Finance: TVM and Bond Valuation, Risk and Return Estimates, Risk and Return Analysis of a Company
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This document provides answers to questions related to TVM and bond valuation, risk and return estimates, and risk and return analysis of a company. It includes calculations and analysis for each question.
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Running head: FINANCE Finance Name of the Student: Name of the University: Author’s note:
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1FINANCE Table of Contents Answer to question 1: TVM and Bond valuation............................................................................2 Sub part (a):.................................................................................................................................2 Sub part (b):.................................................................................................................................2 Sub part (c):.................................................................................................................................2 Sub part (d):.................................................................................................................................3 Sub part (e):.................................................................................................................................3 Sub part (f):..................................................................................................................................4 Answer to question 2: Risk and return estimates.............................................................................4 Sub part (a):.................................................................................................................................4 Sub part (b):.................................................................................................................................5 Answer to question 3: Risk and return analysis of the company:....................................................5 Overview of the company:...........................................................................................................5 Financial Performance:................................................................................................................5 Risk and Return measures of the company:..............................................................................12 Conclusion and recommendation:.............................................................................................13 References and bibliography:........................................................................................................14
2FINANCE
3FINANCE Answer to question 1: TVM and Bond valuation Sub part (a): Computation of Discounted value of the instalments Monthly Instalment Amount$10,000 Number of years4 Number of Payment per year12 Annual Discount rate7% Discounted Value of the instalment$4,17,602 In computation of the present value of the installments, a discount rate of 7% has been considered and a total number of 7 years have been taken. The present value of the installments over the period is the discounted value, which the bank can allow. Sub part (b): Computation of Expected Revenue in 5 years with a 7.40 % growth rate Annual Operating Revenue$1,438.28 Annual growth rate7.40% Number of Years5 Expected annual revenue in 5 years$2,055.25 To arrive at the sales of the fifth year, annual sales have been compounded with the annual growth rate. As the growth will be assumed annually, the compounding technique has been used to arrive at the expected sales in the fifth year. Sub part (c): Computation of Effective Annual Interest Rates for the following loans Loan ALoan BLoan C Loan Amount7.00%7%6.97% Compounding termsSemi-annuallyMonthlyQuarterly
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4FINANCE Compounding period in a year2124 Effective annual interest rate (EAR)7.12%7.18%7.15% Effective annual rate of interest is the equivalent rate of the same interest payment as paid throughout the year in all those above interest-compounding periods. It can be compounded by taking into consideration the total annual affect of the interest. The same compounding and discounting technique has been used to compute the effective interest annually. Sub part (d): Computation of Instalment amount for the purchase of property Value of the property$8,11,000 Annual Interest rate3.80% Number of years10 Number of payments per year4 Quarterly Instalment Amount$24,466 To compute the amount of monthly installment per quarter, which is required to be paid for purchasing the property with a financing option, the annual interest rate is converted into quarterly interest rate as the value of the loan as the full value of the property has been considered. The installments will be paid quarterly and hence the interest rate is to be considered quarterly. The installment amount can be computed by compounding those figures as $24,466 per quarter. Sub part (e): Computation of Yield to maturity of the bond Par value of the bond100 Years till maturity8 Annual coupon rate5.60% Current price117
5FINANCE Yield to maturity3.16% Yield to maturity means the total return as a percentage of the investment, which can be earned by holding the investment till the maturity. The present value of the investment is more than the face value; it means the investor will be realizing a less amount than his investment from the capital yield.Hence, the total yield to maturity becomes less than the coupon rate. From such type of an investment a total of 3.16% can be earned by holding it till the maturity. Sub part (f): Computation of Coupon payment for a required rate of return Par value of the bond$1,000 Years till maturity6 Number of payments per year2 Annual coupon rate7.00% Required rate of return4.10% Current price$1,153 Coupon payment$51 To compute the Coupon payment of the bond, Firstly, the present value of the bond is calculated by considering the required rate of return, and then, the coupon payment has been calculated by applying the PMT formulaand taking the coupon rate. Answer to question 2: Risk and return estimates Sub part (a): Computation of Expected rate of return Under CAPM model ParticularsBGAHypothetical Company Risk free rate1.94%1.94%
6FINANCE Market risk premium6%6% Risk coefficient (Beta)1.23-0.2 Expected return9.32%0.74% The risk free rate has been taken as the yield to maturity of 10 years Australian bond as per recent sources and records. The risk coefficient of the company or the company beta has been taken as 1.23 as per the recent source as on 20 April 2019. Taking all those risk factors and applying the CAPM model the expected rate of return of the company has been computed as 9.23%. It can be evidenced that the risk coefficient of the company is higher that is why the expected rate of return is higher. On the other hand, as the second company is having a negative risk coefficient, the expected rate of return is very low. Sub part (b): Computation of portfolio beta and expected return Percentage of shares in the portfolio50%50% Expected Return9.32%0.74% Beta of the company1.23-0.2 Weightage of beta in the portfolio0.615-0.1 Port Folio Beta0.52 Expected Portfolio return5.03% The portfolio has been constructed taking 50% of the BGA stocks and 50% of the second company. The portfolio beta has been computed taking the two beta multiplied by respective weight. The expected rate of return is computed by applying the CAPM model considering the portfolio beta, risk free rate and the risk premium.
