BAP53 - Basic Corporate Finance Concepts In Business

CORPORATE FINANCE
STUDENT ID:
[Pick the date]

Question 1
1) The expected returns can be estimated as shown below.
Expected Returns (Aussie Traders) = 0.3*(-20) + 0.2*(15) + 0.35*(30) + 0.15*(50) = 15%
Expected Returns (Blue Star) = 0.3*(5) + 0.2*(6) + 0.35*(8) + 0.15*(10) = 7%
Expected Returns (ASX 300) = 0.3*(-4) + 0.2*(11) + 0.35*(17) + 0.15*(27) = 11%
2) The standard deviation of returns can be computed as shown below.
Standard Deviation = (0.063)0.5 = 25.10%
Standard Deviation = (0.00671)0.5 = 8.19%
Standard Deviation = (0.01445)0.5 = 11.60%

3) The better measure of the risk would be standard deviation since it would entail both
systematic and unsystematic risk unlike beta which captures only the systematic risk. As a
result, beta is an incomplete measure of risk (Damodaran, 2015).
4) The relevant inputs are summarised below.
As per the CAPM approach, the following equation holds.
Required Return = Risk free rate + Beta * Market Risk Premium
Required Return (Aussie Traders) = 5 + 1.68*(11-5) = 15.08%
Required Return (Blue Star) = 5 + 0.52*(11-5) = 8.12%
5) As per the given details, $ 50,000 is invested in Aussie Traders and $ 100,000 is invested
in Blue Star.
Total money invested = 50000 + 100000 = $ 150,000
Weight of Aussie Traders = (50000/150000) = 0.33
Weight of Blue Star = (100000/150000) = 0.67
Portfolio beta = 0.33*1.68 + 0.67*0.52 = 0.91
Portfolio Return = 0.33 *15.08 + 0.67*8.12 = 10.44%
6) As per the given details, $ 100,000 is invested in Aussie Traders and $ 50,000 is invested
in Blue Star.
Total money invested = 50000 + 100000 = $ 150,000
Weight of Aussie Traders = (100000/150000) = 0.67
Weight of Blue Star = (50000/150000) = 0.33

Portfolio beta = 0.67*1.68 + 0.33*0.52 = 1.29
Portfolio Return = 0.67 *15.08 + 0.33*8.12 = 12.76%
f) The two share portfolio which offers a higher return per unit beta would be preferable.
0.33 in Aussie Traders and 0.67 in Blue Star = (10.44/0.91) = 11.47%
0.67 in Aussie Traders and 0.33 in Blue Star = (12.76/1.29) = 9.89%
The preferred portfolio would be formed by investing $ 50,000 in Aussie Traders and $
100,000 in Blue Star.
Question 2
The cash flows with regards to the two available options i.e. Renovate and Replace are
highlighted in the following table.
(1) The objective is to estimate the payback period. The payback period is the amount of time
required to recover the initial investment made. The time value of money is not considered.
The cumulative cashflows are used to estimate the payback period (Parrino and Kidwell,
2014). Based on the excel computations, the following results are obtained.
Based on the payback period, Replace option would be preferred as the payback is lower for
this option.

(2) The objective is to estimate the NPV using a WACC of 15%. The excel function NPV has
been used for computation of the NPV for both the options using the cash flow information.
Based on the excel computations, the following results are obtained.
Based on the NPV, Replace option would be preferred as the NPV is higher for this option
and also positive which implies that it would add more value for the shareholders compared
to the renovate option.
(3) The objective is to estimate the IRR of the two options. IRR is defined as the discount rate
which leads to an NPV of zero (Petty et. al., 2015). Based on the excel computations, the
following results are obtained.
Based on the IRR, Replace option would be preferred as the IRR is higher for this option in
comparison with the renovate option.
(4) The objective is to estimate the PI (Profitability Index) of the two options. PI is defined as
the ratio of the present value of cash inflows from the project and the initial investment.
Based on the excel computations, the following results are obtained.
Based on the PI, Replace option would be preferred as the PI is higher for this option in
comparison with the renovate option.
(5) All the capital budgeting techniques tend to reflect that replace option seems to be better
option. However, one potential reason for all the indicators not endorsing the same choice
could be that while IRR, NPV and PI consider the complete life cash flows along with time
value of money, this is not the case with payback period (Brealey, Myers and Allen, 2014).

References
Brealey, R. A., Myers, S. C. and Allen, F. (2014) Principles of corporate finance, 6th ed. New
York: McGraw-Hill Publications
Damodaran, A. (2015). Applied corporate finance: A user’s manual 3rd ed. New York:
Wiley, John & Sons.
Parrino, R. and Kidwell, D. (2014) Fundamentals of Corporate Finance, 3rd ed. London:
Wiley Publications
Petty, J.W., Titman, S., Keown, A., Martin, J.D., Martin, P., Burrow, M. and Nguyen, H. (2015).
Financial Management, Principles and Applications, 6th ed.. NSW: Pearson Education, French
Forest Australia