Financial Management - Sample Assignment

KOI
Trimester 1, 2018
FIN700–Financial Management
ASSIGNMENT– GROUP
Due date: Submit to your Tutor bythe start of your Tutorial in Week 9:
Monday, 14 May, or on Tuesday, 15 May, or on Saturday, 19 May, 2018.
Keep a soft copy in case of misadventure.
Penalties for late lodgment, as per the Subject Outline, will be strictly applied.
This Assignment consists of 4 problems, each involving
calculations, and in some cases recommendations.
You are required to complete this Assignment in Groups of 2 or 3 or 4
people.**Groups of 1 or more than 4 persons will incur a penalty of 5 marks out of
30%.**
All members of the Group should come from the same Tutorial class. You may
consult and discuss the Assignment topic with others, but you must write up your
answers yourselves. Penalties for copying and plagiarism are severe.
You should follow the following typing conventions:
 Answers to be typed, in the space provided after each question
 If additional pages are required, use the blank pages at the end.
 Times New Roman font (at minimum, 12 pitch), 1.5 line spacing; and
 Left and right margins to be at least 2.5 cm from the edge of thepage.
Research,Referencing and Submission
You should quote any references used at the end of each question.
Use Harvard referencing! Seehttp://en.wikipedia.org/wiki/Harvard_referencing
As this is a calculations problem, there is no need to submit via TURNITIN.
Do not submit this page. Submit page 2 onwards, along with KOI Group Assignment Cover Page&Mark’g Rubric.
Marking Guide
The Assignment will be scored out of 70%,with 20 marks also awarded for
quality of Recommendations and 10 for Presentation, in line with the rubric
in the Subject Outline.This mark will be converted to a score out of 30%.
1

Dr Mervyn Fiedler, Subject Co-ordinator, FIN 700. 14 April, 2018.
______________________________________________________________________
***NOTE:When submitting Assignment, please submit from this page onwards,
with a KOI Group Assignment cover page in front,
and a FIN700 Marking Rubric at the back.***
Trimester T118
FIN700
GROUP ASSIGNMENT
Students:Please complete the following before submitting for marking.
Group members
Student No.Student NamePercentage Contribution to AssignmentSignature
1. ………………………………………………………………………………………………
2. ………………………………………………………………………………………………
3. ………………………………………………………………………………………………
4. ………………………………………………………………………………………………
Tutor:
Please circle one name: MsRuhina Karim;MrNishithPanthi; Mr Paul Power;
MsFarzanehOrtacand; Mr Ethan Zheng
Tutorial Day …………………………………………………and Time ……………………….
This Assignment consists of four questions. All questions must be answered.
Please answer all questions in the spaces provided after each question.
Two extra pages are included at the end of the Assignment. If more pages are
required, please copy (or extend) page 14.
2

QUESTION `1.[6 + 4 + 6 = 16 Marks.]
a) This is a two period certainty model problem.
Assume that Daisy Brownhas a sole income from FantasyLtdin which she owns
15% of the ordinary share capital. Currently, she has no savings.
In February, 2018, Fantasy Ltd reported net profits after tax of $600,000, and
announced it expectsnet profits after tax for the currentcalendar year, 2018, to be
30% higher than last year’s figure. The company operates with a dividend payout
ratio of 75%, which it plans to continue, and will pay the annual dividend for 2017
in late-May, 2018, and the dividend for 2018 in late-May, 2019.
In late-May, 2019, Daisy wishes to spend $100,000, which will include the cost of
an overseas trip.How much can she consume in late-May, 2018 if the capital
market offers an interest rate of 10% per year?
Dividend = Dividend Payout * Net Income
Dividends 2016-17 = 600,000 *75%*15%= 67,500
Dividends 2017-18 = 600,000 *1.3*75%*15%= 87,750
100,000 = 87,750 + X*(1+10%)
X= 11,136.36
Therefore the most she can consume is $56,363.64 (67,500-11,136.36)
b) This is an annual equivalent costs problem.
Y Ltd has received two offers for a new computer system. System P will cost
$200,000 now, has a three year life and costs $10,000 a year to operate. System
Q costs $240,000 now, has a four year life and costs $12,000 a year to operate.
The relevant discount rate is 6 per cent per annum. Ignoring depreciation and
taxes, calculate the AEC for each. Which do you prefer, and why?
System P
NPV= 200,000+10,000/(1+6%) + 10,000/(1+6%)^2 +10,000/(1+6%)^3
=$226,730.12
226,730.12= AEC *{(1-(1+6%)-3)/6%}
AEC= $84,821.96
System Q
NPV= 240,000+12,000/(1+6%) + 12,000/(1+6%)^2 +12,000/(1+6%)^3
+12,000/(1+6%)^4
=$281,581.27
281,581.27= AEC *{(1-(1+6%)-4)/6%}
AEC= $81,261.96
System Q should be selected because it has a lower AEC than system P
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c) This question relates to the valuation of interest-bearing securities.
Wildcat BankLtd has experienced large losses on its commercial loan portfolio
and is unable to meet its next two annual interest payments on its recent issue of
unsecured notes. The notes are of $1,000 face value each, mature in May, 2023
and bear a yearly interest coupon payment of 14% per annum.
The Bank paid the interest due this month (May, 2018), and following a meeting
of creditors, arranged to defer payment of the next two interest coupons due in
May, 2019 and May, 2020 respectively. Under the arrangement with creditors,
the Bank will pay the remaining interest coupons (due in May, 2021, May, 2022
and May, 2023) on their due dates, and pay the two deferred coupons (without
interest) along with the normal final interest payment and face value of the notes
on the maturity date.
Wildcat Bank Ltd’s notes are now seen as risky, and require an 18% per annum
return.
REQUIRED: Calculate the current value of each Wildcat Bank unsecured note.
Annual coupon= 14%*1000=140
Cashflows
T-0=140
T-1=0
T-2=0
T-3=140
T-4=140
T-5=140
T-5=140+140+1000
Present Value = 140+140*( 1−(1+18 % ¿¿¿−3)
18 )
/(1+18%)^3+1280/(1+18%)^5
=$884.77
4

