Finance Principle
Q1. Time Value of Money (Ch 4) & Interest Rates (Ch 5)
Bank Investment Scenarios
David plans to invest $10,000 in a 6-month term deposit with National Australia Bank (NAB). (For this question please refer to the ‘NAB Indicator rates –selected term deposit products’ schedule attached to this assignment).
a) What will David’s investment be worth when the above term deposit matures? (4 MARKS)
b) Sofia decides to employ a different investment strategy. She invests $10,000 in a 90-day term deposit and upon maturity she:
• consumes the interest by enjoying an evening at her favorite restaurant AND
• She then re-invests the principal ($10,000) in another 90-day term deposit (assume term deposit rates do not change over time). How does the return on her investment strategy (i.e. interest earned) compare with David’s strategy? (6 MARKS)
c) Jack invested $10,000 in a 9-month term deposit and his friend Sandra deposited $10,000 in a 12-month term deposit.
Jack wishes to have the exact same amount of monies available at the end of the 12 months as his friend Sandra. Thus Jack is aware he must re-invest the principal and any interest earned at the expiry of the 9-month term deposit.
2
What rate of interest on a 3-month investment must Jack earn on the monies at his disposal at the end of 9 months in order to ensure his and Sandra’s wealth is identical at end of month 12? (10 MARKS)
HINT (The correct answer must be given at the nominal interest rate (APR).
3
Q2. Interest Rates (Ch 5)
Lending Scenarios
Part I
You plan to borrow $380,000 from ANZ Bank to fund an investment opportunity. The Bank offers you a reduction in principal loan (in this type of loan repayments comprise principal plus interest) with a nominal interest rate (APR) of 6.8% compounded monthly over a 12-year period.
a) Calculate your monthly repayments to the Bank on the negotiated loan contract. (4 MARKS)
b) What will your outstanding dollar liability be to the Bank at the end of 6 years – assuming you choose not to negotiate a new loan facility with the Bank? (10 MARKS)
Part II
You have $100,000 at your disposal today. You wish to endow a college scholarship. You structure the scholarship so that, beginning today, it will pay out the same amount of money per year forever. The endowment discount rate is 7%.
c) Calculate the amount of money your donation will provide each year in perpetuity. (Note: The first payment to the scholarship does NOT begin next year but DOES begins today) (6 MARKS)
4
Q3. Net Present Value & Internal Rate of Return (Ch 8)
Capital Investment Scenarios
Dreamliner Airline is considering investing in several new aircraft. The initial investment will cost them $675 million. The investment is expected to produce revenue of $118 million per year over the next 25 years. The cost of running the new planes is $23 million per annum over the 25-year period.
a) Provide a graph showing the NPV (y-axis) over a range of the cost of capital (x-axis) from 0% to 20%. (Hint: Use of an excel spreadsheet is recommended. Please show workings) (10 MARKS)
b) Provide the IRR point to 2 decimal places. (4 MARKS)
c) Using the WACC you calculated in Q5 (you will not be able to answer this question until you complete Q5!) and following the IRR investment rule, should Dreamliner Airline take on the investment opportunity to buy the new planes? Explain why or why not? (4 MARKS)
d) Theory suggests the WACC calculation is simply an estimated figure for the cost of capital. Thus by how much could the company WACC deviate before Dreamliner Airline company managers would consider changing their investment decision? (2 MARKS)
5
Q4. Return and Risk (Ch 12)
Market Investment Scenarios
The following table shows monthly closing prices in dollars for four of Australia’s major stocks for given periods. These stocks are BHP Billiton (BHP), QBE Insurance (QBE), Wesfarmers (WES) and Woolworths (WOW). No dividends were paid by any of these companies during these periods.
Date
BHP
QBE
WES
WOW
3-Sep-12
$31.34
$12.37
$35.42
$30.56
1-Aug-12
$31.79
$13.03
$34.52
$29.62
2-Jul-12
$31.93
$14.04
$32.59
$28.57
1-Jun-12
$31.45
$13.38
$29.90
$26.80
1-May-12
$31.97
$12.38
$29.20
$26.44
2-Apr-12
$35.55
$13.84
$30.28
$25.94
You may answer this question using an EXCEL spreadsheet OR you may answer the question using CALCULATION or you may answer the question using both EXCEL and CALCULATION methods.
a) Determine the actual monthly historical returns for each of these stocks. (4 MARKS)
b) Determine the overall expected return for each stock given their historical returns for the complete period given. (4 MARKS)
c) Determine the overall volatility of each stock for the complete given period. (4 MARKS)
d) Plot the four stocks on a risk-return diagram. Label each stock with stock code. (4 MARKS)
e) Which stock appears the best investment on past performance, and why? (4 MARKS)
6
Q5. Cost of Capital (Ch 13)
Cost of funds Scenarios
Dreamliner Airline has 100,000 outstanding shares and is currently trading at $26 per share. The company expects the company dividend to be $2 per share next year. Thereafter the dividend will grow by 2 percent every year.
a) Calculate the cost of equity for this Company (Round the value to 4 decimal places). (4 MARKS)
This company’s only source of debt funding is by use of a perpetual note. This note is currently priced at $55. The note pays quarterly interest on a $100 face value. Assume a constant nominal rate of 4% (in practice the rate changes over time). The total number of notes on issue equal 50,000.
b) Calculate the cost of debt for this Company (Round the value to 4 decimal places). (8 MARKS)
c) Calculate the WACC for this Company (Note the tax rate is 30%). (Round the value to 4 decimal places).
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