KOI Trimester 1, 2017 FIN700 – Financial Management ASSIGNMENT– GROUP v. 2 Due date: Submit to your Tutor by the start of your Tutorial on Monday, 15 May, 2017 or on Tuesday, 16 May, 2017. Keep a soft copy in case of misadventure. Penalties for late lodgment, as per the Subject Outline, will be strictly applied. This Assignment consists of 4 problems, each involving calculations, and in some cases recommendations. You are required to complete this Assignment in Groups of 2 or 3 or 4 people. All members of the Group should come from the same Tutorial class. You may consult and discuss the Assignment topic with others, but you must write up your answers yourselves. Penalties for copying and plagiarism are severe. You should follow the following typing conventions: • Answers to be typed, in the space provided after each question • If additional pages are required, use the blank pages at the end. • Times New Roman font (at minimum , 12 pitch), 1.5 line spacing; and • Left and right margins to be at least 2.5 cm from the edge of the page. Research, Referencing and Submission You should quote any references used at the end of each question. Use Harvard referencing! See http://en.wikipedia.org/wiki/Harvard_referencing As this is a calculations problem, there is no need to submit via TURNITIN. Do not submit this page. Submit page 2 onwards, with KOI Group Assignment Cover Page. Marking Guide The Assignment will be scored out of 100%, in line with the rubric in the Subject Outline. This mark will be converted to a score out of 30%. Dr Mervyn Fiedler, Subject Co-ordinator, FIN 700. 8 April, 2017. ______________________________________________________________________ ***NOTE:When submitting Assignment, please submit from this page onwards, with a KOI Group Assignment cover page in front.*** Trimester T117 FIN700 GROUP ASSIGNMENT Students: Please complete the following before submitting for marking. Group members Student No. Student Name Percentage Contribution to Assignment Signature 1. ……………………………………………………………………………………………… 2. ……………………………………………………………………………………………… 3. ……………………………………………………………………………………………… 4. ……………………………………………………………………………………………… Tutor: Please circle one name: Dr Merv Fiedler; Ms Ruhina Karim; Mr Hock Thye Chan; Mr Nishith Panthi. Tutorial Day …………………………………………………and Time ………………………. This Assignment consists of four questions. All questions must be answered. Please answer all questions in the spaces provided after each question. Two extra pages are included at the end of the Assignment. If more pages are required, please copy (or extend) page 12. QUESTION `1. [8 + (8 + 6) = 22 Marks.] a) This is a two period certainty model problem. Assume that Jack Black has a sole income from Wildcat Ltd in which he owns 10% of the ordinary share capital. In its financial year 2016-17 just ended, Wildcat Ltd reported net profits after tax of $500,000, and announced its net profits after tax expectation for the next financial year, 2017-18, to be 20% higher than this year’s figure. The company operates with a dividend payout ratio of 60%, which it plans to continue, and will pay the annual dividend for 2016-17 in mid-May 2017, and the dividend for 2017-18 in mid-May, 2018. In mid-May, 2017, Jack wishes to spend $40,000. How much can he consume in mid-May, 2018 if the capital market offers an interest rate of 8% per year? b) This question relates to the Capital Asset Pricing Model (CAPM) Fresh Fysh Ltd owns shares in four different companies, as set out below, and -based on their current share prices – expects the following returns. Company Name Expected Return (%) Beta Prawn Ltd 10.8% 0.5 Salmon Ltd 13.0% 0.8 Shark Ltd 15.6% 1.2 Trout Ltd 17.4% 1.7 The risk free rate of interest is currently 6% and the market risk premium is 8%. i) Based on the CAPM, which of the above shares are undervalued, overvalued or correctly valued on the share market? Show all calculations and reasons for your answers. ii) Using the above information, draw a Security Market Line graph, and plot all securities on the chart. QUESTION 2. [(4 + 6) + (4 + 6) = 20 Marks] a) This question relates to the time value of money and deferred perpetuities. Property Developers Ltd returns nothing to the owners in the first 3 years. At the end of the following 2 years, the returns are $120,000 and $220,000 respectively. After that, the return is $300,000 a year in perpetuity. The required return is 10 per cent per annum. All returns are received at the end of each year. i) What is the present value of the constant income flows at the beginning of the sixth year? ii) What is the present value now of the whole income stream? b) This question relates to loan repayments and loan terms. Three years ago, Linda Green