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## Step-by-Step Guide for Analyzing Historical Market Returns

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.

## Comparison of the Risk and Return of the Company with the Market

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.

## Step-by-Step Guide for Analyzing Historical Market Returns

All the data has been taken from the reliable sources :

(a) Calculation of monthly percentage return for the company’s shares during period?

In order to answer this question company JB HI- FI Company has been taken for the further analysis (Brigham and Houston, 2004).

Interpretation

There has been shown monthly percentage return on the basis of Historical price of JB HI- FI finance from 30th June 2015 to 30th June 2016. It divulges that changes in share price of company are highly volatile which result into increase and decrease in return availability to shareholders in significant manner.

Monthly return= (Pt+1- Pt)/Pt

Pt+1= closing price of current year

 Date Adjusted Close Monthly Return 6/30/2015 10.92304 7/1/2015 10.52904 -4% 8/3/2015 10.1788 -3% 9/1/2015 10.0821 -1% 10/1/2015 9.84435 -2% 11/2/2015 11.15206 13% 12/1/2015 10.88697 -2% 1/1/2016 12.8507 18% 2/1/2016 13.06089 2% 3/1/2016 14.15255 8% 4/1/2016 13.28269 -6% 5/2/2016 13.7227 3% 6/1/2016 14.60622 6%

Monthly return= changes in return/ previous year adjusted close *100

(ASX, 2016).

In order to calculate the return changes in monthly adjusted close price of shares of JB HI-FI has been taken into consideration (Brigham et al. 1999).

Computation of standard deviation

Standard deviation has been computed as below

 standard deviation Date Monthly return X=monthly return-mean X*X 8/3/2015 0.00606 -0.03408 0.00116171 9/1/2015 0.09639 0.056241 0.00316306 10/1/2015 0.17033 0.130185 0.0169482 11/2/2015 -0.01408 -0.05423 0.00294078 12/1/2015 0.01667 -0.023478 0.00001714 1/1/2016 -0.03981 -0.07996 0.00639313 2/1/2016 0.03171 -0.00844 7.1185E-05 3/1/2016 0.00473 -0.03542 0.00125431 4/1/2016 -0.04000 -0.08014 0.00642313 5/2/2016 0.10294 0.062797 0.00394343 6/1/2016 0.10667 0.066522 0.00442521 Total 0.04674129 Variance 0.00424921 standard Deviation 0.06518595

Standard deviation has been computed on the basis of Excel formula which could be seen with the attached excels (Melicher and Norton, 2014).

MEAN= Total amount of monthly return for whole year/ number of months

Variances= total amount of X computed *X/ Number of month-1

Standard deviation

Computation of Annualize return and standard deviation (Thomson Reuters, 2016).

 Date Adjusted Close Monthly Return 8/3/2015 10.52904 -4% 9/1/2015 10.1788 -3% 10/1/2015 10.0821 -1% 11/2/2015 9.84435 -2% 12/1/2015 11.15206 13% 1/1/2016 10.88697 -2% 2/1/2016 12.8507 18% 3/1/2016 13.06089 2% 4/1/2016 14.15255 8% 5/2/2016 13.28269 -6% 6/1/2016 13.7227 3% Mean 14.60622 6%

MEAN= Total amount of monthly return for whole year/ number of months

Variances= total amount of X computed *X/ Number of month-1

Standard deviation=

Annualized standard deviation

=(1+0.07)^12-1

Average monthly return

=SUM(C3:C14)/12

Annualize return

=(1+0.03)^12-1

Repeat the same process in market share price index for calculating return and standard deviation

Computation of monthly return in market price index and JB HI- FI Limited (Nizam, et al. 2016).

 Date Adjusted Close Monthly Return Index( Market share) Monthly return 7/1/2015 10.52904 -4% 5699.2 4% 8/3/2015 10.1788 -3% 5207 -9% 9/1/2015 10.0821 -1% 5021.6 -4% 10/1/2015 9.84435 -2% 5239.4 4% 11/2/2015 11.15206 13% 5166.5 -1% 12/1/2015 10.88697 -2% 5295.9 3% 1/1/2016 12.8507 18% 5005.5 -5% 2/1/2016 13.06089 2% 4880.9 -2% 3/1/2016 14.15255 8% 5082.8 4% 4/1/2016 13.28269 -6% 5252.2 3% 5/2/2016 13.7227 3% 5378.6 2% 6/1/2016 14.60622 6% 5233.4 -3%

Computation of standard deviation of Market price index return and JB HI-FI limited

