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KOI

Trimester 2, 2018

FIN700 – Financial Management

ASSIGNMENT– GROUP

Due date: Submit to your Tutor by the start of your Tutorial in Week 9 – i.e., when held, from Monday, 10 September to Saturday, 15 September, 2018. Keep a soft copy in case of misadventure.

Penalties for late lodgment, as per the Subject Outline, will be strictly applied.

This Assignment consists of 4 problems, each involving calculations, and in some cases recommendations.

You are required to complete this Assignment in Groups of 2 or 3 or 4 people. **Groups of 1 or more than 4 persons will incur a penalty of 5 marks out of 30.** All members of the Group should come from the same Tutorial class. You may consult and discuss the Assignment topic with others, but you must write up your answers yourselves. Penalties for copying and plagiarism are severe.

You should follow the following typing conventions: 

Answers to be typed, in the space provided after each question



If additional pages are required, use the blank pages at the end.



Times New Roman font (at minimum, 12 pitch), 1.5 line spacing; and



Left and right margins to be at least 2.5 cm from the edge of the page.

Research, Referencing and Submission

T218 – FIN700 – Financial Management - Group Assignment Page 1 of 15

You should quote any references used at the end of each question. Use Harvard referencing! See http://en.wikipedia.org/wiki/Harvard_referencing As this is a calculations problem, there is no need to submit via TURNITIN.

Marking Guide

The Assignment will be scored out of 70%, with 20 marks also awarded for quality of Recommendations and 10 for Presentation, in line with the rubric in the Subject Outline. This mark will be converted to a score out of 30%.

Dr Mervyn Fiedler, Subject Coordinator, FIN 700. 10 August, 2018.

Do not submit this page submit from page 2 onwards, along with KOI Group Assignment Cover Page & Marking Rubric. ____________________________________________________________________ ***NOTE: When submitting Assignment, please submit from this page onwards, with a KOI Group Assignment cover page in front, and a FIN700 Marking Rubric at the back.***

Trimester T218

FIN700

GROUP ASSIGNMENT

Students: Please complete the following before submitting for marking.

Group members Student No.

Student Name

Percentage Contribution to Assignment

Signature T218 – FIN700 – Financial Management - Group Assignment Page 2 of 15

1. ……………………………………………………………………………………… ………

2. ……………………………………………………………………………………… ………

3. ……………………………………………………………………………………… ………

4. ……………………………………………………………………………………… ………

Tutor: Please circle one name: Dr Mervyn Fiedler; Ms Ruhina Karim; Mr Nishith Panthi; Mr Masoud Ahmadi-Pirshahid; Mr Paul Power; Dr Gazi Hossain

Tutorial

Day

…………………………………………………and

Time

……………………….

This Assignment consists of four questions. All questions must be answered. Please answer all questions in the spaces provided after each question. Two extra pages are included at the end of the Assignment, if more pages are required, please copy (or extend) page 15.

T218 – FIN700 – Financial Management - Group Assignment Page 3 of 15

QUESTION `1 [6 + 4 + 6 = 16 Marks.]

a) This is a two period certainty model problem. Assume that Bradley Lane has a sole income from Fisher Ltd in which he owns 12% of the ordinary share capital. Currently, Bradley has no savings. In August, 2018, Fisher Ltd reported net profits after tax of $800,000 for the last financial year, 2017-18 (1 July, 2017 to 30 June, 2018), and announced it expects net profits after tax for the current financial year, 2018-19, to be 20% higher than last financial year’s figure. The company has a dividend payout ratio of 70%, which it plans to continue, and will pay the annual dividend for 2017-18 in late-September, 2018, and the dividend for 2018-19 in late-September, 2019. In late-September, 2019, Bradley wishes to spend $95,000, which will include the cost of a new car. How much can he consume in late-September, 2018 if the capital market offers an interest rate of 10% per year?

Answer:

Amount $ Share in capital = 12% Profit after tax: for year 2017-18 for year 2018-19 Dividend payout ratio = 70% Dividend amount for Mr. Lane Market Interest Rate for year 2017-18 for year 2018-19 Mr. Lane wishes to spend $95,000 in late September 2019 so require to save amount = $95000 - $14360 Present Value of amount = Future Value / (1+r)n PV = 14360 / 1.1 Dividend received on September 2018 = Amount that can be spend = $67200 - $13055

800,000.00 960,000.00

10% per year 67,200.00 80,640.00 14,360.00 13,054.55 67,200.00 54,145.00

T218 – FIN700 – Financial Management - Group Assignment Page 4 of 15

Mr. Bradley Lane will be required to save $13054.55 in September 2018 to accomplish his wishes to spend $95,000 which include cost of a new car.

