Business Finance Assignment
This assignment contains FOUR Questions.
Question 1 -
a) How does maximising the price of a firm's share equate to maximising shareholder wealth?
b) Can an individual be indifferent to receiving a dollar now or a dollar one year from now? Explain.
Question 2 -
a) Mr. and Mrs. Peabody have recently had a daughter and want to send her to private school. School fees from kindergarten through to school year 7 (primary school) is to be $32,000, while those from school year 8 to year 12 (secondary school) is to be $50,000. Mr. and Mrs. Peabody's daughter is due to start school when she is five years old.
For simplicity, assume there are 8 years of school from kindergarten to year 7 inclusive (kindergarten, yr. 1, 2,...yr. 7). Additionally, assume that fees need to be paid, as a lump sum, at the beginning of both primary and secondary school.
Required:
- Draw a simple time line of the payments to help explain your answer.
- How much money must Mr. and Mrs. Peabody set aside now if fixed-term deposit rates from five to 10 years are currently 4% p.a. compounded monthly, and from 10 to 20 years are currently 6% p.a. compounded monthly? There is a penalty of 10% for withdrawal of funds from a fixed-term deposit before maturity.
b) You are considering two alternate investments - one a perpetuity and the other a stream of uneven cash flows.
The perpetuity pays $25,000 in perpetuity from year 6 onwards, while the uneven cash flow investment pays the following cash flows in years 2 to 7: Yr 2: $80,000, Yr 3: $70,000, Yr 4: $60,000, Yr 5: $50,000, Yr 6: $40,000 and Yr 7: $30,000.
Required: If you can only buy one of the above investments at a rate of return of 6% per annum, which would you prefer? Which would you prefer if you could achieve a rate of return of 8% per annum? Provide detailed workings.
Question 3 -
You have to set up your own retirement fund and aim to invest in a diversified portfolio of stocks of your choosing. In order to reduce the transaction costs of your investing you have estimated that you need to have a minimum of $100,000 to invest into your portfolio in 5 years.
To achieve this target you aim to save the money from your pay, which you will deposit, in equal monthly instalments, in a medium-term cash account offering a nominal rate of 3% per annum compounded monthly.
a) Calculate how much you need to invest on a monthly basis in order to have the $100,000 available to invest in five (5) years.
Accruing this amount of money is the 1st step in your plans for retirement, however, this amount is only a stepping stone as you realise that this will be insufficient for your retirement in 35 years. Given that you are aiming to invest in a diversified manner, you expect that you will achieve a rate of return similar to the market portfolio. You estimate that you can achieve a rate of return on your portfolio of 7% per annum, compounded monthly.
Note: You will not be investing more money, from your wages, into your portfolio as you are confident of your ability to generate returns and you wish to invest the money into other assets.
As indicated, you expect that you will have a working life of 35 years from today, after which you expect you will need a need a minimum of $6,000 per month to live comfortably, in retirement, for a following 25 years. For simplicity, assume that the $6,000 per month payment will be made at the end of the month.
Hint: Use a basic timeline to detail the cash flows.
b) Identify, using applicable calculations, whether you will have enough money (in the form of your portfolio investment) to support your $6,000 per month retirement allowance.
Question 4 -
a) You are considering two different investments. The first option is an investment of $12,000, which pays $19,000 in five years. Alternatively, the second option allows you to invest the $12,000 in a term deposit with pays 9% per annum, compounded monthly, over the same period. Which is the preferred option?
b) Compare a compounding interest rate and a nominal interest rate to an effective interest rate.