 Date Adjusted Close Monthly Return Index( Market share) Monthly return 7/1/2015 10.52904 -4% 5699.2 4% 8/3/2015 10.1788 -3% 5207 -9% 9/1/2015 10.0821 -1% 5021.6 -4% 10/1/2015 9.84435 -2% 5239.4 4% 11/2/2015 11.15206 13% 5166.5 -1% 12/1/2015 10.88697 -2% 5295.9 3% 1/1/2016 12.8507 18% 5005.5 -5% 2/1/2016 13.06089 2% 4880.9 -2% 3/1/2016 14.15255 8% 5082.8 4% 4/1/2016 13.28269 -6% 5252.2 3% 5/2/2016 13.7227 3% 5378.6 2% 6/1/2016 14.60622 6% 5233.4 -3% Standard deviation 7% 4%

Computation of Annualize standard deviation of Market price index return and JB HI-FI limited

 Date Adjusted Close Monthly Return Index( Market share) Monthly return 7/1/2015 10.52904 -4% 5699.2 4% 8/3/2015 10.1788 -3% 5207 -9% 9/1/2015 10.0821 -1% 5021.6 -4% 10/1/2015 9.84435 -2% 5239.4 4% 11/2/2015 11.15206 13% 5166.5 -1% 12/1/2015 10.88697 -2% 5295.9 3% 1/1/2016 12.8507 18% 5005.5 -5% 2/1/2016 13.06089 2% 4880.9 -2% 3/1/2016 14.15255 8% 5082.8 4% 4/1/2016 13.28269 -6% 5252.2 3% 5/2/2016 13.7227 3% 5378.6 2% 6/1/2016 14.60622 6% 5233.4 -3% Standard deviation 7% 4% Annualize Standard deviation 125% 60%

Computation of annualize return and annualize standard deviation of company

 Date Adjusted  Close Monthly Return Index( Market share) Monthly return 7/1/2015 10.52904 -4% 5699.2 4% 8/3/2015 10.1788 -3% 5207 -9% 9/1/2015 10.0821 -1% 5021.6 -4% 10/1/2015 9.84435 -2% 5239.4 4% 11/2/2015 11.15206 13% 5166.5 -1% 12/1/2015 10.88697 -2% 5295.9 3% 1/1/2016 12.8507 18% 5005.5 -5% 2/1/2016 13.06089 2% 4880.9 -2% 3/1/2016 14.15255 8% 5082.8 4% 4/1/2016 13.28269 -6% 5252.2 3% 5/2/2016 13.7227 3% 5378.6 2% 6/1/2016 14.60622 6% 5233.4 -3% Standard deviation 7% 4% Annualize Standard deviation 125% 60% Average monthly return 3% 0% Annualize return 43% 0%

MEAN= Total amount of monthly return for whole year/ number of months

Variances= total amount of X computed *X/ Number of month-1

Standard deviation=

Annualized standard deviation

=(1+0.07)^12-1

Average monthly return

=SUM(C3:C14)/12

Annualize return

=(1+0.03)^12-1

Thomson Reuters, (2016). JB HI FI Limited,JBHIFI:ASX historical prices - FT.com. [online] Markets.ft.com. Available at: https://markets.ft.com/data/equities/tearsheet/historical?s=NCK:ASX [ Accessed on : 22 march 2017.]

Computation of estimated expected return of company

Capital budgeting- It is the process of determining the best suitable investment decision for the investors when there is scarcity of resources. Capital budgeting is accompanied with NPV, IRR and payback period methods. (Brigham  & Ehrhardt, 2013).

## Comparison of the Risk and Return of the Company with the Market

Rf= Risk free rate of return= 3.75%

Rm- Market risk premium = 6.8%

Beta= .57

Computation of expected rate of return

RF+ (Rm-Rf)B

3.75+ (6.8%).57

= 7.62

However, it is analyzed that there is no high risk in the availability of return. In addition to this, the beta of company is also .57 that depicts that returns of company will change by .57 points in the same direction as in the changes in the market return.

It is further observed that company is providing less return to its shareholders as compare to market return. However, the risk of volatility in return is also less as compare to market. Beta of company depends upon the nature of company, its business volatility, market conditions and how it pursues its clients in market. If market risk and return will increase by 1 % then there will be changes in company’s risk and return in same direction.

(b)  Computation of required rate of return

Recalculation of required rate of return as on 30 June 2015

Rf= Risk free rate of return= 3.75%

Rm- Market risk premium = 6.8%

Beta= .98

Computation of expected rate of return

RF+ (Rm-Rf) B

3.75+ (6.8%).98

= 7.66

Risk and return of company in comparison of market risk and return

JB HI- FI Limited is having .57 beta which provides that if external factors of market changes by 1% then there will be changes in the earning of company by .57. However, JB HI- FI limited has been providing good amount of return for its investors. Therefore in compare to market company is less volatile in providing return and less risky as well.