QUESTION 1 continued

b) This is an annual equivalent costs (AEC) problem. Speedy Delivery Ltd, which operates a courier service, requires a new van. It has received two quotes. Van A will cost $70,000 now, has a three year life and will cost $7,000 a year to operate. Van B will cost $90,000 now, has a four year life and will cost $9,000 a year to operate. The relevant discount rate is 6 per cent per annum. Ignoring depreciation and taxes, calculate the AEC for each. Which van do you recommend that Speedy Delivery Ltd buy, and state why?

Answer:

Particulars

Van A 70,000

Van B 90,000

(a) Cost (b) Life

.00 .00 3 Years 4 Years 7,00 9,00

(c ) Operating cost per year (d) Discounting factor @ 6% (e) Present value of operating cost = (c x d )

0.00 0.00 2.6730 3.4651 18711 31185.9 88,711 121,185

(f) Total Cost = (a + e)

.00

.90 33,187

(g) Annual equivalent costs (AEC) = ( f / d )

.80

34,973 .28

AEC of Van A is least in comparison of Van B. Hence, Speedy Delivery Ltd should buy Van A. Operating cost of Van A is less as compare to Van B which also includes discount factor 6%.

T218 – FIN700 – Financial Management - Group Assignment Page 5 of 15

QUESTION 1 continued

c) This question relates to the valuation of interest-bearing securities. Because of the drought, Farmers Bank Ltd has experienced large losses on its rural loan portfolio and is unable to meet its next two annual interest payments on its recent issue of unsecured notes. The notes are of $1,000 face value each, mature in September, 2023 and bear a yearly interest coupon payment of 13%. The Bank paid the interest due this month (September, 2018), and following a meeting of creditors, arranged to defer payment of the next two interest coupons due in September, 2019 and September, 2020 respectively. Under the arrangement with creditors, the Bank will pay the remaining interest coupons (due in September, 2021, September, 2022 and September, 2023) on their due dates, and pay the two deferred coupons (without interest) along with the normal final interest payment and face value of the notes on the maturity date. Farmers Bank Ltd’s notes are now seen as risky, and require a 19% per annum return.

REQUIRED: Calculate the current value of each Farmers Bank unsecured note.

Answer:

FV Interest Coupon Coupon per unit = 1000 x 13%

1,000.00 13%

Year 2021 2022 2023

Cash Inflow 130.00 130.00 1,390.00

130.00 PV@19% 77.14 64.83 582.48 $ 724.45

Current value of each Farmers Bank unsecured note is $ 724.45

T218 – FIN700 – Financial Management - Group Assignment Page 6 of 15

As per arrangement with creditors, Farmers Bank Ltd will pay the remaining interest coupons on their due dates and the two deferred coupons without interest. This will be along with the normal final interest payment and face value of the notes on the maturity date. Therefore, the cash flow of the year 2022 & 2023 shall be same.

References Bessis, J., 2015. Risk management in banking. John Wiley & Sons. Bierman Jr, H. and Smidt, S., 2012. The capital budgeting decision: economic analysis of investment projects. Routledge. Brigham, E.F. and Houston, J.F., 2012. Fundamentals of financial management. Cengage Learning. Damodaran, A., 2012. Investment valuation: Tools and techniques for determining the value of any asset (Vol. 666). John Wiley & Sons. Drury, C.M., 2013. Management and cost accounting. Springer. Madura, J., 2011. International financial management. Cengage Learning.

T218 – FIN700 – Financial Management - Group Assignment Page 7 of 15

QUESTION 2 [(4 + 4) + (2 + 2 + 3 + 3) = 18 Marks]

a) This question relates to the time value of money and deferred annuities. Ruth Bray is age 42 today and plans to retire on her 63rd birthday. With future inflation, Ruth estimates that she will require around $1,600,000 at age 63 to ensure that she will have a comfortable life in retirement. She is a single professional and believes that she can contribute $3,700 at the end of each month, starting in one month’s time and finishing on her 63rd birthday. i) If the fund to which she contributes earns 4.8% per annum, compounded monthly (after tax), how much will he have at age 63? Will she have achieved her targeted sum? What is the surplus or the shortfall?

