Question 1: Valuation
Gold Electronics is an electronics manufacturer located in Box Hill, Victoria. The company's CEO is Rachel Zhang, who inherited the company from her father. The company originally repaired household appliances when it was founded more than 50 years ago. Over the years, the company has expanded, and it is now a reputable manufacturer of various specialty electronic items. You, a recent MBA graduate, have been hired by the company in the finance department.
One of the major revenue-producing items manufactured by Gold Electronics is a smart phone. Gold Electronics currently has one smart phone model on the market and sales have been excellent. The smart phone is a unique item in that it comes in a variety of colours. However, as with any electronic item, technology changes rapidly, and the current smart phone has limited features in comparison with newer models. Gold Electronics has spent $750 000 developing a prototype for a new smart phone that has all the features of the existing one, but adds new features, such as Wifi Tethering. The company has spent a further $200 000 for a marketing study to determine the expected sales figures for the new smart phone.
Gold Electronics' production manager has produced estimates of the costs associated with manufacture of the new smart phone. Refer to the data for your group on the Part2_Data worksheet for the variable costs per unit and fixed costs for the operation per year. The estimated sales volume is 64 000 units in Year 1; 106 000 units in Year 2; 87 000 units in Year 3; 78 000 units in Year 4; and 54 000 units in the final year. The unit price of the new smart phone will be $485. The necessary manufacturing equipment can be purchased for $34.5 million and will be depreciated for tax purposes over a 7-year life (straight-line to zero). It is believed the value of the manufacturing equipment in 5 years' time will be $5.5 million.
Net working capital for the smart phones will be 20% of sales and will have to be funded at the end of the year. The cost of the raw materials is reflected in the variable unit cost. Changes in NWC will first occur at the end of Year 1 based on the first year's sales. Gold Electronics has a 30% corporate tax rate. Refer to the data for your group on the Part2_Data worksheet for the required return.
Rachel has asked you to prepare a report that answers the following questions:
1. MsZhangrequires you to prepare a cash flow analysis (refer to the cash flow template (named Part2.1_worksheet provided in spreadsheet)) by using a spreadsheet. Ms Zhang had been taught that there were various techniques for valuation such as the NPV, payback period, and IRR, and the profitability index (PI) which all could be used for this project. You want to be sure that any recommendation you make to Ms Zhang will be robust and carefully justified. Your job is to make sure this is the case. Explain.
2.How sensitive is the NPV to changes in the price of the new smart phone? (Hint: do a sensitivity analysis)
3.Should Gold Electronics produce the new smart phone?Suppose Gold Electronics loses sales on other models because of the introduction of the new model. How would this affect your analysis?
Question 2:
You recently graduated from university, and your job search led you to Chris Yachts. Since you thought the company's business was headed skyward, you accepted their job offer. As you are finishing your employment paperwork, Vivian, who works in the Finance Department, stops by to inform you about the company's new superannuation plan.
The Chris Yachts superannuation fund has several options for investments, most of which are managed funds. As you know, a managed fund is usually made up of a portfolio of assets. When you purchase shares in a managed fund, you are actually purchasing partial ownership of the fund's assets, similar to purchasing shares in a company. The return of the fund is the weighted average of the return of the assets owned by the fund, minus any expenses. The largest expense is typically the management fee paid to the fund manager, which makes all of the investment decisions for the fund. Chris Yachts uses Gold Financial Services to manage its superannuation plan.
Vivian then explains that the retirement investment options offered for employees are as follows:
1. Gold All Ordinaries Index Fund. This fund tracks the All Ordinaries Index. Shares in the fund are weighted exactly the same as they are in the All Ords. This means that the fund's return is approximately the return of the All Ordinaries Index, minus expenses. With an index fund, the manager is not required to research shares and make investment decisions, so fund expenses are usually low. The Gold All Ordinaries Index Fund charges expenses of 0.20% of assets per year.
2. Gold Property Trust Fund. This fund invests primarily in property trust shares. As such, the returns of the fund are slightly less volatile than the All Ordinaries Index. The fund can also invest 10% of its assets in companies based outside Australia and New Zealand. This fund charges 1.70% of assets in expenses per year.
3. Gold Bond Fund. This fund invests in long-term corporate bonds issued by companies domiciled in Australia and New Zealand. The fund is restricted to investments in bonds with an investment grade credit rating. This fund charges 1.40% in expenses.
4. Gold Money Market Fund. This fund invests in high-quality debt instruments, which include bank bills and government bonds. As such, the return on money market funds is only slightly higher than the return on government bonds. Because of the credit quality and nature of the investments, there is only a very slight risk of negative return. The fund charges 0.60% in expenses.
QUESTIONS
1.Assume you decide you should invest at least part of your money in an All Ordinaries Index fund of companies based in Australia. What are the advantages and disadvantages of choosing the All Ordinaries Index fund compared with the Bond Fund?
2.The returns of the Gold Property Fund are less volatile than those of the All Ordinaries Index fund, but more volatile than the rest of the managed funds offered in the superannuation fund. Why would you ever want to invest in the Property Fund? When you examine the expenses of the funds, you will notice that this fund also has the highest expenses. Will this affect your decision to invest in this fund?
3.A measure of risk-adjusted performance that is often used in practice is the Sharpe ratio. The Sharpe ratio is calculated as the risk premium of an asset divided by its standard deviation. The standard deviations and returns for the funds over the past 10 years are listed below. Assuming a risk-free rate of 4%, calculate the Sharpe ratio for each of these. In broad terms, what do you suppose the Sharpe ratio is intended to measure? Based on the Sharpe ratio, comment on each fund (refer to the "Assignment" folder on the Moodle site for the following information for this assignment).
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Gold Fund
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Ten-year Annual
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Standard Deviation
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All ordinaries Index Fund
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Property Fund
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Bond Fund
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Money Market Fund
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Part 2 Data
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Variable cost per unit ($)
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Fixed costs for operation($)
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Required return (%)
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253
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5078274
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13
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Part 3 Data
