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What are the three important questions of corporate finance you will need to address?

 

Unit Code: HI5002
Unit Name: Finance for Business
Assignment: Tutorial Questions
Due: 11:30 pm Friday 16th October 2020
Weighting: 50%
Total Assignment Marks: 50 marks

 

Unit Learning Outcomes Assessed:
1. Identify business financial decisions, and critically analyze their impacts on value, and the nature
    of the broader financial and regulatory environment in which these decisions are made;
2. Critically evaluate the role of finance in business and appraise the way corporate managers use
    financial theory to solve practical problems;
3. Apply underlying finance theories, concepts, assumptions, limitations and arguments to make
    corporate finance decisions within real-world constraints.


Description:

Each week students were provided with three tutorial questions of varying degrees of
difficulty. These tutorial questions are available in the Tutorial Material Folder for each week on
Blackboard. The Interactive Tutorials are designed to assist students with the process, skills and
knowledge to answer the provided tutorial questions. Your task is to answer a selection of tutorial
questions for weeks 1 to 11 inclusive and submit these answers in a single document.

The questions to be answered are:

 

Question1(7 marks)
You are the new CFO of Risk Surfing Ltd, which has current assets of $7,920, net fixed assets of
$17,700, current liabilities of $4,580 and long-term debts of $5,890.

Required:
a. What are the three important questions of corporate finance you will need to address?
    Please briefly explain them and indicate how they are related to the areas in the balance
    sheet of a company. (1 mark)
b. Calculate owners’ equity and build a balance sheet for the company? (3 marks)
c. How much is net working capital of the company? (1 mark)
d. Calculate the return on assets of the company given that Return on Equity is 30%? (1 mark)
e. What is the PE of the company total number of ordinary share outstanding of the
    companies is 2,000 and market price of each share is $12? (1 mark)

 

Question 2 (11 marks)

You are a young personal financial adviser. Molly, one of your clients approached you for
consultation about her plan to save aside $450,000 for her child’s higher education in United
States 15 years from now. Molly has a saving of $120,000 and is considering different alternative
options:
Investment 1: Investing that $120,000 in a saving account for 15 years. There are two banks for
       her choice. Bank A pays a rate of return of 8.5% annually, compounding semi-annually. Bank B
       pays a rate of return of 8.45 annually, compounding quarterly.
Investment 2: Putting exactly an equal amount of money into ANZ Investment Fund at the end
       of each month for 15 years to get 330 000 she still shorts of now. The fund is offering a rate of
       return 7% per year, compounding monthly.

Required:
a) Identify which Bank should Molly choose in Investment 1 by computing the effective annual
    interest rate (EAR)? (2 marks)
b) Calculate the amount of money Molly would accumulate in Investment 1 after 15 years if she
    chooses Bank B? (2 marks)
c) How much is the annual interest rate, assuming compounding annually Molly should aim at if
    she chooses to invest her $120 000 in a saving account to get the $450,000 ready in just 10 years
    from now? (2 marks)
d) Calculate the monthly payment Molly needs to contribute into ANZ Investment Fund to get
     $330,000 after 15 years in Investment 2? (2 marks)
e) In investment 2, if Molly changes to contribute $1200/month to that super fund at the
    beginning of each month, how much money she would have in ANZ Investment fund after 15
    years? (2 marks)
f) Molly is offered an investment that will pay $12 000 each year forever. How much should she
   pay for this investment if the rate of return 12% applies? (1 mark)

 

Question 3(7 marks)

You are an active investor in the securities market and you have established an investment
portfolio of two stock A and B five years ago.