Ruth Bray has achieved its targeted and there is surplus to Ruth Bray of $4515.591 ii)

Using the entire fund balance, Ruth then wishes to commence a monthly pension

payable by the fund starting one month after her 63 rd birthday, and ending on her 87 th birthday, after which she expects that the fund will be fully expended. If the fund continues to earn the above return of 4.8% per annum, compounded monthly, how much monthly pension will Ruth receive, if the fund balance reduces to zero as planned after the last pension payment on her 87th birthday? iii) Total Fund value at age of 63 Equal contribution for pension = 1604516 / (25 x 12) Rate per month = 4.8/12 Time period = 25 years x 12

1,604,516.00 5,348.39 0.40% 300 Months

Future value of Annuity =

Future value of Annuity = so Ruth will receive monthly pension till her 87th birthday =

3,091,610.00 10,305.37

QUESTION 2 continued. T218 – FIN700 – Financial Management - Group Assignment Page 8 of 15

b)

This question relates to loan repayments and loan terms. James and Mary Hall wish to borrow $750,000 to buy a home. The loan from the Federal Bank requires equal monthly repayments over 25 years, and carries an interest rate of 4.5% per annum, compounded monthly. The first repayment is due at the end of one month after the loan proceeds are received. You are required to calculate: i) The effective annual interest rate on the above loan (show as a percentage, correct to 3 decimal places).

James & harry Formula of Effective rate of Interest

Number of Compounding years Annual Interest Rate Effective Annual Interest Rate

300 4.50% 4.602%

ii) The amount of the monthly repayment (consisting of interest and principal repayment components) if the same amount is to be paid every month over the 25 year period of the loan.

Monthly installments EMI = [P x R x (1+R)^N]/[(1+R)^N-1] Principal Interest Per annum years No of Payments T218 – FIN700 – EMI

750000 4.5% 25 300 $4,168.74

nt Page 9 of 15

QUESTION2 continued.

iii)

The amount of $Y, if - instead of the above – the Federal Bank agrees that James

and Mary will repay the loan by paying the bank $3,000 per month for the first 12 months, then $3,500 a month for the next 12 months, and after that $Y per month for the balance of the 25 year term.

EMI = [P x R x (1+R)^N]/[(1+R)^N-1] Principal After payment of 2 Principal Interest Per annum years No of Payments PMT

739175.2 4.5% 23 276 $4,303.63

years

iv) How long (in years and months) would it take to repay the loan if, alternatively, James and Mary decide to repay $4,400 per month, with the first repayment again being at the end of the first month after taking the loan, and continuing until the loan was repaid. [HINT: The final repayment is likely to be less than $4,400, and will be paid one month after the final full installment of $4,400 is paid.)

EMI = [P x R x (1+R)^N]/[(1+R)^N-1] Principal EMI Interest

750000 4400 4.50%

T218 – FIN700 – Financial Management - Group Assignment Page 10 of 15

Repayment Period

22 years 11 Month

References Alhabeeb, M.J., 2012. Mathematical finance. Wiley. Brigham, E.F. and Houston, J.F., 2012. Fundamentals of financial management. Cengage Learning. Brooks, R. and Mukherjee, A.K., 2013. Financial management: core concepts. Pearson. Chandra, P., 2011. Financial management. Tata McGraw-Hill Education.

T218 – FIN700 – Financial Management - Group Assignment Page 11 of 15

QUESTION 3 [(2 + 2 + 4 + 3 + 3 + 2 = 16 marks]

This question relates to alternative investment choice techniques William Slater is considering the following cash flows for two mutually exclusive projects.

Year

Cash Flows, Investment P ($)

Cash Flows, Investment Q ($)

0

-60,000

-60,000

1

20,000

30,000

2

30,000

30,000

3

44,000

30,000

You are required to answer the following questions: i) If the cash flows after year 0 occur evenly over each year, what is the payback period for each project, and on this basis, which project would you prefer?

Answer:

Total cash flow of Project P ($20000 + $30000 + $44000) Cash flow occur from every year evenly so Cash flow every year = $94000 / 4 Payback period =

94,000.00 23,500.00

Year before full recovery + (Unrecovered cost at start of year / cash flow during the year) So 1 + ($13000 / $23500) = 1.55 Years Total cash flow of Project Q ($30000 + $30000 + $44000) 90,000.00 cash flow every year = $90000 / 4 22,500.00 Payback period = Year before full recovery + (Unrecovered cost at start of year / cash flow during the year) 1 + ($15000 / $22500) = 1.67 Years If cash flow started from 0 year evenly, Project P should be selected on the basis of payback period. Project P shall take lesser time to recover invested amount compare to Project Q. T218 – FIN700 – Financial Management - Group Assignment Page 12 of 15

This also implies that return on investment on the project P will be received earlier than the return on investment made on project Q.

