(PDF) The economic effects of capital gains taxation

Project

Table of Contents
INTRODUCTION................................................................................................................................3
DISCUSSIONS/ WORKINGS.............................................................................................................3
Evaluating capital gain/ loss on the basis of constant or dividend growth model...........................3
Presenting situation under which zero-coupon bond be selling at a premium................................3
Stating implications for finance managers and their decision making process...............................4
Stating assumptions regarding risk when using WACC..................................................................4
Q. 1 Calculation of performance of Elite Jewellery Ltd. And So Lo Supermarket.........................5
(a).....................................................................................................................................................5
(b).....................................................................................................................................................6
(c).....................................................................................................................................................6
(e).....................................................................................................................................................6
(f).....................................................................................................................................................7
(g).....................................................................................................................................................7
Q. 2 Calculation of Intrinsic/ Market valuation of Entroc's LTD....................................................7
(a).....................................................................................................................................................7
(b).....................................................................................................................................................8
(c).....................................................................................................................................................8
Q. 3 Evaluation of project and decide to whether invest in which project......................................9
CONCLUSION....................................................................................................................................9
REFERENCES...................................................................................................................................11

INTRODUCTION
This report is about the financial knowledge of valuing the various securities and taking the
decisions in which project to invest so that investors are more attracted to invest in that company. It
covers the valuation of bonds, preference shares, long term debts and ordinary shares with growth.
This report also covers that company should invest in which project that gives the company higher
profits. While taking the decision in which project company should invest to maximize its profits
two methods of measuring the projects has been taken i.e. Net Present Value and Pay Back Period.
DISCUSSIONS/ WORKINGS
Clients Financial Questions
Evaluating capital gain/ loss on the basis of constant or dividend growth model
Constant Dividend Growth Model is used to measure the fair value of an equity share.
Intrinsic share price is the theoretical measurement of the share price. The intrinsic value of an
equity share is calculated to compare the intrinsic share price with the current market price to know
that whether they are overvalued or undervalued. Based on these comparisons, investors can decide
whether to purchase or sell the shares. Dividend Growth Model uses the dividends as a part of its
calculation while calculating intrinsic price of equity shares (Morden 2016). Every year growth is
been added to every year's dividend and then the value is discounted by the weighted average cost
of capital. This is minimum requirement of the investor in order to take the decision that they have
to further invest in the company or not. The value of share is calculated as-
P= D 1/(K-G)
where, P= Intrinsic value price per share of the equity
D= expected dividend per share one year from the present time
G= expected dividend growth rate
K= required rate of return
This model does not considers the capital investment as part of the determining the share
price because it is only the part of the returns and share price cannot be calculated on the basis of
capital investment. Dividend Growth model is the theoretical calculation of the share price while
capital investment returns are real returns occurs for the investor.
Presenting situation under which zero-coupon bond be selling at a premium
A zero coupon bond is a debt security on which investor does not pay any interest or coupon
amount and they are also traded at a deep discount rendering huge profits when they are redeemed

