For this question you are required to further analyse the ASX listed company you chose for Assignment 1. As in Assignment 1, use DatAnalysis to access the required company financial data. Index data can be found at websites suggested in the Web Links section of the unit’s MySCU site.
a) Analyse the historical market returns for the company’s shares from 30 June 2015 to 30 June 2016 (the last trading day). The following gives you a step-by-step guide to doing this analysis:
i. Calculate the monthly percentage returns for the company’s shares during the period. (To keep
it simple, ignore dividends for this analysis and use adjusted monthly closing prices.) Then calculate the average monthly percentage return and standard deviation of returns and, using the procedure described in your text, annualise the returns and standard deviation. (Assume that the shares are held for the entire period so that no capital gain is realised during the period and consequently there is no reinvestment and compounding.)
ii. Repeat the process in part i) for the same period but this time for the market as a whole, using the All Ordinaries price index as a proxy.
iii. Use CAPM to estimate the expected (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 6.8% and use the company’s current beta (thus assuming it has not changed since 30 June 2015).
iv. Using the figures you have calculated, discuss and evaluate the risk and return of the company in comparison with the market and expected return, and in light of events.
b) Recalculate the required return on the company’s shares as at 30 June 2016. What has happened to the required return and why How would the required return change if you also knew that average risk aversion in the market increased during 2016 What does theory predict would have happened to share prices as a result of these combined changes
c) Briefly describe a likely “average” risk capital budgeting project for the company. Consider its possible life, cash flow pattern and investment size relative to the company. Also hypothesise the avariables to which NPV might be most sensitive and would therefore need the most focus in project analysis. No quantitative analysis is needed to answer this question. Focus on qualitative factors. If the company has several business divisions, choose one for this question.
You are helping Vadar Ltd (VAD) with its capital budgeting decisions. The business produces and retails skateboards and extreme sports apparel, has a 17% cost of capital and is subject to a 30% tax rate. There are two major areas on which Vadar would like your advice.
Vadar is considering whether it should expand into cricket apparel. The opportunity has arisen because the building next door has become available for a five-year lease and trends suggest cricket apparel is a stable sector of the market, however already dominated by major brands.Plant and equipment will cost $225,000, which the business will depreciate for tax purposes using a prime cost rate of 10% per annum. When the project is wound up at the end of the five years, the general purpose equipment is expected to be sold for an estimated $7,500.
Sales in the first year are expected to be $490,000 increasing at a high rate of 9% in the second and third years and then falling by 4% per year for the last two years of the project as competition in the sector is continuous. Consultants called in previously by Vadar, who were paid $25,000 in fees, estimated that variable costs for the project will be 21% of its revenues. Building rental, fixed salaries and other fixed costs directly related to the cricket project are expected to be $215,000 in the first year and increase by 3% per year thereafter. The investment in net operating working capital related to the project is expected to be 13% of the following year’s sales revenues. This investment will be recovered by the end of the project. It is also thought that the project will cannibalise after tax profits of $62,000 per year for Vadar’s existing extreme apparel business.
Vadar needs to replace its warehouse lighting system as soon as possible because the existing system is overloaded. Three different systems are being considered. The first is a second generation incandescent lighting system which will last 5 years and cost $8,500 to install. The second is a fluorescent lighting system, which will last 10 years and cost $13,000 to install. The third is a LED lighting system, which will last 20 years and cost $19,000 to install. None of the systems will have any salvage value but all will be replaced at the end of their lives.
After examining all costs, the net cash outflows for each system are: $1,000 per year for the incandescent system, $750 per year for the fluorescent system; and $65 per year for the LED system. Requirements and marking criteria Provide Vadar with a memo that provides your recommendations on the issues outlined above. Your memo should also include details of your analysis and briefly explain and justify your chosen methods and any assumptions made. Table format for presenting figures is preferable. Twelve marks will be allocated to analysis of the cricket project and six marks to analysis of the lighting system. Marks for each will be awarded for demonstrated understanding of the issues through: justification of chosen analytical techniques, correct application of those techniques, discussion of assumptions made, and appropriate and insightful conclusions and recommendations.