Assessment item 1
Task
Assessment 1 is an online test where you must complete 20 multiple-choice questions using the Test feature in Interact2 site by 9 August 2016.
Rationale
The rationale for this assessment is to encourage interaction and engagement in this subject from early weeks. This assignment covers work studied in Topics 1 and 2 and provides you with an opportunity to demonstrate specific technical competencies and skills in utilising quantitative techniques in financial analysis. This assignment will also be used to identify disengaged students.
Assessment item 2
Case Study - Risk Analysis
Task
You recently joined a small investment company in Sydney as an intern. As part of your first assignment you've been given an opportunity to invest $10,000 of a not so sophisticated investor to the following alternatives:
Capital Fashion Ltd bonds (apparel retailers), with a face value of $1,000 and a coupon interest rate of 8.75% are selling for $1,314 and mature in 12 years.
Agri Credit Ltd (financial services provider) preference shares are paying a dividend of $2.50 and selling for $25.50
Southern Cross Electrical Ltd (electrical appliances manufacturer) ordinary shares are selling for $36.75. The shares recently paid a $1.32 dividend and the company's earnings per share have increased from $1.49 to $3.06 in the past five years. The firm expects to grow at the same rate for the foreseeable future.
Your client's required rates of return for these investments are 6% for the bond, 7% for preference shares and 15% for the ordinary shares. Using the above information, answer the following questions:
1. Calculate the value of each investment based on the required rate of return.
2. Which investment would you recommend and why? Research on the current trends and future prospects on each of the industries and include a summary.
3. Assume Southern Cross Electricals' Chief Finance Officer expects an earning downturn and a resulting decrease in growth of 3%. How does this affect your recommendation?
4. What required rates of return would make your recommendation indifferent to all three options?
Rationale
This assessment task covers topics 1 to 6 and has been designed to ensure that you are engaging with the subject content on a regular basis.
The case study will provide an opportunity to apply the concepts in an authentic scenario that you may encounter in the workplace and also:
- be able to show suitable communication skills in the context of corporate finance.
- be able to show specific technical competencies and skills in utilizing quantitative techniques in financial analysis.
- be able to critically evaluate mainstream financial theory and concepts.
Presentation
Please refer to the presentation requirements in Appendix 1.
Assessment item 3
Task
You've been offered a full time position as an assistant financial analyst at Bathurst Metal Works. Your latest assignment involves the analysis of several risky projects. Because this is your first assignment dealing with risk analysis, you have been asked not only to provide a recommendation on the project in question but also respond to a number of questions aimed at judging your understanding of risk analysis and capital budgeting. The memorandum you received outlining your assignment follows:
To: Assistant Financial Analyst From: Chief Financial Officer
Re: Capital budgeting and risk analysis
You are required to conduct a risk analysis of the following new project, as outlined below. This new project involves purchase of a new laser cutting tool that can be used in Bathurst Metal Works' manufacturing division. The products manufactured using the new technology are expected to sell for an average price of $300 per unit, and the company analyst performing the analysis expects Bathurst Metal Works can sell 20,000 units per year at this price for a period of five years. To get started this business will require the purchase of a $2 million piece of equipment that has a residual or salvage value in five years of $200,000. In addition, Bathurst Metal Works expects to have to invest an additional $300,000 in working capital to support the new business. Other pertinent information concerning the business venture is as follows:
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Initial cost of the equipment
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$2,000,000
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Project and equipment life
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5 years
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Salvage value of equipment
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$200,000
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Working capital required
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$300,000
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Depreciation method
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Straight line
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Depreciation expenses
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$360,000
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Discount rate or required rate of return
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12%
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Tax rate
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30%
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In addition, estimates for unit sales, selling price, variable cost per unit and cash fixed cost for the base- case, worst-case and best-case scenario are as follows:
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Base-case
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Worst-case
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Best-case
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Unit Sales
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20,000
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15,000
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25,000
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Price per unit
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$300
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$250
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$330
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Variable cost per unit
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$200
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$210
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$180
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Cash fixed cost per year
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$500,000
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$450,000
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$350,000
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Depreciation
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$360,000
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$360,000
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$360,000
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i. Estimate the cash flows for the investment under the listed base-case value assumptions. Calculate the project's NPV for these cash flows.
ii. Evaluate the NPV of the investment under the worst-case assumptions.
iii. Evaluate the NPV of the investment under the best-case assumptions.
iv. Explain how sensitivity and scenario analysis are useful for evaluating project risk?
v. How can break-even analysis be helpful in evaluating project risk?
Rationale
This assessment task covers topics 1 to 10 and has been designed to ensure that you are engaging with the subject content on a regular basis.