borrowed $600,000 to buy a furniture business. The loan from BMX Bank required equal monthly repayments over 10 years, and carried.an interest rate of 7.2% per annum, compounded monthly. Today, after making the last monthly payment for the third year, the bank tells Lisa that the interest rate will be increased immediately to 9.6% per annum, compounded monthly, in line with market rates. It also tells her that, with the rise in rates, she has two alternatives. She can increase her monthly repayment (so as to pay off the loan by the originally agreed date), or she can keep paying the same monthly repayment as now, but this will mean that she must extend the term of the loan. You are required to calculate: i) The new monthly repayment if Linda accepts the first alternative. ii) The extra period added to the term of the loan if Linda adopts the second alternative. QUESTION 3. [(8 + 4) + (8 + 4) = 24 marks] a) This question relates to annual equivalent costs (AEC) William Gray is proposing to manufacture a new type of surfboard. He has two alternative proposals - Plan A (a three year plan) and Plan B (a four year plan) - under consideration. Under Plan A, the initial manufacturing costs are $100,000 immediately, followed by servicing costs of $3,000 a year at the end of each of the next three years. Under Plan B, the initial manufacturing costs are $90,000 immediately, followed by servicing costs of $8,000 a year at the end of Year 1, $9,000 at the end of Year 2, and $10,000 at the end of each of Years 3 and 4. The discount rate is 9 per cent per annum. Ignore depreciation and taxes. You are required to: i) Calculate the annual equivalent costs (AEC) of each Plan ii) Which Plan would you recommend to William Gray? Give reasons for your recommendation. b) This question relates to the valuation of bonds. Bradley White, a retired school teacher, has two 8 per cent per annum $100,000 Australian Government bonds that mature on 15 May 2020 and 15 May 2024 respectively. At the date of the last half-yearly interest payment, viz.,15 November, 2016, both bonds were selling at par. Since then, interest yields on bonds have risen by 2% per annum, compounded half-yearly. Sarah now intends to sell the bonds and put a deposit on a country property. i) Calculate the price she will receive from each bond if she sells on 15 May, 2017 at the new yield, immediately after receiving the interest payments due that day. ii) Explain the relative price movements in the two bonds, as evidenced in your answer to i) above. QUESTION 4. [30 + 4 = 34 marks]. This question relates to capital budgeting. Canberra Systems Ltd is considering the purchase of new technology costing $500,000, which it will fully finance with a fixed interest loan of 10% per annum, with the principal repaid at the end of 4 years. The new technology will permit the company to reduce its to reduce its labour costs by $190,000 a year for 4 years, and the technology may be depreciated for tax purposes by the straight-line method to zero over the 4 years. The company thinks that it can sell the technology at the end of 4 years for $20,000. The technology will need to be stored in a building, currently being rented out for $30,000 a year under a lease agreement with 4 yearly rental payments to run, the next one being due at the end of one year. Under the lease agreement, Canberra Systems Ltd can cancel the lease by paying the tenant (now) compensation equal to one year’s rental payment plus 10%, but this amount is not deductible for income tax purposes. This is not the first time that the company has considered this purchase. Twelve months ago, the company engaged Amazing Consultants, at a fee of $27,000 paid in advance, to conduct a feasibility study on savings strategies and the company made the above recommendations. At the time, the company did not proceed with the recommended strategy, but is now reconsidering the proposal. The company further estimates that it will have to spend $15,000 in 2 years’ time overhauling the technology. It will also require additions to current assets of $35,000 at the beginning of the project, which will be fully recoverable at the end of the fourth year. Canberra Systems Ltd’s cost of capital is 12%. The tax rate is 30%. Tax is paid in the year in which earnings are received. REQUIRED: (a) Calculate the net present value, that is, the net benefit or net loss in present value terms of the proposed purchase and the resultant incremental cash flows. (b) Should the company purchase the technology? State clearly why or why not. END OF ASSIGNMENT QUESTIONS ADDITIONAL PAGE 1 (for workings, or if your answers take more space.) ADDITIONAL PAGE 2 (for workings, or if your answers take more space).