QUESTION 1
a) This question relates to alternative investment choice techniques
Stanley Livingstone is considering the following cash flows for two mutually exclusive projects.
Year Cash Flows, Investment X ($) Cash Flows, Investment Y ($)
0 -40,000 -40,000
1 12,000 18,000
2 18,000 18,000
3 27,000 18,000
You are required to answer the following questions:
i) If the cash flows after year 0 occur evenly over each year, what is the payback period for each project, and on this basis, which project would you prefer?
IN THE REMAINING PARTS, ASSUME THAT ALL CASH FLOWS OCCUR AT THE END OF EACH YEAR.
ii) Would the payback periods then be any different to your answer in i)? If so, what would the payback periods be?
iii) Sketch freehand the net present value (NPV) profiles for each investment on the same graph. Label both axes and the NPV profile for each investment.
iv) Calculate the internal rate of return (IRR) for each project and indicate them on the graph. [NOTE: It is satisfactory if the approximate IRR is calculated for Investment X by trial and error, and stated as a percentage correct to the nearer whole number. The IRR for Investment Y should be calculated as a percentage exactly, correct to 1 decimal place.]
v) Calculate the exact crossover point and indicate it on the above graph.
vi) State which of the investments you would prefer, depending on the required rate of return (i.e., depending on the discount rate).
b) This question relates to the valuation of bonds.
Bradley White, a retired school teacher, has two 6 per cent per annum $100,000 Australian Government bonds that mature on 15 August, 2020 and 15 August, 2023 respectively. At the date of the last half-yearly interest payment, viz., 15 February, 2017, both bonds were selling at par.
Since then, interest yields on bonds have risen by 2% per annum, compounded half-yearly. Bradley now intends to sell the bonds and put a deposit on a suburban townhouse.
i) Calculate the price he will receive from each bond if he sells on 15 August, 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.
iii) Suppose that Bradley defers buying the bonds for 84days, that is until 7 November, 2017. How much will he pay for each bond on that day? [NOTE: Between the bond interest due dates from mid-August to mid-February is 184 days, during which time interest accrues on a compound basis.]