QUESTION 2. [(4 + 4) + (2 + 2 + 3 + 3) = 18 Marks]
a) This question relates to the time value of money and deferred annuities.
Joan Dalyis age 38today and plane to retire on her 600h birthday. With future
inflation, Joan estimates that she will require around $1,800,000 at age 60 to
ensure that he will have a comfortable life in retirement. She is a single
professional and believes that she can contribute $3,600 at the end of each
month, starting in one months’ time and finishing on her 60th birthday.
i) If the fund to which she contributes earns 5.4% per annum, compounded
monthly (after tax), how much will he have at age 60? Will she have
achieved her targeted sum? What is the surplus or the shortfall?
Target Fund at Age 60 $1,800,000.00
Number of Years to Age 60 22 years
Monthly PMT $3,600.00
i(12) 5.40%
j =5.40%/12= 0.45%
FV at age 60 = 3600*{((1+0.45%)22*12-1))/0.45%}
=$1,817,426
Joan will achieve her targeted sum of $1.8 million
Surplus= 1,817,426-1,800,000
$17,426
ii) Using the entire fund balance, Joan then wishes to commence a monthly
pension payable by the fund startingone month after her 60th birthday,
and ending on her 85th birthday, after which she expects that the fund will
be fully expended. If the fund continues to earn the above return of 5.4%
per annum, compounded monthly, how much monthly pension will Joan
receive, if the fund balance reduces to zero as planned after the last
pension payment on her 85th birthday?
Fund at Age 60 $1,817,426.13
Number of Years to Age 85 25
i(12) 5.40%
j =5.40%/12= 0.45%
Find X?
1,817,426.13 = X*{(1-(1+0.45%)-25*12)/0.45%}
X=1,817,426.13/{(1-(1+0.45%)-25*12)/0.45%}
X=11,052.31
5

QUESTION 2 continued.
b) This question relates to loan repayments and loan terms.
Jack and Jill Jacobswish to borrow $700,000 to buy a home. The loan from the
HighwayBank requiresequal monthly repayments over 20 years, and carries.an
interest rate of 4.2% per annum, compounded monthly. The first repayment is
due at the end of one month after the loan proceeds are received.
You are required to calculate:
i) the effective annual interest rate on the above loan (show as a
percentage, correct to 3 decimal places).
Nominal rate compounded monthly (i(12))=4.2%
EAR =( 1+i(12)/12)12-1 =( 1+4.2%/12)12-1
=4.282%
ii) the amount of the monthly repayment (consisting of interest and principal
repayment components) if the same amount is to be paid every month
over the 20 year period of the loan.
Loan Amount $700,000
Number of Years 20
i(12) 4.2%
j =4.2%/12= 0.35%
Monthly PMT?
700,000 = PMT*{(1-(1+0.35%)-20*12)/0.35%}
PMT=700,000/{(1-(1+0.35%)-20*12)/0.35%}
PMT=4,316
iii) the amount of $X, if - instead of the above –the Highway Bank agrees
that Jack and Jill will repay the loan by paying the bank $3,500 per
month for the first 12 months, then $3,800 a month for the next 12
months, and after that $X per month for the balance of the 20 year term.
PV $700,000
Number of Years 20
i(12) 4.2%
j =4.2%/12= 0.35%
EAR (i) =4.282%
6