This will provide an opportunity to apply the concepts in an authentic scenario that you may encounter in the workplace and also:
- be able to evaluate and explain the congruence of accounting, finance and treasury functions.
- Be able to demonstrate specific technical competencies and skills in utilising quantitative techniques in financial analysis.
Assessment item 4
Task
Rationale
The final examination will cover all the topics in this subject using a mixture of multiple choice questions, short question answers and quantitative problems which has been designed to ensure the following learning outcome are covered:
- be able to explain and critique the objectives of financial management in contemporary
- organisations;
- be able to critically evaluate mainstream financial theory and concepts;
- be able to discuss and evaluate ethical considerations in financial dealings;
- be able to demonstrate appropriate communication skills in the context of corporate finance;
- be able to demonstrate specific technical competencies and skills in utilising quantitative techniques in financial analysis.
PART A
Record your answers to the following questions on the answer sheet provided, using a 2B pencil. MULTIPLE CHOICE QUESTIONS
1. Which of the following is not a feature of accounting profits?
A. Rarely the same as cash flows.
B. Ignore timing of cash flows.
C. Ignore time value of money.
D. Make no provision for decline in asset values.
2. The principal goal of corporate financial management should be to:
A. Maximise reported profits.
B. Minimise tax liabilities.
C. Maximise sales.
D. Maximise shareholder wealth.
3. Required rates of return are influenced by:
A. An investment's expected rate of return.
B. Inflation.
C. The investor's opportunity cost of capital.
D. A, B & C.
4. A direct relation between risk and required rates of return implies that:
A. Investors are risk-takers.
B. Investors are risk averse.
C. Investors are risk neutral.
D. High-risk projects are preferred to low-risk projects.
5. Which of the following is an example of agency costs?
A. Production costs
B. Income tax
C. Excessive travel expenses incurred by management
D. Dividends
6. Assuming a company income tax rate of 30%, a fully-franked dividend of $15,000 carries a franking credit (to the nearest dollar) of:
A. $4,500 B. $19,500 C. $6,429 D. $10,500
7. Which of the following is not a necessary feature of an efficient secondary market?
A. An efficient title transfer system
B. Low transaction costs
C. Large numbers of buyers and sellers
D. A central business district location
8. Which of the following is not a financial asset of the holder?
A. Bank deposits
B. Debentures
C. Convertible notes
D. Accounts payable
9. If a nominal annual rate of 12% is compounded monthly, the effective annual rate is: A. 12.12%
B. 12.60%
C. 12.68%
D. 12.86%
10. The future value of $100 invested for four years at a nominal rate of 8% pa compounded quarterly is:
A. $136.05 B. $137.28 C. $450.61 D. $1,863.93
11. A company expects to pay an annual dividend next year of ten cents per share, which it expects will increase indefinitely thereafter at a rate of 2% per year. If the share's current market price is
$2.00, what is its expected annual rate of return? A. 6.67%
B. 6.93%
C. 7.10%
D. 10.67%
12. The relationship between interest rates and the term to maturity, where the risk of default is held constant, is known as the:
A. risk structure of interest rates
B. term to maturity
C. yield to maturity
D. term structure of interest rates
13. Which of the following is not a concept or definition of risk?
A. A combination of danger and opportunity
B. The range of possible outcomes
C. The standard deviation of possible outcomes
D. The expected outcome
14. Which of the following expressions best describes the notion of risk reduction through diversification?
A. Look before you leap.
B. A bird in the hand is worth two in the bush.
C. A stitch in time saves nine.
D. Don't put all your eggs in one basket.
15. If the risk-free rate is 4% and the expected market return 12%, what is the required rate of return for a security with a beta value of 1.2?
A. 9%
B. 12.5%
C. 15%
D. 13.6%
16. If a share plots above the Security Market Line, then:
A. it is overpriced
B. it is underpriced
C. it earns a return greater than that required for its level of risk
D. demand for the share will increase, causing its price to rise and its expected return also to rise
17. Which of the following is not one of the four main principles of corporate capital budgeting criteria?
A. Focus on cash flows
B. Maximising market share
C. Allowing for the time value of money
D. Allowing for project risk
18. The profitability index of a project is:
A. the ratio between the future value of a project's expected net cash flows and its initial outlay
B. the ratio between a project's net present value and its initial outlay
C. the ratio between the present value of a project's expected net cash flows and its initial outlay
D. the ratio between a project's average expected profits and its initial outlay
19. Which of the following statements about the payback period method of project evaluation is false?
A. the method deals with cash flows
B. the method provides a reliable indicator of a project's expected impact on shareholder wealth
C. the method can be used as a rough screening device to eliminate projects the returns of which will not materialise until later years
D. the method focuses on early cash flows, which are less uncertain than later cash flows
20. Which of the following is irrelevant to project evaluation?
A. initial outlay
B. differential cash flows over the project's life
C. terminal cash flows
D. sunk costs
21. Which of the following five indivisible projects should a company invest in, given a capital budget constraint of $1 million?
