Banking and Finance: Share Prices, Royal Commission Impact, Capital Budgeting

This article discusses the share prices of AMP and CBA, the impact of Royal Commission on both firms, and the capital budgeting techniques used to evaluate two projects. It also explains the difference between NPV and IRR and their recommendations.

Running head: BANKING AND FINANCE
Banking and Finance
Student Name
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2BANKING AND FINANCE
Table of Contents
Part A:-.............................................................................................................................................3
Current Share price..........................................................................................................................3
Part A 2: Role of Royal commission and its impact on AMP and CBA.........................................4
Part B: Capital Budgeting................................................................................................................6
1.Difference between NPV and IRR...............................................................................................6
2. Determination of Net Present Value of both the projects............................................................6
3. Determination of IRR of both the projects..................................................................................7
4. Changes in required rate of return...............................................................................................8
5 Difference in recommendations in case of NPV and IRR............................................................9
References......................................................................................................................................10

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Part A:-
Current Share price
The current share prices of AMP and Commonwealth Bank of Australia (CBA) are 3.22 and
71.94 as of 22nd September, 2018 (Asx.com.au. 2018).
The trend analysis of share price of AMP over 5 years can be evaluated with the help of the
following graph:-
2014 2015 2016 2017 2018
0
1
2
3
4
5
6
4.33
5.57 5.42
5.04
3.21
Share prices of AMP
Graph 1: Share prices of AMP over the period of last 5 years
(Source: Asx.com.au. 2018)
From the above graph, it can be inferred that the share prices have declined over the last few
years. The highest was in the year 2015 and the current share price can be considered as the
lowest in comparison to other years. This cannot be considered as a positive sign for the firm
AMP..
The trend analysis of share price of Commonwealth Bank of Australia (CBA) over 5 years can
be evaluated with the help of the following graph:-

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2014 2015 2016 2017 2018
60
65
70
75
80
85
90
77.26
85.39 85.53
79.42
71.42
CBA
Graph 2: Share prices of CBA over the period of last 5 years
(Source: Asx.com.au. 2018)
From the above graph, it can be inferred that the share prices have declined over the last few
years. The highest was in the years 2015 and 2016 (85.39 and 85.53) and the current share price
can be considered as the lowest in comparison to other years (Asx.com.au. 2018). The trend of
the share prices cannot be considered as a positive sign for CBA as its share prices are declining
over the past few years
Part A 2: Role of Royal commission and its impact on AMP and CBA
The Royal commission was established in December, 2017. The major role of Royal
Commission is to identify any Australian financial services are dealing in any misconduct
activities. However, the activities of Royal commission can be considered as positive in the long
run, however, in case of short run, it may cause collateral damage to the economy of Australia.
In case of market risk (systematic risk), the impact will be negative, as interest rates will decline
due to its wide impact in Australian economy. It has been observed that the interest rates of
Australia has gone down to 1.5 percent (The New Daily. 2018). In case of unsystematic risk, it
will have a negative impact on the share prices of the firms and this will cause the investors to
lose their money. In addition to this, this will lead the banks to suffer reputational distress and

5BANKING AND FINANCE
hamper their brand image (Viney and Phillips 2015). It will also have a negative impact on
Australian stock market as a whole. Therefore, it can be concluded that Royal commission will
have a negative impact upon both systematic and unsystematic risk.
Royal commission have investigated upon the misconduct of both AMP and CBA. The
major findings are as follows:-
 There are problems in monitoring the mortgage brokers in case of CBA
 Effective risk management team in case of home loans in CBA
 AMP admitted that they lied to the regulators
 CBA was involved in changing the amount of fees of the clients who died (The New
Daily.2018).
This has caused a negative impact upon both AMP and CBA. In case of AMP, the market value
of the firm has dropped by $4million. CBA had to pay a penalty of $700 million civil penalty as
a result of its misconduct (CNBC. 2018).
When the news of misconduct came in, the shares of AMP went down by 5 percent which was
the lowest since 2003. Since February when the inquiry of the commission started, the shares of
AMP went down by 36 percent, which is not a very good sign for the firm.
In case of CBA, the bank paid a penalty of $700 million as civil penalty. However, the bank also
declared 8.6 percent dividend yield which is exceptionally high (Mfam.com.au 2018). This
attracted more investors. After the news, the share prices of CBA did fall to 67.45 percent during
May and June, however, due to declaration of dividend, the prices got increased again in July,
2018 (The New Daily. 2018).

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Part B: Capital Budgeting
1.Difference between NPV and IRR
The difference between Net present value and Internal rate of return can be explained with the
help of the following table:-
NPV IRR
Definition Total summation of all the
present values of cash flows
is termed as Net present value
of the project
The rate of return in which
summation of discounted
cash inflows is equal to cash
out flows is termed as IRR
Significance It represents the total amount
of surplus from the project
It represents the
break-even point of the
project
Value NPV is expressed in absolute
terms of value
IRR is expressed in
percentages
Changes in expected rate of
return
If expected rate of return
decreases, NPV will increase
and vice versa
Changes in expected rate of
return do not have any impact
on IRR
:
Table 1: Difference in Net Present Value and Internal rate of return
(Source: Weber 2014)
2. Determination of Net Present Value of both the projects
The calculations of Net Present Value can be evaluated with the help of the following table:-
Project X Project Y
Rate of return 12% Rate of return 12%
Initial
investment
($300,000) Initial investment ($300,000)