700,000= 3500*( 1−(1+ J ¿¿ ¿−12)
J )+ 3800*( 1−(1+J ¿¿ ¿−12)
J )*(1+i)−1+X*(
1−(1+J ¿¿ ¿−18∗12)
J )*(1+i)−2
700,000=41,059.90+42,748.90+ X*( 1−(1+ J ¿¿ ¿−216)
J )*(1+i)−2
X = $4,426.46
iv) How long (in years and months) would it take to repay the loan if,
alternatively,Jack and Jill decide to repay $4,500 per month, with the first
repayment again being at the end of the first month after taking the loan,
and continuing until the loan was repaid. [HINT: The final repayment is
likely to be less than $4,500, and will be paid one month after the final full
instalment of $4,500 is paid.)
Loan $700,000
i(12) 4.2%
j =4.2%/12= 0.35%
EAR (i) =4.282%
PMT $4500
Find Number of payments?
700,000 =4,500*{(1-(1+0.35%)-n*12)/0.35%}
n = 18.753 years or 225.032 months
=18 years 10 months
7

QUESTION 3. [(2 + 2 + 4 + 3 + 3 + 2 = 16 marks]
This question relates to alternative investment choice techniques
AndrewHardcastleis considering the following cash flows for two mutually
exclusive projects.
Year Cash Flows, Investment M ($) Cash Flows, Investment N ($)
0 -48,000 -48,000
1 15,000 24,000
2 24,000 24,000
3 36,000 24,000
You are required to answer the following questions:
i) If the cash flows after year 0 occur evenly over each year, what is the
payback period for each project, and on this basis, which project would
you prefer?
Pay back period= initial investment/periodic cash inflow
Project M:
Assume Payments are even over year
Therefore, periodic cash flow=(15,000+24,000+36,000)/3 = 25,000
PBP = 48,000/25000= 1.92
Project N:
Assume Payments are even over year
Periodic cash flow=(24,000+24,000+24,000)/3 = 24,000
PBP = 48000/24000= 2
Select Project M since it has a shorter pay back period
8

IN THE REMAINING PARTS, ASSUME THAT ALL CASH FLOWS
OCCUR AT THE END OF EACH YEAR.
ii) Would the payback periods then be any different to your answer in i)? If
so, what would the payback periods be?
Yes it would be different as follows
Payback period = Years before recovery + unrecovered cost at start year/cash
flow during the year
Project M:
Year cumulative
cash flow
0
(48,000)
1
15,000
15,000
2
24,000
39,000
3
36,000
75,000
PBP = 2 + (48,000-39,000)/36000= 2.25
Project N:
Year cumulative
cash flow
0
(48,000)
1
24,000
24,000
2
24,000
48,000
3
24,000
72,000
PBP = 2 + (48,000-48,000)/24000= 2
In this situation, select Project N because it has shorter pay back period
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iii) If the required return is 10% per annum, what are:
- the net present values of each project?
Project M
I= 10%
NPV =-48,000 + 15,000*(1+I)^-1 +24,000*(1+I)^-2 + 36,000*(1+I)^-3
=12,518.40
Project M
I=10%
NPV =40,000 + 24,000*(1+I)^-1 +24,000*(1+I)^-2 + 24,000*(1+I)^-3
=11,684.44
- the present value (or profitability) indexes of each project?
Profitability Index =(NPV + initial investment) / initial investment
Project M
NPV=12,518.40
Profitability index = (12518.4 +48,000)/48000
=1.26
Project M
NPV =11,684.44
Profitability index = (11684.44+48,000)/48000
=1.24
10

iv) Calculate the internal rate of return (IRR) for each project.
[NOTE: It is satisfactory if the approximate IRR is calculated for
Investment X by trial and error, and stated as a percentage correct to the
nearer whole number. The IRR for Investment Y should be calculated as
a percentage exactly, correct to 1 decimal place.]
IRR= Return that gives Zero NPV
Project M
0= -48000 + 15,000*(1+IRR)^-1 +24,000*(1+IRR)^-2 + 36,000*(1+IRR)^-3
Using Trial and error
Assume IRR = 22%, NPV = 245.23
Assume IRR = 22.5%, NPV = -178.08
Assume IRR = 22.4%, NPV = -93.90
Assume IRR = 22.35%, NPV = -51.72
Assume IRR = 22.30%, NPV = -9.48
Assume IRR = 22.28%, NPV = 7.43
Therefore IRR = 22.3%
Project N
0= -48,000 + 24,000*(1+IRR)^-1 +24,000*(1+IRR)^-2 + 24,000*(1+IRR)^-3
=- 40,000 + 24,000 (( 1 – (1+IRR)^-3)/IRR)
IRR = 23.4%
v) Calculate the exact crossover point(an interest rate, expressed as a
percentage correct to two places of decimals) of the respective net
present values for the above projects.
Cross over point is where NPV M = NPV N
-48,000 + 15000*(1+I)^-1 +24000*(1+I)^-2 + 36,000*(1+I)^-3 =-48,000 +
24,000 (( 1 – (1+I)^-3)/I)
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15,000*(1+I)^-1 +24,000*(1+I)^-2 + 36,000*(1+I)^-3 =24,000 (( 1 – (1+I)^-
3)/I)
Using Trial and error get 15.47%
vi) Having regard to the above calculations, state – with reasons - which of
investments M and N you would prefer.
Select Project M because it has a higher NPV and profitability index in
comparison to Project N. Furthermore, the IRR is greater than the
companies required return and it has a shorter payback period
12