There will be no changes in the required rate of return of company as it would be completely depends upon the beta of company. In both years beta has been taken as .57.

If investors knew the risk aversion in the market then it would result into decrease in required return. It would be inferred that if the risk aversion in the company increases then there would be less risk associated with the return. Therefore, it would be concluded that if investors would know the risk aversion of market then it would result into decrease in the return of the company. it could be justified with the proven market hypothecation that higher the risk then there will be higher the return available for the investors and vice versa.

## Description of a Likely Average Risk Capital Budgeting Project for Vadar Ltd

The prediction of risk aversion of shares would result into increment in the share price and more investor would want to invest their money in the capital of JB HI- FI limited.

© Average risk capital budgeting decision based on hypothesis of variable taken

In this question we could take two business decisions which JB Hi- Fi could take

First- Company could invest \$ 5, 00,000 to enter into joint venture with a small company which would result into cash inflow of \$1,00,000 for 10 years.

Second- Company could make investment of \$ 10, 00,000 in installing new machine which would add value chain of company and eventually results into 2,00,000 benefit for the company on yearly basis.

After analyzing both above project it would be inferred that company should make investment in project 1 as it provides positive NPV. However, IF NPV is most sensitive then company would need to manage project escalation amount for the uncertainty. The main risk in capital budgeting would be related with uncertainty of external factors. However, in order to mitigate such problem escalation of cost of capital 10% has been taken into consideration (Daunfeldt &Hartwig, 2014).Company will chose project-1 for its investment decision making as it provides for return for its investors.

It is the project financing technique which is used by investors for their investment decision. However, these are the decision making tools which is useful in case of scarcity of resources.

Helping Vadar Ltd has been planning to change its existing machines with two different projects. With its capital budgeting tools NPV has been computed to analysis the best suitable course of action. However, there are two options available for the helping Vadar for changing its existing business system. Vadar has planned to expand in its cricket apparel and developing new lighting system.

Project cricket

 Year 1 2 3 4 5 Working capital required \$   63,700.00 \$     5,733.00 \$   69,948.97 \$     2,705.72 \$   67,042.78 Net present value of WC \$   62,635.20 \$     5,542.94 \$   66,499.51 \$     2,529.29 \$   61,623.63 Sales \$ 490,000.00 \$ 534,100.00 \$ 582,169.00 \$ 558,882.24 \$ 536,526.95 Variable cost \$ 102,900.00 \$ 112,161.00 \$ 122,255.49 \$ 117,365.27 \$ 112,670.66 contribution \$ 387,100.00 \$ 421,939.00 \$ 459,913.51 \$ 441,516.97 \$ 423,856.29 Fixed cost \$ 215,000.00 \$ 221,450.00 \$ 228,093.50 \$ 234,936.31 \$ 241,984.39 EBDIT \$ 172,100.00 \$ 200,489.00 \$ 231,820.01 \$ 206,580.66 \$ 181,871.90 Depreciation \$   22,500.00 \$   22,500.00 \$   22,500.00 \$   22,500.00 \$   22,500.00 EBIT \$ 149,600.00 \$ 177,989.00 \$ 209,320.01 \$ 184,080.66 \$ 159,371.90 Tax @ 30% \$   44,880.00 \$   53,396.70 \$   62,796.00 \$   55,224.20 \$   47,811.57 PAT \$ 104,720.00 \$ 124,592.30 \$ 146,524.01 \$ 128,856.47 \$ 111,560.33 PAT( including depreciation) \$ 127,220.00 \$ 147,092.30 \$ 169,024.01 \$ 151,356.47 \$ 134,060.33 Total cash inflow \$ 127,220.00 \$ 147,092.30 \$ 169,024.01 \$ 151,356.47 \$ 208,603.11 P.V. factor \$            0.98 \$            0.97 \$            0.95 \$            0.93 \$            0.92 Present value of cash inflow \$ 125,093.41 \$ 142,215.86 \$ 160,688.77 \$ 141,487.20 \$ 191,741.45

Vedar by making computation in its cricket apparel business could easily drive good amount of benefits from its business functioning. By evaluating current situation it is considered that if company start to invest in these business functions of cricket apparel then it would earn good amount of profit as cash inflow (Burns & Walker, 2015).

The net present value is the amount of profit or difference between present values of cash inflow from the present value of cash outflow. The NPV of cricket apparel is already \$337396.13 which reflects that if company engaged in investing its money incricket apparel then it would end up with earning \$337396 from its business operations. Now it would be inferred that Vedar should invest their money in cricket apparel for creating value for its investment. However, company should arrange some money for the project escalation for the negative business situation. It is further observed that if Vedar would invest its money in cricket apparel business then it would result into diversification of business as well in different sector (Madura, 2003).

