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FINM7409 Financial Management for Decision Makers

Final Exam, Semester 1, 2022

Problem 1 (8 marks)

Part A (2 marks)

What is the present value of the following cash flow to be received?

a. $2000 received in 5 years at 10% compounded annually

b. $5000 received in 10 years at 5% compounded semi-annually

Part B (2 marks)

After researching various term deposit products, you have found that you can deposit your money in either Commonwealth Bank or Westpac Bank. Commonwealth Bank is offering a deposit rate of 10.5% compounded monthly, while Westpac Bank is offering 11% compounded quarterly. Which bank offers the better rate?

Part C (2 marks)

You would like to have $100,000 in 10 years’ time. To achieve your target, you plan to invest equal amount of money each year in the stock market. Assume the return from the stock market is 10% per year. Your first payment will be made immediately. How much should you invest annually?

Part D (2 marks)

Ten years ago, you took out a $300,000, 30-year mortgage loan to finance your house purchase. The interest is 6%, compounded monthly, and the monthly payment is $1,800. What is the outstanding balance on your current loan immediately after you make the 120th payment?

Problem 2 (10 marks)

Part A (6 marks)

As a graduate accountant, you are asked by your manager to evaluate two investment projects. Both projects concern the purchase of new machinery. The follow data are available for each project.

	A ($)	B ($)
Cost of machine	100,000	75,000
Expected profit before depreciation & tax
Year 1	50,000	25,000
Year 2	50,000	35,000
Year 3	30,000	35,000
Year 4	20,000	35,000

Estimated residual value at the end of Year 4

20,000

15,000

Assume the required rate of return for both projects are 10%, and straight-line depreciation is used. The company tax rate is 30%.

a. Calculate Accounting Rate of Return for both projects

b. Calculate the payback period for both projects

Part B (4 marks)

As the investment manager, you are evaluating two mutually exclusive projects. Both projects require the same initial investment of $20 million. The first investment will generate $4 million per year in perpetuity. The second investment will generate $3 million at the end of the first year and its revenues will grow at 3% per year thereafter. The cash flows of both projects start at the end of the first year.

a. Calculate the IRRs for both projects?

b. Calculate the NPVs for both projects, assume the cost of capital is 6%?

c. Given your answer to a) and b), which project should you choose and why?

Problem 3 (12 marks)

Part A (2 marks)

What is the relationship between yield to maturity and the value of a bond?

Part B (2 marks)

There are two types of return from investing in ordinary shares. What are they?

Part C (2 marks)

AAC Ltd issued a 90-day bank bill 30 days ago. The face value of the bill is $100,000. Ifthe current market yield on this bill is 4% per annum, what is the price of the bill today?

Part D (3 marks)

Altus Investment Ltd has just bought a bond with 10-year maturity and a face value of $100. The coupon rate is 6%, paid annually. Assume the required yield to maturity is 6%. A year later, Altus sold the bond when the yield to maturity is 5%. What is the return on this investment?

Part E (3 marks)

Sydney Train’s share price was $10 when the company announced that it will cut next year’s dividend to $0.6 per share from $1 (the dividend just paid). It will use the savings to expand its network, and as a result, the growth in dividend is expected to accelerate to 7% from current value of 4%. How do you think the announcement will affect Sydney Train’s share price? Hint: you need to calculate the new share price.

Problem 4 (10 marks)

Part A (2 marks)

CSL Ltd has a beta of 0.80. If the expected market return is 10% and the risk-free rate is 4%, what is the expected return for CSL Ltd according to CAPM?

Part B (2 marks)

Portfolio diversification effect depends on both the volatility of the individual stocks in the portfolio and the correlations among those stocks. Is this statement correct? Explain your answer.

Part C (4 marks)

You are evaluating an investment in a portfolio comprising two firms’ ordinary shares. You have collected the following information about the ordinary shares in BHP and Rio Tinto (both are large mining companies):

	Expected Return	Standard Deviation
BHP	0.15	0.2
Rio Tinto	0.18	0.24
Correlation coefficient	0.8

a. If you invest equal amount of money in these two firms, what is the expected return and the standard deviation of the portfolio?

b. What will be the standard deviation of the portfolio if the correlation coefficient becomes 0.3? Compared to (a), how should you change your investment strategy(hint: how can you lower correlation?)?

Part D (2 marks)

BP Oil Ltd has a beta of 1.2 and an expected return of 11%. A risk-free asset currently earns 4%.

a. What is the expected return on a portfolio that is equally invested in the two assets?

b. If a portfolio of the two assets has a beta of 0.8, what are the portfolio weights?

Problem 5 (10 marks)

Part A (2 marks)

Based on the most recent balance sheet, Susan identifies the total debt for the company is $8m million. The total interest payment for the coming year will be about $1 million. Susan then argues that “We owe $8 million, and we will pay $1 million interest. Therefore, our cost of debt is 12.5% ($1 million/$8 million)” . What’s wrong with this conclusion?

Part B (4 marks)

Brookfield Railway Ltd has the following securities outstanding:

Corporate bond: 20,000, 5.0% coupon bonds outstanding, at $1,000 face value, with

15 years to maturity. The bond is currently trading at par value.

Ordinary shares: 1,000,000 ordinary shares selling for $50 per share. The share will

pay a dividend of $3 next year. The dividend is expected to growth by 4% per year indefinitely.

Preference shares: 125,000, 6% preference shares (face value of $100) selling at $80

per shares.

Assume tax rate is 30%.

Calculate the WACC for Brookfield Railway Ltd.

Part C (2 marks)

Modigliani and Miller capital structure theorem states that firm value is not affected by the capital structure. But in reality, why do managers care a great deal about capital structure? List two reasons and explain.

Part D (2 marks)

Lunas Ltd currently has no debt outstanding, and is entirely financed by $1 million of equity. The company is considering refinancing and issuing $0.5 million of debt to buy back ordinary shares. The debt has 30-year maturity with an interest rate of 5% per year. Lunas currently has a dividend payout ratio of 100% and will maintain this rate into the future. The current income statement Lunas Ltd is presented below. Assume corporate tax rate is 30%.