Financial Decisions, Loan Repayment, Portfolio Returns and Bond Valuation

This article discusses various financial decisions that need to be taken by a finance manager in any company, including capital allocation, budgeting, and raising finance. It also covers loan repayment, portfolio returns, and bond valuation with relevant formulas and examples. The subject is Business Finance.

BUSINESS FINANCE
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Question 1
a) There are various financial decisions that need to be taken by a finance manager in any
company. These include decisions related to capital allocation, budgeting along with
financial planning and raising finance is required. Capital allocation refers to the
distribution of capital to profitable projects so as to maximise returns on investment.
Further, budgeting implies that adequate financial planning and control ought to be done
through budgets. Also, it is imperative that adequate financial resources must be available
to the company’s disposal so that the business activities and expansion can continue.
These are key functions which tend to ensure that the company is able to achieve the
stated objectives (Parrino et.al., 2013).
b) One of the key financial decisions to be taken by financial manager pertains to allocation
of capital or capital budgeting. This typically involves new projects where it is imperative
to choose amongst the available choices since it may be difficult to pursue all projects.
Thus, the financial manager needs to conduct analysis of these projects based on estimate
future cash flows using capital budgeting techniques such as IRR and NPV (Arnold,
2015).
Another important financial decisions taken by the financial manager pertains to budgeting
where the budget estimates need to be done considering a host of factors including the past
performance of the firm and the existing environmental conditions. Budget is a key tool for
performance management, control and hence needs to highlight realistic estimates of the
future performance (Detsher, 2016).
Financial resources are required for the company to run the business both in the form of
working capital and term loan. The cash management needs to be performed for ensuring that
the firm does not face any cash crunch. Also, money should be arranged in a timely manner
to meet any shortfalls for implementing the proposed projects (Parrino et.al., 2013).
c) With regards to capital allocation, consider a mining firm which is planning to invest $ 1
billion in a particular mine oversees. As a financial manager, analysis of the investment
needs to be performed using suitable capital budgeting techniques so as to opine on
whether the investment should happen or not (Arnold, 2015).

In relation to budget, the key decisions pertain to making future estimates regarding the
estimates revenues and expenses based on the current year performance and host of factors
that may influence firm performance. Besides, an example of decision pertaining to raising
finance could be in the form of which financial source should be availed for raising capital to
the extent of $ 500 million say for funding an acquisition. It could be in the form of both debt
and equity and thus the financial manager need to decide how much debt and equity should
be raised considering capital structure and financial position of the company (Payne &
Gullifer, 2015).
Question 2
a) The property is priced at $ 1.8 million and 50% of this amount would be paid through
personal deposits. Hence, the loan amount to be taken = 0.5*1.8million = $ 0.9 million.
However, there is a loan application fees for each of the two banks and this amount would
be added to the total amount borrowed.
(i) Bank A
Loan application fee = $500
Loan assumed for property purchase = $0.9million or $900,000
Hence, amount borrowed = Loan application fee + Loan taken = 500 + 900000 = $900,500
(ii) Bank B
Loan application fee = $250
Loan assumed for property purchase = $0.9million or $900,000
Hence, amount borrowed = Loan application fee + Loan taken = 250 + 900000 = $900,250
(b) The formula for computation of instalment for repayment of loan is given below.
Instalment amount = [P x R x (1+R)N]/[(1+R)N-1]

P = Principal, R = Applicable rate of interest, N = number of time periods for the loan
repayment.
(i) Bank A
The relevant inputs values are given below.
P = $900,500
R = 3.67% p.a. or (3.67/24) per fortnight = 0.1529% per fortnight
N = 25 years or 25*24 fortnights = 600 fortnights
Hence, instalment amount every fortnight = (900500*0.001529*1.001529600)/(1.001529600-1)
= $2,294.25
Therefore annual repayment = 2292.25*24 = $55,061.92
(ii) Bank B
The relevant inputs values are given below.
P = $900,250
R = 3.67% p.a. or (3.67/12) per month = 0.3058% per fortnight
N = 25 years or 25*12 months= 300 months
Hence, instalment amount every fortnight = (900250*0.003058*1.003058300)/(1.003058300-1)
= $4.589.36
Therefore annual repayment = 4589.36*12 = $55,072.3
(c) Based on the above computation, it is apparent that annual repayment is lesser for BANK
A and thus amortisation schedule for Bank A loan is highlighted below.
Relevant Formulas used are indicated below
1) Interest = Balance at the beginning * Interest rate per fortnight
2) Principal Repayment = Fortnightly instalment – Interest
3) Balance at the end = Balance at the beginning – Principal Repayment