on its par value. These bonds are artificially stripped of their coupons by a financial institutions and
then repackaged as zero- coupon bonds. Zero Coupon bonds fluctuate more in price than the bonds
with coupon rates (Ma and et.al., 2017). Zero coupon cannot be sold at a premium price i.e. higher
than the face value. They can be sold either par value or lower than the par value i.e. discount rate.
Intrinsic Price of the Zero coupon bond is calculated as-
Price= M/(1+R)^n
where M= maturity value or face value of the bond
R= required rate of interest
n= number of years until maturity
The interest earned on the Zero coupon bond is known as imputed interest because it is the
estimated interest which Government cannot recover in the money because they are artificially
converted into the Zero coupon bonds. Purchasing zero coupon bonds give tax exemption status
which is beneficial for an investor to invest in such securities.
Stating implications for finance managers and their decision making process
Article of Association is a set of formal documents filed with a government body to legally
document the creation of a corporation. In this article number and types of authorized shares are
mentioned. The company goes first for the initial public offer (IPO) in order to bring the financing
for the company.
The difference between bid-ask or bid- offer spread represents the highest price that the
buyer is willing to pay for the share and the minimum share price at which seller is ready to sell its
shares. The share price of the company is determined largely by the supply and demand. The
company which is having growth aspects in the future attracts more number of investors and they
buy the share of the company at the higher amount than the existing price in the market (Magni
2015). Prices fall when the company's have a poor outlook and have no growing aspects in the
future. A continuous rise in the prices of the share is known as uptrend and continuous fall in the
price is known as downtrend.
There are other factors which determine the price of the shares according to their
expectations about the unpredictable future, not according to current earnings. Rising prices of the
company's share also attracts more number of buyers to attract towards in purchasing the company's
share and this also increases the price of the share. Experts describes continuous increase in the
price as the “Bull market” and the continuous decrease in the fall in the price of the share is known
as “Bear market”.

Stating assumptions regarding risk when using WACC
Weighted Average Cost of Capital is used in the calculation of overall cost of the company
which the company. This is calculated by multiplying the cost of securities with the respective
proportion of those securities in the company. This is used to know that the company needs the
minimum amount of return from the company otherwise company will be in the loss (Weighted
average cost of capital, 2019). Company's returns are more than the cost of capital it means the
company is in the profit and company should try to maintain the same returns. It is used in the
CAPM model for the company which helps in the calculating the price of the company.
CLIENTS INVESTMENT
Q. 1 Calculation of performance of Elite Jewellery Ltd. And So Lo Supermarket
(a)
Expected returns of Elite Jewellery Ltd. And So Lo Supermarket are-
Particulars Elite Jewellery Ltd. So Lo Supermarkets Ltd
Probability
of return
Returns over
12 months
Weighted
Return
Probability
of return
Returns over
12 months
Weighted
Return
Year 1 0.15 -1 -0.15 0.1 1 0.1
2 0.6 12 7.2 0.4 7 2.8
3 0.25 18 4.5 0.3 10 3
4 0.2 14 2.8
Expected
Return (R) 11.55% 8.7%
Standard Deviation of Elite Jewellery Ltd. And So Lo Supermarket are-
Particulars Elite Jewellery Ltd. So Lo Supermarkets Ltd
Returns over
12 months
Expected
Return
Return –
Expected
return
Returns over
12 months
Expected
Return
Return –
Expected
return
Year 1 -1 11.55 157.503 1 8.7 59.290
2 12 11.55 0.203 7 8.7 2.890
3 18 11.55 41.603 10 8.7 1.690

4 14 8.7 28.090
199.308 91.960
Standard
Deviation 8.15 4.8
(b)
Expected Returns is the amount of returns that a portfolio may generate. This is calculated by
the chances of returns to occur and what are the possible returns over the past 12 months. Standard
Deviation of a portfolio means how much a mean of the portfolio deviates from the investment
returns. It is calculated by squaring the deviations and dividing them by n number of years and
taking out square root of the following. According to the above calculations, As the standard
deviation i.e. risk is increasing return of the company is also increasing (Petrovskaya and et.al.,
2016). Thus, risk and return are directly related to each other.
(c)
Main difference between Beta and Standard Deviation is Beta calculates the 1% change in the
market portfolio will lead how much change in the company's portfolio whereas Standard Deviation
calculates the risk of individual shares. Beta estimates whole volatility whereas Standard Deviation
estimates total risk. Beta measures the market risk premium whereas Standard Deviation measures
risk.
Calculation of Diversified Portfolio using CAPM model
Particulars Elite Jewellery Ltd. So Lo Supermarkets Ltd
Risk Free rate of return 5 5
Market risk 8.151 4.795
Beta 0.85 0.6
Portfolio return 7.68% 4.88%
(e)
Client should purchase the shares of Elite Jewellery Ltd. because expected returns of the

