Question 1: In the last decade there has been a shift towards the direct transfer of funds from investors to the operate sector. Examine some of the reasons for this trend.
Question 2: (Annuity payment and term loan) On 31 December Liz Klemkosky bought a yacht for $50000, paying a deposit of $10000 and agreeing to pay the balance in 10 equal annual instalments that would include both the principal and 10 % interest. How big would the annual payments be?
Question 3: (CAPM and the required return) Assume the beta computed for CBA in problem 9-20 was estimated in 2010. What is tour estimate of the share investor's required rate of return? (If you did not do problem 9-20, assume a beta value of 1.1).
Question 4: (Ordinary share valuation) Header Motors Ltd paid a $3.50 ordinary share dividend last year. If the company's ordinary share dividends are expected to have a growth rate of 5% p.a., what is the value of each ordinary share of ordinary share investors require a 20% rate of return?
Question 5: (Bond Valuation) You own a bond with a par value of $1000 that pays a $100 annual coupon. The bond matures in 15 years. Your required rate of return is 12% p.a.
(a) Calculate the value of the bond.
(b) How does the value of the bond change if your required rate of return (i) increases to 15% p.a., or (ii) decreases to 8% p.a.?
(c) Assume that the bond matures in 5 years instead of 15 years. Recompute your answers in part (b).
Question 6: (EAAs) Greenberg Trading is considering two mutually exclusive projects, one with a four-year life and one with a nine-year life. The net cash flows form the two projects are as follows.
| YEAR |
PROJECT A |
PROJECT B |
| 0 |
-$160,000 |
-$160,000 |
| 1 |
65000 |
35000 |
| 2 |
65000 |
35000 |
| 3 |
65000 |
35000 |
| 4 |
85000 |
40000 |
| 5 |
|
40000 |
| 6 |
|
40000 |
| 7 |
|
45000 |
| 8 |
|
45000 |
| 9 |
|
45000 |
(a) Assuming a 10% required rate of return on both projects, calculate each project's EAA. Which project should be selected?
(b) Calculate the present value of an infinite-life replacement chain for each project.
Question 7: (Integrated problem) Correlli Ltd, a taxations category 2 company, has done some preliminary evaluation of the following four investment projects, as detailed below.
| Investment |
Investment cost |
Investment cost |
| A |
$200,000 |
18 |
| B |
125000 |
16 |
| C |
150000 |
12 |
| D |
275000 |
10 |
The latest balance sheet for the company shows:
| Long-term debt |
$ |
| Bonds: Par $100, annual coupen 16.35%, 5 years to maturity Equity |
1,500,000 |
| Preference shares (55000 shares outstanding, 94 cents dividend) |
550,000 |
| Ordinary Shares (825000 shares issued) |
1,650,000 |
| Total |
$3,700,000 |
The company's bank has advised that the interest rate on any new debt finance provided for the projects would be 8% p.a. The company's preference shares currently sell for $9.09, and to induce investors to take up a new offering of preference shares the company would have to set the issue price at a discount of 4% off the present market price.
The company's existing shares sell for $3.03 each and management has disclosed that it expects to pay a dividend of 16 cents at the end of the next year. Historically, dividends have increased at an annual rate of 9% p.a. and are expected to continue to do so in the future. The ordinary equity component to finance new projects will require new shares to be sold at a 10 % discount from the current $3.03 price, and the costs for undertaking the new issue are estimated to be 30 cents per share. The company tax rate is 30%
(a) Determine the market value proportions of debt, preference shares and ordinary equity comprising the company's capital structure.
(b) Calculate the after-tax costs of finance for each source of finance.
(c) Determine the after tax weighted average cost of finance for the company
(d) Determine which investments should be made.
Question 8: Briefly explain some of the reasons why the big banks borrow funds from overseas and how the use to which they put these funds provides evidence of the potential cost disadvantage to firms (the banks' customers) who borrow via term loans.