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Project
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Initial outlay
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Profitability Index
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Net Present Value
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A
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300,000
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1.22
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66,000
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B
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200,000
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1.20
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40,000
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C
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600,000
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1.15
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90,000
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D
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500,000
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1.12
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60,000
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A. A, B & C
B. A & B
C. A & C
D. A, B & D
22. Which of the following measures is most suitable for choosing mutually exclusive projects of unequal lives?
A. Net Present Value
B. Internal Rate of Return
C. Accounting Rate of Return
D. Equivalent Annual Annuity
23. Which of the following is not used to evaluate or allow for risk in capital budgeting?
A. risk adjusted discount rates
B. certainty-equivalent cash flows
C. simulation
D. accounting rate of return.
24. If a 90-day bill with a face value of $100,000 is issued at an annual discount rate of 6.75%, what will be the net proceeds of the issue after paying an acceptance fee of $100?
A. $98,124.87 B. $98,262.86 C. $92,807.42 D. $98,024.87
25. A firm offers a prompt settlement discount of 1% to its debtors for accounts settled within ten days of the invoice date. What is the annualised cost of the discount as a percentage of the funds obtained through prompt settlement? Assume: (i) annual compounding; (ii) that debtors taking the discount will pay on the tenth day after the invoice date and that those who don't take the discount pay 33 days after the invoice date.
A. 12.00%
B. 16.03%
C. 12.82%
D. 12.68%
26. A company has the following capital structure:
Source After-tax cost % per year Market Value $ in million
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Debt
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10
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20
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Preference shares
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12
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20
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Ordinary shares
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15
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60
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Accounts payable
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-
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10
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What is the company's after-tax weighted average cost of capital? A. 13.40%
B. 12.83%
C. 12.33%
D. 9.25%
27. A zero-coupon bond will be redeemed ten years from now at its face value of $1,000. If the market yield for this type of investment is 8%, the bond's current market price is:
A. $1,000.00 B. $1,064.18 C. $935.82 D. $463.19
28. The most relevant alternative to acquiring the use of an asset through a financial lease is:
A. buying the asset
B. borrowing the asset
C. hiring the asset
D. owning the asset
The following information relates to the next three questions.
A company has seven million shares on issue with a current market price of $9.44 per share. The company decides to raise additional share capital of $6.3 million through a rights issue offered at $9.00 per share.
29. How many new shares will be issued?
A. 6.3 million B. 700,000
C. 630,000
D. 810,000
30. What will be the value of one right (to acquire one new share)? A. $0.60
B. $0.837 C. $0.93 D. $0.40
31. What will be the theoretical ex-rights price per share? A. $9.90
B. $10.00 C. $9.40 D. $9.60
32. Business risk is a direct result of a firm's
A. financing decisions
B. investment decisions
C. debt-equity ratio
D. price/earnings ratio
The following information relates to the next five questions.
Alpha is an unlevered firm in which shareholders require a return of 14% after-tax. Alpha is valued at
$100,000 and corporate taxes are 30%.
33. What are the perpetual earnings before interest and taxes of Alpha? A. $25,000
B. $15,000 C. $26,667 D. $20,000
34. What is the theoretical value of Alpha if it uses $70,000 of new perpetual debt to buy back shares if the interest rate is 10%?
A. $109,600 B. $121,000 C. $108,000 D. $128,333
35. What return will shareholders require in Alpha after it becomes levered? A. 9.3%
B. 19.6%
C. 22.1%
D. 17.8%
36. What is the weighted average cost of capital in Alpha if it is unlevered? A. 15.0%
B. 14.2%
C. 12.5%
D. 14.0%
37. What is the weighted average cost of capital in Alpha after it issues the debt? A. 15.4%
B. 15.5%
C. 12.1%
D. 11.6%
38. Which of the following is the correct sequence of events relating to the payment of dividends?
A. Announcement date, record date, ex-dividend date, payment date.
B. Announcement date, payment date, ex-dividend date, record date.
C. Announcement date, ex-dividend date, record date, payment date.
D. Ex-dividend date, announcement date, record date, payment date.
39. Which of the following is least likely to provide a company with a means of transferring value to its shareholders?
A. A share buy-back.
B. A cash dividend.
C. A dividend reinvestment plan.
D. A share split.
40. A company has just paid a dividend of $0.10 per share. If dividends are expected to grow indefinitely at an annual rate of 4% and the required rate of return is 12%, what is the intrinsic value of the share?