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7FINANCE Answer to question 3: Risk and return analysis of the company: Overview of the company: BegaCheeseLimitedisanAustraliancompanydealingindairyandassociated agricultural products. Bega Cheese limited is an Australian stock exchange listed company and they are known for their special cheese. They are having a huge in house farm and a production and packaging system to meet the customers’ needs with improved, innovative and quality products. They have been performing well financially and operationally for the last couple of years. Their shares are currently quoting at 4.90AUD in the Australian Stock Exchange (begacheese.com.au 2019). Financial Performance: Bega Cheese Limited is performing financially well for the last couple of years. As can be seen from their annual reports and financial performance parameters, they are having a long term growth rate of 10.56 % in their sales. They are increasing their investment and production with the increasing demand for their products in the domestic as well as international market, but their overall growth rate in their stock price is negative as they are having a very low net mergin for the last year. The company is having a 37.6 total debt to equity ratio, which is below the industry average of 51.91. it implies the company is assuming lower risk to manage their capital structure and to finance their long term capital needs, but still they are making a well tradeoff between their debt and equity which resulted in a 48.05 % EPS growth rate for the company, which is only 8.07 % for the industry (reuters.com 2019). Their key financial performance parameters and ratios can be tabulated as under with comparative charts to compare their performance with the industry averages.
8FINANCE Chart showing fluctuation in the share price of BEGA Cheese VALUATION RATIOS CompanyIndustrySector P/E Ratio (TTM)7.4222.2740.49 P/E High - Last 5 Yrs.53.2336.5441.37 P/E Low - Last 5 Yrs.7.1717.6925.46
9FINANCE P/E Ratio (TTM)P/E High - Last 5 Yrs.P/E Low - Last 5 Yrs. 0 10 20 30 40 50 60 Company Industry Sector From the above ratios and graphs, it can be observed that, the company is performing substantially in terms of price to earnings ratio. The price to earnings ratio implies the relationship between the market price of the shares and the earnings price of the share. Their figures are below the current and five years average of industry and the respective sector. RISK COEFFICIENT CompanyIndustrySector Beta1.230.930.69
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10FINANCE CompanyIndustrySector 0 0.2 0.4 0.6 0.8 1 1.2 1.4 Beta Beta From the above graph, it can be seen that, the risk coefficient of the company is higher than the industry and the sector average. The company is taking huge amount of debt in financing their fixed assets. They need to make a tradeoff between the risk and return to achieve the highest return to the shareholders. DIVIDENDS CompanyIndustrySector Dividend Yield1.492.322.22 Dividend Yield - 5 Year Avg1.842.32.48 Dividend 5 Year Growth Rate912.49.45
11FINANCE Dividend YieldDividend Yield - 5 Year AvgDividend 5 Year Growth Rate 0 2 4 6 8 10 12 14 DIVIDENDS Company DIVIDENDS Industry DIVIDENDS Sector Intermsofdividendpaymentsanddividendgrowth,thecompanyisperforming marginally well, in terms of growth in the dividend payment the company is performing almost close to the industry. DIVIDEND PAYOUT RATIO CompanyIndustrySector Payout Ratio(TTM)12.1725.1958.62 CompanyIndustrySector 0 10 20 30 40 50 60 70 Payout Ratio(TTM) Payout Ratio(TTM)