Required:
a) If your portfolio has provided you with returns of 9.7%, -6.2%, 12.1%, 11.5% and 13.3%
    over the past five years, respectively. Calculate the geometric average return of the
    portfolio for this period? (1 mark)?
b) Assume that expected return of the stock A in your portfolio is 14.6%. The risk premium
    on the stocks of the same industry are 5.8%, the risk-free rate of return is 5.9% and the
    inflation rate was 2.7. Calculate beta of this stock using Capital Asset Pricing Model
    (CAPM) (1 mark)?
c) Assume that you bought 200 stock B in your portfolio for total investment of $1200, now
    the market price of the stock is $75, the dividend paid for this stock is $2 each year. How
    much is the capital gain of this stock (1 mark)?
d) Assume that the following data available for the portfolio, calculate the expected return,
    variance and standard deviation of the portfolio given stock A accounts for 45% and                                                                  stock B accounts for 55% of your portfolio? (4 marks)

 

 

A

B

Expected return  

12.5%

18.5%

Standard Deviation of return

15%

20%

Correlation of coefficient (p)

0.4

 


Question 4(11 marks)

Blooming Ltd. currently has the following capital structure:

Debt: $2,500,000 par value of outstanding bond that pays annually 12% coupon rate with an annual before-tax yield to maturity of 10%. The bond issue has face value of $1,000 and will mature in 25 years.

Ordinary shares: 65,000 outstanding ordinary shares. The firm plans to pay a $7.50 dividend per share in the next financial year. The firm is maintaining 3% annual growth rate in dividend, which is expected to continue indefinitely.

Preferred shares: 40 000 outstanding preferred shares with face value of $100, paying fixed  dividend rate of 14%. 

Company tax rate is 30%.


Required:

Complete the following tasks:
a) Calculate the current price of the corporate bond? (2 marks)
b) Calculate the current price of the ordinary share if the average return of the shares in
    the same industry is 9%? (2 marks)
c) Calculate the current value of the preferred share if the average return of the shares in
    the same industry is 12% (2 marks)
d) Calculate the current market value (rounded off to the nearest whole number) and capital
    structure of the firm (rounded off to two decimal places). Identify the total weights of
    equity funding (2 marks)
e) Compute the weighted average cost of capital (WACC) under the traditional tax system
    for the firm, using dividend constant growth model for calculation the cost of ordinary
    equity (3 marks)


Question 5 (7 marks)

Bunnings Ltd is considering to invest in one of the two following projects to buy a new
equipment. Each equipment will last 5 years and have no salvage value at the end. The
company’s required rate of return for all investment projects is 8%. The cash flows of the
projects are provided below.

 

 

Equipment 1

Equipment 2

Cost

$186,000

$195,000

Future Cash Flows

 

 

Year 1

86 000

97 000

Year 2

93 000

84 000

Year 3

83 000

86 000

Year 4

75 000

75 000

Year 5

55 000

63 000



Required:

a) Identify which option of equipment should the company accept based on
    Profitability Index? (4 marks)
b) Identify which option of equipment should the company accept based on
    discounted pay back method if the payback criterion is maximum 2 years?
    (3 marks)

 


Question 6 (7 marks)

Net profit of Lily Fashion House Ltd in the current year is $2,575, 000. The company is planning
to launch a project that will requires an investment of $745 000 next year. Today the company’s
stock has market value of $22/share. Lily Fashion House has the current capital structure of 60%
in equity and 40% in debt.

Required:

a. The company is paying a cash dividend of $4.50/share plus an extra-cash dividend of
    $1.5/share. Tomorrow the stock will go ex-dividend. Explain why there is ex-dividend date
    and ex-dividend price? Calculate the ex-dividend price tomorrow morning. Assuming the
    tax on dividend is 25%? (2 marks)
b. How much dividend Lily Fashion House can pay its shareholders this year and what is
    dividend payout ratio of the company. Assume the Residual Dividend Payout Policy
    applies? (2 marks)
c. Floral Textile Ltd. is a daughter company of the Lily Fashion House Group and currently
    under a liquidation plan due to severe business contraction caused by the COVID 19
    pandemic. The company plans to pay total dividend of $3.5 million now and $ 8.5 million
    one year from now as a liquidating dividend. The required rate of return for shareholders
    is 13.5%. Calculate the current value of the firm’s equity in total and per share if the firm
    has 2.5 million shares outstanding? (3 marks)



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