A. $1.20 B. $1.25 C. $1.30 D. $1.35
PART B
This part comprises five (5) questions worth 12 marks each. Attempt all questions and record your answers in the answer book provided.
Question 1
Briefly explain what is meant by the "agency problem" and outline measures that a company might take to minimise that problem.
Question 2
(a) A bond has a redemption value of $100 and a redemption date ten years from now. It has a coupon rate of 8% and pays interest twice per year. If the current annual bond yield is 6% what is the bond's current value? Give your answer in dollars to two decimal places. [Note that an annual bond yield is simply divided by two to arrive at the half-year yield.]
(b) Sydney Bank has just paid an annual dividend of $0.40 per share. If its dividends are expected to grow indefinitely at a rate of 5% per year and the required rate of return is 12% per year, what is the intrinsic value of one Sydney Bank share? (Give your answer in dollars to two decimal places.)
(c) Given a risk-free rate of 4.25% and an expected market return of 12.00%, what is the required rate of return for an asset with a beta value of 1.2? (Give your answer in percentage points to two decimal places.)
(d) Sydney Bank has just paid an annual dividend of $0.40 per share. Today its shares are trading at a price of $10. What return would an investor expect to earn by investing in Sydney Bank shares if its dividends are forecast to grow indefinitely at an annual rate of 3%? (Give your answer in percentage points to two decimal places.)
(e) If you purchase a share for $5.00 and sell it after one month for $5.06, what is your holding period return expressed as an effective annual rate? (Ignore transaction costs. Give your answer in percentage points to two decimal places.)
Question 3
(A) A company has a capital structure comprising 5 million issued shares with a current market price of $10 per share. Expected profit is $6 million, all of which will be paid out as dividends. The company has no debt and pays no tax on its profits.
(i) Under the present capital structure, what is the market value of the firm?
(ii) What is the rate of return (% pa) on the company's equity capital?
(iii) Suppose the company issues $5 million of long-term debt at an interest rate of 8% and uses the entire proceeds of the issue to buy back some of its ordinary shares.
(a) What will be the annual interest bill (in dollars)?
(b) What will be the expected annual profit after paying interest?
(c) How many shares will be bought back?
(d) What will be the total market value of equity after the share buy-back?
(e) What will be the total market value of the company (equity plus debt) after the share buy-back?
(f) What will be the rate of return (% pa) on the company's equity capital after the share buy-back?
(g) What will the company's weighted average cost of capital (WACC) after the share buy-back?
(B) Identify three (3) ways in which a company can return its profits to its shareholders.
Question 4
An asset can be purchased today at an installed cost of $1,000. It is forecast to generate annual operating net cash inflows of $250 for the next five years and to be sold for $100 at the end of four years. (Assume that there is no income tax and that annual net cash flows occur at the end of each year.)
(a) Draw a time-line showing all the cash flows relating to this asset.
(b) Using a discount rate of 10% per year, what is the present value of the forecast cash inflows? (Give your answer to the nearest cent.)
(c) Using the present value you calculated in part (b), what is the net present value of this project? (Give your answer to the nearest cent.)
(d) If the asset is depreciated at the rate of $200 per year:
(i) What will be the accounting profit in years 1 to 4?
(ii) What will be the accounting profit in year 5?
(iii) What will be the average annual accounting profit?
(iv) What will be the average investment (based on the asset's installed cost and salvage value)?
(v) What will be the accounting rate of return? (Give your answer in percentage points to two decimal places.)
(e) If the cash inflows can be reinvested at 10% per year, what will be the investment's modified internal rate of return?
(f) Assuming (for this part only) that the operating net cash inflows are generated continuously, how many years will it take to pay back the cost of the investment? (Give your answer in years to two decimals.)
Question 5
(a) A company's long-term capital currently comprises $32 million of debt and $52 million of equity. Its target capital structure is 40% debt; 60% equity. The company has $4 million of internally-generated funds that can be used to either finance the equity portion of new investments or pay dividends. The company's weighted average cost of capital is 14%. It is considering four investment opportunities, for which the required investment outlays and expected internal rates of return are shown below:
Project Investment Cost ($ '000) Internal rate of return (%)
A 1,800 17.50
B 1,000 16.00
C 2,200 14.50
D 2,800 13.65
(i) Which projects should be accepted?
(ii) What is the total investment cost of the accepted projects?
(iii) How much of that total investment cost should be funded from (i) new debt and (ii) existing equity? (Give your answer in dollars.)
(b) Ethics in finance or rather a lack of ethics is a recurring theme in the present context. Why do you think ethics is still relevant in the present competative financial environment? Give an example of a company carrying out ethical behaviour.