12FINANCE GROWTH RATES CompanyIndustrySector Sales (MRQ) vs Qtr. 1 Yr. Ago-4.582.3-0.89 Sales (TTM) vs TTM 1 Yr. Ago2.576.685.26 Sales - 5 Yr. Growth Rate5.638.9810.71 CompanyIndustrySector -6 -4 -2 0 2 4 6 8 10 12 Sales (MRQ) vs Qtr. 1 Yr. Ago Sales (TTM) vs TTM 1 Yr. Ago Sales - 5 Yr. Growth Rate From the above graph it can be noticed that the company is having a negative sales MRQ while the industry average was positive, though the sectors’ overall performance was also negative. GROWTH RATES CompanyIndustrySector EPS - 5 Yr. Growth Rate48.058.078.17
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13FINANCE CompanyIndustrySector 0 10 20 30 40 50 60 EPS - 5 Yr. Growth Rate EPS - 5 Yr. Growth Rate In terms of growth in the sales, the company is performing tremendously. The company is having a high growth rate in sales in the last five years. The company’s performance is over the industry and the sector average. FINANCIAL STRENGTH CompanyIndustrySector Quick Ratio (MRQ)2.441.210.88 Current Ratio (MRQ)3.071.591.51 LT Debt to Equity (MRQ)37.5927.457.7 Total Debt to Equity (MRQ)37.651.9118.85 Interest Coverage (TTM)14.643.5739.32
14FINANCE Quick Ratio (MRQ) Current Ratio (MRQ) LT Debt to Equity (MRQ) Total Debt to Equity (MRQ) Interest Coverage (TTM) 0 10 20 30 40 50 60 FINANCIAL STRENGTH Company FINANCIAL STRENGTH Industry FINANCIAL STRENGTH Sector PROFITABILITY RATIOS CompanyIndustrySector Gross Margin (TTM)12.5730.738.82 Gross Margin - 5 Yr. Avg.12.222937.51 EBITD - 5 Yr. Avg5.0715.0319.52 Operating Margin (TTM)16.1413.1118.02 Operating Margin - 5 Yr. Avg.6.8312.0617.73 Pre-Tax Margin (TTM)16.1412.2618.12 Pre-Tax Margin - 5 Yr. Avg.6.8310.8217.39 Net Profit Margin (TTM)11.318.8813.5 Net Profit Margin - 5 Yr. Avg.4.847.7212.88 Effective Tax Rate (TTM)29.9427.8125.88 Effective Tax Rate - 5 Yr. Avg.29.1828.1325.85
15FINANCE Gross Margin (TTM) Gross Margin - 5 Yr. Avg. EBITD - 5 Yr. Avg Operating Margin (TTM) Operating Margin - 5 Yr. Avg. Pre-Tax Margin (TTM) Pre-Tax Margin - 5 Yr. Avg. Net Profit Margin (TTM) Net Profit Margin - 5 Yr. Avg. Effective Tax Rate (TTM) Effective Tax Rate - 5 Yr. Avg. 0 5 10 15 20 25 30 35 40 45 PROFITABILITY RATIOS Company PROFITABILITY RATIOS Industry PROFITABILITY RATIOS Sector In terms of profitability, the company’s performance is not satisfactory. In most of the profitability parameters, their figures are much below the industry as well as the sector average. It implies their inefficient operational management. They need to improve their operations and operation management to earn higher profit from the existing facilities. EFFICIENCY CompanyIndustrySector Receivable Turnover (TTM)7.8613.0421.45 Inventory Turnover (TTM)5.956.786.25 Asset Turnover (TTM)1.490.891.76
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16FINANCE Receivable Turnover (TTM)Inventory Turnover (TTM)Asset Turnover (TTM) 0 5 10 15 20 25 EFFICIENCY Company EFFICIENCY Industry EFFICIENCY Sector MANAGEMENT EFFECTIVENESS CompanyIndustrySector Return on Assets (TTM)16.897.9424.69 Return on Assets - 5 Yr. Avg.8.987.9328.42 Return on Investment (TTM)23.7812.1260.7 Return on Investment - 5 Yr. Avg.13.3611.7262.71 Return on Equity (TTM)30.8215.4772 Return on Equity - 5 Yr. Avg.16.6914.8171.31
17FINANCE Return on Assets (TTM) Return on Assets - 5 Yr. Avg. Return on Investment (TTM) Return on Investment - 5 Yr. Avg. Return on Equity (TTM) Return on Equity - 5 Yr. Avg. 0 10 20 30 40 50 60 70 80 MANAGEMENT EFFECTIVENESS Company MANAGEMENT EFFECTIVENESS Industry MANAGEMENT EFFECTIVENESS Sector From the efficiency measures and the above graph, it can be observed that, the company is having good remarks in terms of efficiency ratios.In terms of return on equity, their performance is more than the industry average, and in many other efficiency parameters, they are doing well. Risk and Return measures of the company: The ultimate objective of the financial leverage is to maximize the return to the shareholders of the company. In achieving such objective, the company needs to manage their funds and make an optimal combination of the debt and equity in the capital structure, which trades off between the risk and return and yields a maximum return to the shareholders. From the above analysis, it can be seen that the company is taking less debt finance as the company beta is much higher than the industry and the sector average. They have successfully made a optimal combination of debt and equity which resulted a good EPS and growth rate in EPS. In terms of
