017].

Richelson, H. and Richelson, S. 2011. Bonds: The Unbeaten Path to Secure Investment Growth. John Wiley & Sons

Sutherland, J. and Canwell, D. 2004. Key Concepts in Accounting and Finance. Palgrave Macmillan.

The wall Street Journal. 2017. [Online]. Available at: https://quotes.wsj.com/AU/XASX/MTR/financials [Assessed on: 30 June, 2017].

Yahoo Finance. 2017. [Online]. Available at: https://finance.yahoo.com/quote/MTR.AX/key-statistics?p=MTR.AX [Assessed on: 30 June, 2017].