Finance principle

IMPORTANT INSTRUCTIONS:

• This individual assignment is due by above date and time.
• Show all working to demonstrate you have understood how to solve each problem.
• If you use a financial calculator, state the sequence of steps to solve the problem.
• Please present your answers in at least 2 decimal points.
• Please attach this cover sheet. A typed or handwritten hard copy of the assignment must be submitted.
• Answer must be legible. If the marker cannot follow or read your answers, marks cannot be rewarded.
• Answer all sections.

Student ID Family Name Given Name Signature Name of your tutor

Marker’s use:

Section Number Marks for each section
Q1 /20
Q2 /20
Q3 /20
Q4 /20
Q5 /20
Total marks /100

What is the present value of a security that will pay $5,000 in 20 years if securities of equal risk pay 7% annually?

b) 3 marks
If you deposit $10,000 in a bank account that pays 10% interest annually, how much will be in your account after 10 years?

c) 6 marks
What is the present value of a $200 perpetuity if the interest rate is 7%? If interest rates doubled to 14%, what would its present value be?

d) 8 marks
You are negotiating a contract with your employer. You have been offered three possible 4 year contracts. Your opportunity cost is 10%. Payments are guaranteed, and they would be
made at the end of each year. Terms of each contract are as follows:

Year 1 Year 2 Year 3 Year 4
Contract A $55,000 $55,000 $55,000 $55,000
Contract B $55,000 $56,000 $58,000 $60,000
Contract C $80,000 $40,000 $50,000 $50,000

Which contract would you accept? Show workings.

The nominal interest is 12% with interest paid quarterly. What will be the effective annual rate?

b) 8 marks
Minnie has taken a 30-year mortgage for $500,000. The mortgage requires monthly payment of $5,143.06 with an interest rate of 12% per annum.

i. How much interest is in the first payment?
ii. How much repayment of principle is in the first payment?

c) 8 marks
Mickey is planning to save $50,000 per quarter for 10 years. Savings will earn interest at an (nominal) interest rate of 12% per annum. Calculate the present value for this annuity if interest is compounded semi-annually.

Question 4: Investment Decision Rules (chapter 8)

A firm with a 14% WACC is evaluating 2 projects for this year’s budget. After-tax cash flows are as follows:

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
Project A -$8,000 $2,200 $2,200 $2,200 $2,200 $2,200
Project B -$20,000 $5,700 $5,800 $6,000 $6,200 $6,500

i. Calculate NPV for each project. ii. Calculate IRR for each project.
iii. Calculate MIRR for each project.
iv. Calculate payback for each project.
v. Calculate discounted payback for each project.

Question 4: Risk and Return (chapters 11 and 12)

a) 10 marks
Consider the following information for two stocks, Stocks Y and Z and the returns on the two stocks are positively correlated.

Stocks Expected return Standard deviation
Y 9% 15%
Z 15% 17%

i. Assume you held a portfolio consisting of 60% of Stock Y and 40% of Stock Z. Calculate the average return of the portfolio during this period.
ii. Calculate the standard deviation of the portfolio if the correlation between Stock Y and
Stock Z is 10%.

b) 10 marks
An Italian restaurant chain will generate the following rates of return in the following scenarios:

State of economy Probability Rates of return if state of economy occurs
Boom 30% 125%
Normal Economy 50% 15%
Recession 20% -100%

i. Calculate the expected rate of return.
ii. Calculate the standard deviation of return for its shareholders.

Question 5: Cost of Capital (chapter 13)

a) 4 marks
XYZ Limited current share price is $20 and it has just paid a $1 dividend. As XYZ is a mature firm, this $1 dividend is expected to grow at a rate of 4% per year. What is an estimate of the return shareholders of XYZ Ltd expected to earn?

b) 4 marks
XYZ also has preference shares outstanding that pays $2 per share fixed dividend. If this stock is currently priced at $24, what is the return that preference shareholders expect to earn?

c) 4 marks
XYZ has issued a 5 year bond with a coupon rate of 11% and par value of $1,000. The price received by XYZ was $1,200. What is XYZ’s pre-tax cost of debt?

d) 4 marks
XYZ has 5m ordinary shares outstanding and 1 m preference shares outstanding. Its equity has a total book value of $50m and its liabilities have a book value of $20m. If XYZ’s ordinary and preference shares are priced as in parts a) and b), what is the market value of the XYZ’s assets?

e) 4 marks
XYZ faces a 30% tax rate. Given the information in parts a) – d), and your answer to those problems, what is XYZ’s WACC?

 

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