Question 1
Big Bang 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 Year 2 Year 3 Year 4 Year 5 |
86 000 93 000 83 000 75 000 55 000 |
97 000 84 000 86 000 75 000 63 000 |
Big Bang’s net income in current year is $450,000. The company maintains a capital structure of 55% in equity funding and 45% in debt funding.
Required:
- Identify which option of equipment should the company accept based on NPV method (Note: Please round up the result of each calculation of PV to 2 decimal places only for simplification)
- Identify which option of equipment should the company accept based on Profitability Index method.
- Which equipment option should the company finally choose if the company is facing soft capital rationing?
- How much dividend Big Bang Ltd can pay its shareholders given the chosen project you decided in question (c) and if the Residual Dividend Payout Policy applies?
Question 2
You are working as a personal financial adviser. Alecia, one of your clients approached you for consultation about her plan to buy her dream house that costs $400,000. Alecia has a saving of $100,000 and is considering two alternative options:
Investment 1: Investing that $100,000 in an investment that would pay a rate of return of 9% annually, compounding semi-annually for 15 years.
Investment 2: Buying her dream house now. Then Alecia needs to borrow $300,000 mortgage from Prosperity Bank. The current interest rate the bank offered for the new mortgage is 4% annually, compounding monthly. The standard life of mortgage in Australia is 30 years.
Required:
- Compute the effective annual interest rate (EAR) Alecia would actually get in Investment 1.
- Calculate the amount of money Alecia would accumulate in Investment 1 after 15 years.
- In Investment 1, how many year longer does Alecia need to wait until she has $400,000 to buy her dream house?
- Calculate the monthly mortgage payment Alecia needs to pay for 30 years in Investment 2.
- In investment 2, if Alecia leases the house to a company for a rent of $400 per week for 10 years, and put that rent in her bank account at the beginning of each week, how much money she will have in her bank account after 10 years if the interest rate is 3.5% annually, assuming compounding weekly?
Question 3
The following information is available for Blue Ocean Group Ltd.:
Debt: Outstanding corporate bond that pays annually 10% coupon rate with an annual before-tax yield to maturity of 12%. The bond issue has face value of $1,000 and will mature in 20 years.
Ordinary shares: Outstanding ordinary shares which just paid a $8.50 dividend per share in the current financial year. The firm is maintaining 4% annual growth rate in dividends, which is expected to continue indefinitely.
Green Lagoon is the daughter company of the Blue Ocean Group and has the following capital structure:
- 50,000 ordinary shares outstanding at a market price of $36 a share. The shares have just paid a $5.84 annual dividend and have a dividend growth rate of 2.8%.
- 32,000 preference shares with a 8% fixed dividend, outstanding at a market price of $50 a share. The preference shares have a par value of $100.
- The outstanding bonds have a total face value of $4,500,000. The bonds have face value per bond of $1000 and market price of 98.5% of face. The bond’s before tax YTM is 8%. The corporate marginal tax rate for the company is 30%.
Required: Complete the following tasks:
- Calculate the current price of the corporate bond for the Blue Ocean Group?
- Calculate the current market value of the ordinary share of the Blue Ocean Group if the average return of the shares in the same industry is 13%?
- Calculate the current market value (rounded off to the nearest whole number) and capital structure of the Green Lagoon (rounded off to two decimal places), identify the total weight of equity funding.
- Calculate the cost of each funding source or Green Lagoon in case the company would like to raise new funds, using dividend constant growth model for calculation the cost of ordinary equity.
- Compute the weighted average cost of capital (WACC) under the classical tax system for the Greeen Lagoon.
Question 4
You are a financial investor who actively buys and sells in the securities market. Now you have a portfolio, including four shares: $7,500 of Share A, $4,800 of Share B, $5,700 of Share C, and $2,500 of Share D.
Required:
- Compute the weights of the assets in your portfolio?
- If your portfolio has provided you with returns of 7.7%, 10.5%, – 8.7% and 14.2% over the past four years, respectively. Calculate the geometric average return of the portfolio for this period?
- Assume that expected return of the stock A in your portfolio is 13.2%. The risk premium on the stocks of the same industry are 6.8%, beta of this stock is 1.3. Calculate the risk-free rate of return using Capital market pricing model (CAPM)?
- You have another portfolio that comprises of two shares only: $500 Tesla shares and $700 Eagle shares. Below is the data of your portfolio:
Tesla | Eagle | |
Expected return | 13% | 20% |
Standard Deviation of return | 20% | 45% |
Correlation of coefficient (p) | 0.4 |
Compute the expected return of your portfolio.
e. Compute the expected risk (standard deviation) of the portfolio.
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