ACCT 606 Financial Management for Accountants Semester Two 2022 Assignment # 2
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ACCT 606
Financial Management for Accountants
Semester Two 2022
Assignment # 2
QUESTION 1: WEIGHTED AVERAGE COST OF CAPITAL (55 Marks)
Titan Industries Limited (TIL) is a large, publicly listed company specialising in manufacturing 300-WATT foldable electric scooters and has recently gained market share. The company is planning for a new eight-year project to manufacture foldable electric scooters. For that, the company will build a new manufacturing plant on the land the company had bought five years ago for $8.25 million . The land is currently valued at $12.75 million . The management estimates that the land can be sold for $15.3 million after taxes in eight years. The Plant for the project will cost $235 million to build, and the company is expecting a four-year payback period for the entire project. The following market data on Titan Industries Limited securities are current:
Debt |
$140,000,000,4.25% coupon bonds outstanding with 20 years to maturity redeemable at par, selling for 97.5 per cent of par; the bonds have a $1000 par value each and make semi-annual coupon payments. |
Equity |
20,000,000ordinary shares, selling for $28 per share |
Non-redeemable Preference shares |
10,000,000 shares (par value $ 10 per share) with 3.25% dividends (after taxes), selling for $16.92 per share |
Additional Information:
• The company’s tax rate is 28%. The project requires $ 11.75 million in initial net working capital at period zero. The company had been paying dividends to its ordinary shareholders consistently. Dividend information for the past five years is as follows:
Year (-5) ($) |
Year (-4) ($) |
Year (-3) ($) |
Year (-2) ($) |
Year (-1) ($) |
Year (0) ($) |
0.76 |
0.79 |
0.84 |
0.86 |
0.90 |
0.96 |
• The manufacturing plant has a ten-year tax life, and the company uses the Diminishing value method of depreciation at 20% per annum. At the end of Year 8, the Plant can be scrapped for $ 48.5 million. The company’s estimations show that 238,000 electric scooters can be manufactured and sold per year (Years 1-8), and the selling price per unit in year one is $1,385, but the price will increase by 2% per year. Similarly, the variable costs per unit are expected to be $715 in year one, and the costs will increase by 2.25% per year in the subsequent periods. The project will incur $96 million per annum in fixed costs (fixed costs include coupon payments to bondholders). The company will sell the land at the end of year 8.
Required:
1. Calculate the project’s initial (time 0) cash flows (4 MARKS)
2. Compute the weighted average cost of capital (WACC) of Titan Industries Limited . Show all workings and state the assumptions underlying your computations. (16 MARKS)
3. Make a recommendation about whether Titan Industries Limited should go ahead with this project. Justify your recommendation by explaining why or why not. (35 MARKS) Note: To make a recommendation use the following methods. Where relevant, the WACC calculated in question 2 should be used as your discount rate .
a) Net Present Value (NPV),
b) Internal Rate of Return (IRR)
c) Profitability Index (PI),
d) Payback period, and
e) Discounted payback period
Note: Work all solutions to the nearest two decimals, show the depreciation table, and calculate
gain/loss on the sale of Plant and Land. Record tax effects in the income statement.
QUESTION 2
PORTFOLIO ANALYSIS
(45 Marks)
Suppose you are considering an investment in a two-factor portfolio. You wanted to analyse the stock return data for five years, from August 2017 to August 2022, of four companies listed on the New Zealand Stock Exchange (www.nzx.com). In any possible two-factor portfolio, the weight of each security in the portfolio will be 50%. The possible portfolio combinations are A&B; B&C; A&C; C&D; A&D, and B&D.
Companies for analysis:
A. Port of Tauranga Limited (POT)
B. Genesis Energy Limited (GNE) and any TWO NZ-listed companies of your choice.
Calculate monthly stock returns for the above four companies from August 2017 to August 2022. Stock return can be calculated using the formulae: Ri= (Pt - Pt-1)/Pt-1). Stock price data can be obtained either from https://finance.yahoo.comorfrom NZX Company Research (To access NZX Company Research, go to AUT Library> Business Databases> NZX Company Research).
Required:
1. Using the appropriate Excel function (see fx), determine the average monthly return, the standard deviation, and variance for each company. (Use 60-month returns data and use Excel functions “Variance . S” and “Standard Deviation . S.”) (4 marks)
2. Graphically show the stock price performance of the four companies for the periods from August 2017 to August 2022. (3 marks)
3. Comment on the companies’ stock price performance trend since August 2017. (3 marks)
4. Determine the covariance between securities A&B; B&C; A&C; C&D; A&D, and B&D. (Use the 60-month returns data and the Excel function “COVARIANCE S.”) (3 marks)
5. Using two-factor portfolio equations, calculate the portfolio returns and risks (show both standard deviation and variance for risk) for the SIX possible portfolios. (4 marks)
6. Select the best investment you would undertake. You may use the ratio of (Rp/6p) to select your investment choice. Explain the rationale for your choice of investment. (5 marks)
7. Draw a portfolio graph (showing Risk on the X-axis and Return on the Y-axis) for the investment portfolio that you have chosen in (6) above for a range of investment weights that you could choose from (i.e., you could invest 5% in one company and 95% in the other or 10% in one company and 90% in the other and so on).
Determine from the portfolio graph the minimum risk you could obtain for this portfolio and the respective
weightings that should be invested in each of the securities in the portfolio. (8 marks)
8. Determine betas for the four securities by regressing each company’s returns on the returns of S&P/NZX50 Index for the same period and explain what the beta values (i.e., the slope coefficients in the regression) indicate. (6 marks)
The S&P/NZX50 Gross index data can be obtained from:https://finance.yahoo.com/quote/%5ENZ50?p=^NZ50&.tsrc=fin-srch.
(Regression Calculation: Go to Data > Data Analysis and choose regression. The company returns constitute the Y input, and the index returns the X input. Alternatively, the “slope” found in f(x) also represents Beta.
If Data Analysis does not appear, you can add the tool. It is available in Excel. Go to File > Options, choose Add-ins, Manage, click the drop-down button, select Excel Add-ins, and then click on Go. Select Analysis Tool Pak and OK).
9. Can risky security have an expected return less than the risk-free rate? Why or why not? Explain.
Use a relevant example to support your answer. (5 marks)
10. The covariance of security with the rest of a well-diversified portfolio is a more appropriate measure of the risk of the security than the security’s variance- Explain. (4 marks)
2022-09-26