Question 3
(a)Telstra Stock
Closing price as on January 3, 2017 = $ 5.16
Closing price as on January 30, 2018 = $ 3.60
Dividends paid during the period = 0.155 + 0.155 = $0.31
Holding period Returns =[(Closing Price + Dividends – Opening Price)/Opening Price]*100
Holding period returns = [(3.6 + 0.31-5.16)/5.16]*100 = -24.22%
Commonwealth Bank
Closing price as on January 3, 2017 = $ 82.97
Closing price as on January 30, 2018 = $79.09
Dividends paid during the period = 1.99 + 2.3 = $ 4.29
Holding period Returns =[(Closing Price + Dividends – Opening Price)/Opening Price]*100
Holding period returns = [(79.09 + 4.29-82.97)/82.97]*100 = 0.49%
AGL Energy
Closing price as on January 3, 2017 = $ 22.51
Closing price as on January 30, 2018 = $23.53
Dividends paid during the period = 0.5+0.41 = $ 0.91
Holding period Returns =[(Closing Price + Dividends – Opening Price)/Opening Price]*100

Holding period returns = [(23.53 + 0.91-22.51)/22.51]*100 = 8.57%
(b)The respective weights of Telstra, Commonwealth Bank and AGL are 40%, 20% and 40%
respectively.
Expected return on portfolio = Weight of TLS in Portfolio *Holding period returns of TLS+
Weight of CBA in Portfolio *Holding period returns of CBA+ Weight of AGL in Portfolio
*Holding period returns of AGL
Hence, expected return on portfolio = 0.4*(-24.22) + 0.2*(0.49) + 0.4*(8.57) = -6.16%
(c)The respective weights of Telstra, Commonwealth Bank and AGL are 40%, 20% and 40%
respectively.
Hence, beta of portfolio = 0.4*Telstra Beta + 0.2*Commonwealth Beta + 0.4*AGL Beta =
0.4* 0.6916 + 0.2*1.1038 + 0.4*0.6133 = 0.7427
(d) The formula for Capital Asset Pricing Model is indicated below.
Expected returns = Risk free rate + Beta* Market Risk Premium
Expected returns = -6.16%, Beta = 0.7427, Risk free rate = 2.67%
Substituting the requisite inputs in the given model we get,
-6.16 = 2.67 + 0.7427*Market Risk Premium
Solving the above, we get Market Risk Premium = -11.89%
Question 4
a) The relevant formula is shown below.
FV = PV (1+r)n

In the given case, PV or present value = $ 5,000
Rate of interest or r = 2.8% p.a. compounded semi-annually or 1.4% per six months
Number of periods or n = 4 years or 8 half years
Hence, FV = 5000(1+0.014)8 = $ 5,588.22
b) The relevant formula is shown below.
FV = PV (1+r)n
In the given case, PV or present value = $ 10,000, FV or future value = $ 30,500
Rate of interest or r = 2.8% p.a. compounded every two months or (2.8/6) or 0.46667% per
two months
Hence, 30500 = 10000*(1.0046667)n
Solving for n, we get n = 239.5196
Since n highlights a period of 2 months, hence the total time period = (239.5196 *2/12) or
39.92 years
c) The price of the zero coupon bond would be equal to the present value of the principal
repayment which would happen at the maturity since no coupon payments would be
derived.
Face value = $ 1,000
Market interest rate = 3.99% p.a. or (3.99/2) or 1.995 % per six months
Maturity period = 30 years or 60 half years
The relevant formula is shown below.
PV= FV/(1+r)n
In the given case, FV = $ 1,000, n = 60, r= 1.995%

Hence, PV = 1000/(1.01995)60 = $ 305.68
The value of the given zero coupon bond is $ 305.68.
Total amount of bonds required to raise $ 1 million or $ 1,000,000 = 1000000/305.68 = 3272
bonds
d) Dividend in year 1 = £220
Dividend in year 2 = £220 * 1.27 = £279.4
Dividend in year 3 = £279.4 *1.15 = £321.31
Dividend in year 4 = £321.31*1.08 = £347.01
The value of dividends from 4th years onwards can be estimated using the Gordon Model.
Stock price = Next year dividend/(Required rate on equity – Perpetual annual dividend
growth)
Value of all future dividends at the end of year 3 = 347.01/(0.17-0.8) = £3855.72
Intrinsic price of stock = (220/1.17) + (279.4/1.172) + (321.31/1.173) + (3855.72/1.173) =
£3000.15
The share purchase would not be considered desirable since the current price at £3,500
exceeds the intrinsic price of £3000.15 and thus is overvalued at current price.

References
Arnold, G. (2015) Corporate Financial Management (3rd ed.). Sydney: Financial Times
Management.
Detscher, S. (2016) Corporate finance and the theory of the firm. Germany: GRIN Verlag
GmbH.
Parrino, R., Yong, H., Kingsbury, N., Kidwell., D., Ekanayke, S., Murray., J., & Kofoed, J.,
(2013) Fundamentals of Corporate Finance (2nd ed.). Melbourne: John Wiley and
Sons Australia.
Payne, J., & Gullifer, L. (2015) Corporate finance law: Principles and policy (4th ed.).
Oxford, United Kingdom: Hart Publishing.