## Recommendation for the Lighting System for Vadar Ltd's Warehouse

Lighting system

Computation of total cash outflow of Incandescent lighting system

 Years 0 1 2 3 4 5 Cash outflow  OF first machine 8500 1000 1000 1000 1000 1000 P.V. factor 1 0.854701 0.730514 0.624371 0.53365 0.456111 Total cash outflow 8500 854.701 730.514 624.371 533.65 456.111

Computation of cash outflow of Fluorescent lighting system

 Years 0 1 2 3 4 5 6 7 8 9 10 Cash outflow  OF second  machine 13000 750 750 750 750 750 750 750 750 750 750 P.V. factor 1 0.854701 0.730514 0.624371 0.53365 0.456111 0.389839 0.333195 0.284782 0.243404 0.208037 5.658604 Present value of cash outflow 13000 641.026 547.885 468.278 400.238 342.083 292.379 249.897 213.587 182.553 156.028 16493.95

Computation of LED system

 Years 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 Cash outflow  OF third machine 19000 65 65 65 65 65 65 65 65 65 65 65 65 65 65 65 65 65 65 65 65 P.V. factor 1 0.854701 0.730514 0.624371 0.53365 0.456111 0.389839 0.333195 0.284782 0.243404 0.208037 0.17781 0.151974 0.129892 0.111019 0.094888 0.081101 0.069317 0.059245 0.050637 0.04328 5.627767 Present value of cash outflow 19000 55.5556 47.4834 40.5841 34.6872 29.6472 25.3395 21.6577 18.5109 15.8212 13.5224 11.5576 9.87832 8.44301 7.21624 6.16773 5.27156 4.50561 3.85095 3.29141 2.81317 76.51807

Analysis of lighting system

By evaluating all the information given in this project a detail computation has been made. In this equivalent methods has been used which provides the equivalent basis for all three projects. However, as per the equivalent annuity method it is divulged that project 2 Fluorescent lighting system should be selected by the Vedar as it provides less cash outflow In the given time manner. The annual cash outflow of all the three projects are given below. However, it is observed that company should opt for the project-2 as it gives less cash outflow in determined approach.

Due to different span of life of project Equivalent annuity method has been selected so that best suitable course of action could be developed for evaluating these three projects. In this method cumulative factors are used to identify the per year cash outflow of organization.

Conclusion

Now with the scarcity of resources company should invest its money in project-2 of Fluorescent lighting system which will result into less cash outflow as compare to other options available for the company.

Recommendation

By analyzing all the information given in these project it is observed that company should go for project -1 which will provide good amount of cash inflow and also assist company to make improvisation in its business functioning.

References

Bloomberg, (2017). Australia Govt Bonds Generic Yield 10 Year Analysis - GACGB10. [online] Bloomberg.com. Available at: https://www.bloomberg.com/quote/GACGB10:IND [Accessed 22 March 2017].

Brigham, E. and Houston, J. (2004). Fundamentals of financial management. Mason, Ohio: Thomson/South-Western.

Brigham, E., Gapenski, L. and Ehrhardt, M. (1999). Financial management. Fort Worth: Dryden Press.

Madura, J. (2003). International financial management. Mason, Ohio: Thomson/South-Western.

Melicher, R. and Norton, E. (2014). Introduction to finance. Hoboken, NJ: Wiley.

Thomson Reuters, (2017). Nick Scali Ltd, NCK:ASX historical prices - FT.com. [online] Markets.ft.com. Available at: https://markets.ft.com/data/equities/tearsheet/historical?s=NCK:ASX [Accessed 20 March 2017].

Brigham, E.F. and Ehrhardt, M.C. 2016. Account Finance. Cengage Learning, PP 1-549.

Nizam, N. Z., & Hoshino, Y. 2016. Corporate Characteristics of Retail Industry among 11 Asian and American Countries. Journal of Management Research, 8(1), 224-247.

Roth, M., 2017. Top Stocks 2017: A Sharebuyer's Guide to Leading Australian Companies. John Wiley & Sons.

ASX, (2016). ASX, [Online], Accessed on: 22 march 2017, Available at: https://search.asx.com.au/s/search.html?query=jb+hi+fi+ltd&collection=asx-meta&profile=web

Thomson Reuters, (2016). JB HI FI Limited,JBHIFI:ASX historical prices - FT.com. [online] Markets.ft.com. Available at: https://markets.ft.com/data/equities/tearsheet/historical?s=NCK:ASX [ Accessed on : 22 march 2017.]

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