IN THE REMAINING PARTS, ASSUME THAT ALL CASH FLOWS OCCUR AT THE END OF EACH YEAR.

ii)

Would the payback periods then be any different to your answer in i)? If so, what

would the payback periods be?

Answer:

Project P Year

Cash Flows

0 1 2 3

(60,000.00) 20,000.00 30,000.00 44,000.00

Payback Period = 2 + (10000 / 44000) Project Q Payback Period

2.23 years 2 years

Cumulative Cash Flows 20,000.00 50,000.00 94,000.00

Yes the answer would be different if cash flow occurs at the end of each year then return on project Q will be received earlier i.e. 2 years which is 2.23 year in the project P.

QUESTION 3 continued.

iii) If the required return is 8% per annum, what are: - The net present values of each project?

Answer:

T218 – FIN700 – Financial Management - Group Assignment Page 13 of 15

Project P Investment

60,000.00

Year

Cash Flows

1 2 3 Cash Flows Less: Investment Net Present Value Project Q Investment PV of Discounting Factor 8% for 3 years Present value of cash flows $30000 x PV of Discounting Factor 8% for 3

20,000.00 30,000.00 44,000.00

years Net Present Value

Discounting Factor@8% 0.9259 0.8573 0.7938

Amount 18,518.00 25,719.00 34,927.20 79,164.20 (60,000.00) 19,164.20

60,000.00 2.5771

77,313.00 17,313.00

Net Present Value of Project P is more than Project Q so Project P should be selected - The present value (or profitability) indexes of each project?

Answer:

Profitability Index = Cash Flows / Investments For Project P 1.3194 For Project Q 1.2886

QUESTION 3 continued.

iv) Calculate the internal rate of return (IRR) for each project. [NOTE: It is satisfactory if the approximate IRR is calculated for Investment P by trial and error, and stated as a percentage correct to the nearer whole number. The IRR for Investment Y, where the positive cash flows form an ordinary annuity, should be calculated as a percentage exactly, correct to 1 decimal place.] T218 – FIN700 – Financial Management - Group Assignment Page 14 of 15

Calculation of IRR by Trial & Error Method Project P Let be Rate 21% cash flow = (20000 x 0.826 + 30000 x 0.683 + 44000 x 0.564) For receiving cash flow we have to increase the rate Rate 22% cash flow = (20000 x 0.820 + 30000 x 0.672 + 44000 x 0.551) So IRR for Project p should be near to 22% to 23% Project Q Annuity factor of rate 22% 2.042 Cash flow = 30000 x 2.042 Annuity factor of rate 24% 1.9813 Cash flow = 30000 x 1.9813

61,826.00 60,804.00

61,260.00 59,439.00

v) Calculate the exact crossover point (an interest rate, expressed as a percentage correct to two places of decimals) of the respective net present values (NPVs) for the above projects.

Answer:

Calculation of the exact crossover point : Exact IRR by interpolation between 22% and 24% So 22% + [(61267 - 60000) / (61267 - 59439)] x 2

23.40%

vi)Having regard to the above calculations, state – with reasons - which of investments P and Q you would prefer.

Answer:

T218 – FIN700 – Financial Management - Group Assignment Page 15 of 15

Project P should be selected for the following reasons: 1. If cash flow started from 0 year evenly, Project P should be selected on the basis of payback period. 1. Net Present Value of Project P is more than Project Q so Project P should be chosen 2. Cash flow in the end of last year is greater in Project P than Project Q 3. Present value of both the project, project P is more favorable than Q. 4. Cash inflows of project P is more than project Q. References Arshad, A., 2012. Net present value is better than internal rate of return. Interdisciplinary Journal of Contemporary Research in Business, 4(8), pp.211-219. Brooks, R. and Mukherjee, A.K., 2013. Financial management: core concepts. Pearson. Gorshkov, A.S., Rymkevich, P.P., Nemova, D.V. and Vatin, N.I., 2014. Method of calculating the payback period of investment for renovation of building facades. Stroitel'stvo Unikal'nyh Zdanij i Sooruzenij, (2), p.82. Mackevičius, J. and Tomaševič, V., 2010. Evaluation of investment projects in case of conflict between

the

internal

rate

of

return

and

the

net

present

methods. Ekonomika, 89.