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BAFI1008 business finance

SCHOOL OF ECONOMICS, FINANCE AND MARKETING
BAFI1008 – BUSINESS FINANCE SEMESTER 2 2020
Take-Home Final Assessment

Section A

Question 1

You have a choice between receiving $500 now or $530 in six months' time. Current interest rates are 10% p.a. (simple interest).

  1. As a rational investor, which option would you choose and why?
  1. Calculate the minimum interest rate p.a. that would reverse your choice above.

(1 + 1 = 2 points)

Question 2

How much would you be prepared to pay for a share in two years' time when it begins to pay a 15c dividend each year and is currently priced at $2? Assume the required rate of return is 7.5% p.a.

(2 point)

Question 3

If management imposes a limit of $500,000 on capital investments, which of the following project combinations should it accept?

Project

Initial Cash Outlay ($)

Net Present Value ($)

Internal Rate of Return (%)

A

100,000

12,000

12

B

150,000

14,000

13.5

C

200,000

25,000

11.1

D

200,000

26,000

12.2

E

300,000

35,000

12.7

F

300,000

38,000

12.5

(2 points)

Question 4

A portfolio consists of 60% of Security A (expected return of 0.10 and standard deviation of 0.03) and 40% of Security B (expected return of 0.20 and standard deviation of 0.05) and the correlation coefficient between A and B is 0.0012.

  1. Calculate the expected return and standard deviation of the portfolio.
  1. Calculate the standard deviation of the portfolio if there was no diversification benefit.

(1 points)

Question 5

Assume that BHF Ltd has a current growth rate of 10% p.a. that is expected to be maintained for only another three years and then fall to 5% p.a., where it is expected to remain indefinitely. Given that the required return on BHF's shares is 12% and that the last dividend of 50 cents has just been paid, the price of BHF's shares will be:

(4 points)

Question 6

Karen has to make rental payments of $1000 at the start of every month, throughout the four-year duration of her university course. Her university fees are $4000 to be paid at the start of each year. She earns $1500 per month (paid at the end of each month) from a parttime job. Assume an interest rate of 8% p.a. and that she keeps the part-time job for the next four years. How much money, in present value terms, can she withdraw each month for the next four years?

(3 points)

Question 7

If you don’t repay a loan, and a lot of time passes, the debt can grow to unmanageable proportions, as happened to an unfortunate borrower in Melbourne.

A grandmother has been forced to put her house up for sale after she ended up owing a massive $83 000 —on a $15 000 loan. Andrea lane, 57, borrowed the money in 2002 to pay for her father’s funeral and to buy a new oven for her Clayton home.

But she could not meet the cost of the loan and 18 years later, the amount she owed had grown to $83 000 … Andrea said: ‘I borrowed the money when I was grieving for my father. I just signed the papers.’

  1. Based on original loan of $6000, calculate the monthly repayments to be repaid over 5 years. Assume an interest rate of 25% p.a.

Andrea can afford to pay $600 per month into the loan, and she has been able to negotiate a new interest rate of 8% p.a.

  1. How long would it take Andrea to repay the loan?
  2. If she cannot afford to increase her current repayments, and is unable to negotiate a better interest rate, recommend a strategy to reduce the total length of time to repay the loan? Based on this strategy, how much interest would she save?

(1 + 2 + 2 = 5 points)

Section B

Question 8

A firm may choose a project with a rapid payback period rather than one with a larger net present value. Discuss the validity of this statement.

(2 points)

Question 9

The internal rate of return represents the rate of interest that recovers the initial investment outlay. Discuss the validity of this statement.

(3 points)

Question 10

In the face of the global financial crisis, Kevin Rudd introduced government guarantees on deposits. Discuss covering at least the following two parts:

  1. An introduction/summary of the Government Guarantee.
  2. The general impact of this policy to the efficient frontier based on the Australian environment.

(2 + 2 = 4 points)

Question 11

The market value of a company is calculated as the sum of the net assets and owners equity on the company's balance sheet. Discuss the validity of this statement.

(3 points)

Question 12

As debtholders rank ahead of shareholders, it is expected that the required rate of return on debt will be higher than the required rate of return on shares. Discuss the validity of this statement.

(2 points)

Question 13

The capital asset pricing model (CAPM) assumes that all securities are priced according to their unsystematic risk. Discuss the validity of this statement.

(2 points)

Section C

Consider the following information:

Extract of balance sheet for LOMO Ltd. as at 30 JUNE 2020:

Equity $'000

Issued And Paid-Up Capital

21m 60c ordinary shares 12,600

13.7m $1 1.8% preference shares 13,700

Reserves and Retained Profits

Retained profits 8,000

Share premium reserve 7,300

General reserve 4,000

45,600

Debt

Mortgage 2,700

Debentures 3,560

Bank overdraft 10,432

16,692

You also have the following additional information available to you as of today:

  • The current market price of the firm's ordinary shares is $2.30.
  • The firm's preference shares are currently selling for $1.70 each.
  • The debentures will mature in 5 years. They have a coupon rate of 6% per annum. If the company currently sought long-term finance, it would have to pay interest rates of 8.9% per annum on debentures.
  • The mortgage has 4 years remaining and was taken out at 9.9%. Current rates are

11.5%

  • The firm is currently paying 8% per annum on its bank overdraft loan.
  • Interest on debentures, mortgage and the bank overdraft are paid half-yearly.
  • The corporate tax rate is 33 cents in the dollar.
  • The estimated Beta of the company's ordinary shares is 2.3.
  • The current yield on a 10-year government bond is 4.2% per annum.
  • The expected return on the market portfolio is 11% per annum.

Question 14

Required:

Calculate WACC. Display your results in the table below.

(5 points) Show your full working out.

Fill in the table below.

Component

Market

Weighting

Before-Tax

After-Tax

Weighted

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