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Inflow year 1 $80,000 Inflow year 1 $160,000
Inflow year 2 $140,000 Inflow year 2 $160,000
inflow year 3 $130,000 inflow year 3 $160,000
Inflow year 4 $160,000 Inflow year 4 $160,000
Inflow year 5 Inflow year 5 $160,000
Inflow year 6 Inflow year 6 $160,000
NPV $68,973.2
5
NPV $166,049.91
Table 2: Calculation of Net Present Value of the projects
(Source: Created by Author)
From the above table, it can be inferred that the NPV of Project X is $68,973.25 and NPV of
project Y is $166,049.91. The calculations have been shown in the excel spreadsheet.
Since, both the Net present values are positive, therefore, both the projects will be accepted.
3. Determination of IRR of both the projects
Project X Project Y
Rate of return 12% Rate of return 12%
Initial
investment
($300,000
)
Initial
investment
($300,000)
Inflow year 1 $80,000 Inflow year 1 $160,000
Inflow year 2 $140,000 Inflow year 2 $160,000
inflow year 3 $130,000 inflow year 3 $160,000
Inflow year 4 $160,000 Inflow year 4 $160,000
Inflow year 5 Inflow year 5 $160,000
Inflow year 6 Inflow year 6 $160,000
IRR 23% 39%

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Table 3: Calculation of IRR of the projects
(Source: Created by Author)
From the above table, it infers that IRR of project X is 23 percent and IRR of project Y is 39
percent. This further suggests that the break-even point of both projects are 23 percent and 39
percent respectively. The required rate of return of both the projects is 12 percent. In case of both
the projects, IRR has exceeded the required rate of return of the investor. Therefore, it can be
inferred that both the projects will be accepted since IRR is greater than the required rate of
return from the project (Burns and Walker 2015).
4. Changes in required rate of return
If the required rate of return is decreased to 10 percent from 12 percent, then the changes in
calculations can be evaluated with the help of the following diagram:-
PROJECT X PROJECT Y
RATE OF
RETURN
10% Rate of return 10%
INITIAL
INVESTMENT
($300,000) Initial
investment
($300,000)
INFLOW YEAR 1 $80,000 Inflow year 1 $160,000
INFLOW YEAR 2 $140,000 Inflow year 2 $160,000
INFLOW YEAR 3 $130,000 inflow year 3 $160,000
INFLOW YEAR 4 $160,000 Inflow year 4 $160,000
INFLOW YEAR 5 Inflow year 5 $160,000
INFLOW YEAR 6 Inflow year 6 $160,000
NPV $86,711.66 $188,344.06
IRR 23% 39%
Table 4: Calculation of NPV and IRR with rate of return 10 percent

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(Source: Created by Author)
It can be inferred that if the required rate of return is changed, then, it would not have any impact
on internal rate of return. However, expected rate of both the projects have decreased, which led
to rise in Net present value as NPV is inversely proportional to the discounting factor (Brigham
et al. 2016). This resulted in increase of surplus of both the projects as NPV has increased by a
considerable amount.
Therefore, both the projects will still be accepted, even if rate of return decreases from 12
percent to 10 percent.
5 Difference in recommendations in case of NPV and IRR
It can be inferred that if Net present value is positive, then the project is said to be accepted. If
IRR is above expected rate of return, then, the project is said to be accepted. However, there are
few cases, where both these techniques offer different recommendations.
If the net present value is positive, however, at the same time, if IRR is lesser than the expected
rate of return, then, the project will be said to be rejected. This is the only when, NPV and IRR
give different recommendations. When, IRR is less than the required rate of rate, the project will
be rejected, even if the NPV of the project is positive, though it depends upon the investor
regarding which recommendations he should follow (Chittenden and Derregia 2015).

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References
Asx.com.au. (2018). Home - Australian Securities Exchange - ASX. [online] Available at:
https://www.asx.com.au/ [Accessed 22 Sep. 2018].
Brigham, E.F., Ehrhardt, M.C., Nason, R.R. and Gessaroli, J., 2016. Financial Managment:
Theory And Practice, Canadian Edition. Nelson Education.
Burns, R. and Walker, J., 2015. Capital budgeting surveys: the future is now.
Chittenden, F. and Derregia, M., 2015. Uncertainty, irreversibility and the use of ‘rules of
thumb’in capital budgeting. The British Accounting Review, 47(3), pp.225-236.
CNBC. (2018). UPDATE 3-Australia's AMP counts the cost of past misdeeds, shares dive.
[online] Available at: https://www.cnbc.com/2018/07/27/reuters-america-update-3-australias-
amp-counts-the-cost-of-past-misdeeds-shares-dive.html [Accessed 22 Sep. 2018].
Mfam.com.au (2018). How the royal commission will affect the banks (CBA, NAB, WBC,
ANZ) - Monthly Newsletter, May Edition - MF & Co.. [online] MF & Co. Available at:
https://www.mfam.com.au/73700/how-the-royal-commission-will-affect-the-banks-cba-nab-
wbc-anz-monthly-newsletter-may-edition [Accessed 22 Sep. 2018].
Viney, C. and Phillips, P. (2015). Financial Institutions, Instruments and Markets. 8th edition.
Weber, T.A., 2014. On the (non-) equivalence of IRR and NPV. Journal of Mathematical
Economics, 52, pp.25-39.