18FINANCE efficiency they are performing far better and showed a high mark over the industry averages, their current year’s net profit margin is also noticeably over the industry average (reuters.com 2019). To achieve the risk and return trade off and to make a proper balance between the risk and return, the company should use that much amount of debt in their capital structure, which will help the company to reduce the overall cost of capital to the minimum level. If the overall cost of capital can be reduced to the lowest possible level, then the return to the shareholder will be highest. Conclusion and recommendation: Based on the above discussions and calculation, it can be concluded, a proper tradeoff between risk and return can give a company the best result in terms of financial efficiency and performance. Achieving that objective the Bega Cheese limited have also shown the good side of their performance and have achieved a remarkable financial performance over the industry average. Lastly, it can be recommended for the company to focus on their key success factors, long term profitability and long term capital management to achieve a sustainable long term growth.
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19FINANCE References and bibliography: Barr, M.J. and McClellan, G.S., 2018.Budgets and financial management in higher education. John Wiley & Sons. begacheese.com.au(2019).Home-BegaCheese.[online]BegaCheese.Availableat: https://www.begacheese.com.au/ [Accessed 20 Apr. 2019]. Chen, H., Cummins, J.D., Viswanathan, K.S. and Weiss, M.A., 2014. Systemic risk and the interconnectedness between banks and insurers: An econometric analysis.Journal of Risk and Insurance,81(3), pp.623-652. Dewandaru, G., Bacha, O.I., Masih, A.M.M. and Masih, R., 2015. Risk-return characteristics of Islamicequityindices:Multi-timescalesanalysis.JournalofMultinationalFinancial Management,29, pp.115-138. Finkler, S.A., Smith, D.L. and Calabrese, T.D., 2018.Financial management for public, health, and not-for-profit organizations. CQ Press. Hicks, J.R., 2017. From ‘Value and Capital’. InBond Duration and Immunization(pp. 57-61). Routledge. Lutz, F., 2017.The theory of interest. Routledge. Muritala, T.A., 2018. An empirical analysis of capital structure on firms’ performance in Nigeria.IJAME. Renz, D.O., 2016.The Jossey-Bass handbook of nonprofit leadership and management. John Wiley & Sons.
20FINANCE reuters.com,R.(2019).${Instrument_CompanyName}${Instrument_Ric}Analysts| Reuters.com.[online]U.S.Availableat: https://www.reuters.com/finance/stocks/analyst/BGA.AX [Accessed 20 Apr. 2019]. reuters.com, R. (2019).${Instrument_CompanyName} ${Instrument_Ric} Chart| Reuters.com. [online] U.S. Available at: https://www.reuters.com/finance/stocks/chart/BGA.AX [Accessed 20 Apr. 2019]. reuters.com, R. (2019).${Instrument_CompanyName} ${Instrument_Ric} Financial Statement | Reuters.com.[online]U.S.Availableat:https://www.reuters.com/finance/stocks/income- statement/BGA.AX [Accessed 20 Apr. 2019]. Shahzad, S.J.H., Ferrer, R., Ballester, L. and Umar, Z., 2017. Risk transmission between Islamic and conventional stock markets: A return and volatility spillover analysis.International Review of Financial Analysis,52, pp.9-26.