QUESTION 4. [18 + 2 = 20 marks].
This question relates to capital budgeting.
Interstate Haulage Ltdis considering the purchase of two new modern large
truckscosting $500,000 each, which it will fully financewith a fixed interest loan of 8% per
annum, with interest paid monthly and the principal repaid at the end of 4 years. The
trucks will be used in the company’s interstate and intra-state trucking business.
The two new trucks will replace three existing smaller trucks and will permit the company
to reduce its storage costs by $50,000 a year and its labour costs by $200,000 a year,
both over the next 4 years. [Assume these savings are realized at the end of each year.]
The new trucksmay be depreciated for tax purposes by the straight-line method to zero
over the next 4 years. The company thinks that it can sell the trucksat the end of 4 years
for $150,000 each.
QUESTION 4 continued.
The three smaller old trucks were bought 1 year ago for $250,000 each, with a then life
expectancy of 5 years, and have been depreciated by the straight-line method at 20% a
year. If the company proceeds with the above purchase, the old trucks will be sold this
month for $100,000 each.
This is not the first time that the company has considered this purchase and
replacement. Twelve monthsago, the company engaged Cartage Consultants, at a fee
of $20,000 paid in advance, to conduct a feasibility study on savings strategies and
Cartagemade the above recommendations. At the time, Interstate Haulage Ltd did not
proceed with the recommended strategy, but is now reconsidering the proposal.
Interstate Haulage Ltdfurther estimates that it will have to spend tax-deductible amounts
of $40,000 in 2 years’ time and $50,000 in 3 years’ time overhauling the trucks.
It will also require additions to current assets of $30,000 at the beginning of the project,
which will be fully recoverable at the end of the fourth year.
Interstate Haulage Ltd’scost of capital is 10%. The tax rate is 30%. Tax is paid in the
year in which earnings are received.
13

REQUIRED:
(a) Calculate the net present value (NPV), that is, the net benefit or net loss in
present value terms of the proposed purchase costs and the resultant
incremental cash flows.
[HINT: As shown in the text-book, it is recommended that for each year you
calculate the tax effect first, then identify the cash flows, then calculate the
overall net present value. Finally, make your recommendation.]
Assumptions
2 Truck Cost $ 1,000,000.00
Depreciation_2 New truck $ 250,000.00
Salvage Value_2 New Trucks $ 300,000.00
Cost 3 old trucks $ 750,000.00
Price Old 3 trucks $ 300,000.00
Depreciation_3 Old truck $ 150,000.00
Loss on sale of 3 trucks $ 300,000.00
Net Working capital $ 30,000.00
Storage cost savings $ 50,000.00
Labor cost savings $ 200,000.00
Tax 30%
Discount Rate 10.00%
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Year 0 Year 1 Year 2 Year 3 Year 4
Cost Savings_Storage 50,000 50,000 50,000 50,000
Cost Savings_Labour 200,000 200,000 200,000 200,000
Less overhaul Costs 0 40,000 50,000 0
Operating profit 250,000 210,000 200,000 250,000
Less Depreciation Exp 250,000 250,000 250,000 250,000
Less loss on sale of Old
Trucks 300,000 0 0 0
Net Income before tax (300,000) (40,000) (50,000) 0
Less Income Tax 90,000 12,000 15,000 0
Net Income after Tax (210,000) (28,000) (35,000) -
Add Depreciation 250,000 250,000 250,000 250,000
After Tax Cash Flow operations 40,000 222,000 215,000 250,000
Initial Investment (1,000,000)
After Tax Terminal Flow 210,000 210,000
Net Working Capital (30,000) 30,000
After Tax Cash flows (1,000,000) 220,000 222,000 215,000 490,000
NPV @10% $ (120,320)
15

(b) Should the company purchase the new trucks? State clearly why or why not.
Based on the above NPV analysis, the company should not proceed with
the purchase of the new truck because the NPV is negative suggesting
the project will not be profitable
END OF ASSIGNMENT QUESTIONS
ADDITIONAL PAGE 1 (for workings, or if your answers take more space.)
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ADDITIONAL PAGE 2 (for workings, or if your answers take more space).
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