company are high than the So Lo Supermarket Ltd. and also Portfolio Return of Elite are higher
than the So Lo company. However, the risk associated with the shares are also high but there is
more probability to get back all the expected returns.
(f)
Share Price of Elite Ltd. Will be increasing more because the company's returns and portfolio
both are high so their will be more demand of the shares in the market and more investors will be
attracted to the company's shares. So, this will increase the share price of Elite because its demand
will be increasing and So Lo supermarket share price will be decreasing because its supply is high.
(g)
Client's Portfolio and returns both will be increasing as it is known that risk and returns both are
directly related to each other. Client should invest in the Elite company because it will giving more
returns as compared to So Lo Supermarket.
Q. 2 Calculation of Intrinsic/ Market valuation of Entroc's LTD.
(a)
Calculation of Intrinsic/ Market valuation of Entroc's LTD.
Calculation of Bond
Yield to Maturity 6.00%
Par Value 1000000
Maturity Period 6
Semi-annual Coupon rate 7.00%
Coupon per period 70000
Time periods for semi-annual coupon payments 12
Present value of semi-annual payments 586869.08
Present value of face value 496969.36
Total value of bond 1083838.44
Preference Shares

Required Return 9.00%
Par Value 100000
Dividend per period 0.6
Dividend per period 60000.00
Total value of Preference shares 666666.67
Ordinary Shares
Required Return 12.00%
Par Value 2000000
Dividend per period 0.2
Dividend growth rate 5.00%
Dividend per period 400000
Total value of Preference shares 5714285.71
(b)
Calculation of Intrinsic/ Market valuation of Entroc's Ltd.
Balance Sheet as at 31 March 2019
Long Term Debt $
Bonds 1083838
Equity
Preference Shares 666667
Ordinary Shares 5714286
Total 7464791
(c)
Elite's book value is equal to $3100000 and market value is equal to $746791 are because of the
ordinary shares dividend rate is increasing every year by 5% and also required rate of return of
preference shares is 9% and also yield to maturity of the corporate bonds is are less than the coupon
rate which has increased the market value of the company as compared to the book value of the
company (Pinto and et.al., 2015). Also, the company's ordinary share price is growing by 5% every
year so attracts the large number of investors.

Q. 3 Evaluation of project and decide to whether invest in which project
Calculation of Discounted Cash Inflows
Particulars Project 1 Project 2
Initial Investment -17000000 -21000000
Annual Cash Inflows 4500000 8500000
Life of system 10 7
Discount rate @ 14% 5.22 4.29
Discounted Cash inflows 23472520.41 36450591.13
Calculation of Net Present Value
Cash Inflows 23472520.41 36450591.13
Cash Outflows -17000000 -21000000
Net Present Value 6472520.41 15450591.13
Calculation of Pay Back Period
Initial Investment -17000000 -21000000
Annual Cash Inflows 4500000 8500000
Pay Back Period 3 Years 9 months 2 years 4 months
Company should select Project 2 because in both the criteria of evaluation project 2 is giving
more benefits as compared to the Project 1. Project 2 is giving more net present value as compared
to Project 1 and also Pay Back Period of project 1 higher than the Project 1 (Bianchini and et.al.,
2016). If the company goes with investing in the Project 2 than company can recover its initial
investment within 2 years and 4 months. Client will be ready to invest in the company if company
will invest in the Project 2 because in both the criteria Project 2 is more beneficial to the company.

CONCLUSION
The report contains that meaning of Weighted Average Cost Of Capital, Zero Coupon
Bonds, how share prices increases or decreases etc. It also contains the valuation of various debt
securities such as ordinary shares, preference shares and long term debt. Company should go for the
selection of Project 2 because in both the criteria Project 2 is giving more benefits to the company
as compared to the Project 1 and this will also hep the company to attract the more number of
investors for the company. Report also include the Expected returns of two companies and their
relation with risk and their respective Beta.