Question 1

Part A

Assume you want to borrow \$6,000 for a period of four years. You have two choices. ANZ bank is offering to lend you the amount at 7.25% p.a.. You can also borrow from Westpac bank and will have to repay a total of \$8,162.93 at the end of four years. Which bank should you go with, and what is the interest rate if you borrow from Westpac bank?

Part B

Wilson Ltd has borrowed from a bank to invest in a project. The loan requires a payment of \$20,000 every year for five years. The lender quoted Wilson Ltd a rate of 8.50% p.a.. How much did the bank lend to Wilson Ltd?

Part C

Sarah is evaluating whether she should take over a retail business. The current owner had originally signed a 25-year lease, of which 15 years still remain. The restaurant has been growing steadily at a 5 per cent growth for the last several years. Sarah expects the business to continue to grow at the same rate for the remaining lease term. At the end of last year, the business had a net cash flows of \$310,000. What is the present value of this investment if the discount rate is 15%?

Part D

You have \$10,000 to invest for the next 40 years for your retirement. You are offered an investment plan that will pay you 5% per year for the next 20 years and 10% for the last 20 years. How much will you end up with in 40 years’ time? Does it matter if the investment plan pay you 10% for the first 20 years and 5% for the next 20 years? Why or why not?

Question 2

Part A

There is an opportunity to expand the existing business by purchasing a new machinery for production. The machinery costs \$500,000 and will be depreciated on straight-line basis to zero over 5 years. If the machinery will increase the operating profit before depreciation by \$150,000, \$160,000, \$170,000, \$180,000, and \$200,000 over these 5 years. What is the average accounting rate of return for the new machinery? Assume the machine is purchased with all equity and the tax rate is 30%.

Part B

There are two mutually exclusive investment opportunities. The initial investment for both projects are \$100,000. The first investment will generate \$20,000 per year in perpetuity. The second project is expected to generate \$15,000 for the first year and the amount will grow at 2% per year after that. The first cash flow for both investments start at the end of the first year.

1. Calculate the internal rate of return for both investments.
2. Assume the cost of capital is 7%, calculate the NPV for both investments.
3. Based on your answers in (a) and (b), which investment should you choose? Why?

Question 3

Dell Ltd has no debt outstanding, and currently has a market value of \$125 million. There are three possible scenarios for the next year:

 Economic condition Earnings before interest and tax (EBIT) Strong \$15 million Normal \$10 million Weak \$5 million

The company is considering issuing \$50m of debt with 5% interest rate. Dell will use the money raised through the debt issuance to repurchase the ordinary shares. There are currently 10 million shares outstanding.

1. Assume no tax, what are the possible outcomes for earnings per share (EPS) next year before the debt is issued?
2. Assume Dell has issued the debt and repurchased the shares, calculate (a) again. What do you observe?

Question 4

There are two stocks in your portfolio.

 Stock Weight E(r) Variance A 1/3 9% 0.0036 B 2/3 15% 0.0081

1. Assume stock A and B are perfectly positively correlated, calculate the risk and return for your portfolio.
2. Repeat (a), assume the correlation is 0. Why is the risk now lower than in (a)?

Question 5

Pearson Ltd is financed through the following sources:

• Ordinary share: 100 million shares outstanding, with current market price of one share at \$2.2
• Bank loan: \$100 million borrowed from ANZ bank with an interest rate of 6%  Corporate bond: Pearson’s corporate bond is currently trading at 80% of its face value. The bonds pay coupons once per annum and have a total book value of \$100 million. The current yield to maturity on the bond is 8% per annum.

The risk-free rate is 3% and the market risk premium is 6%. It is estimated that Pearson has an equity beta of 1.5. Assume corporate tax rate is 30%, calculate the WACC for Pearson Ltd.

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