Report on Financial Instruments: AMP and CBA Share Evaluation

This report provides a detailed financial analysis of AMP Limited (AMP) and Commonwealth Bank of Australia (CBA) shares. Part A examines the current share prices of AMP and CBA, along with their historical price trends over a five-year period. It also discusses the impact of the Royal Commission on financial institutions like CBA and AMP, highlighting issues of misconduct and regulatory scrutiny. Part B focuses on capital budgeting, distinguishing between the required rate of return and the internal rate of return. It then evaluates two hypothetical projects using net present value (NPV) and internal rate of return (IRR) calculations, providing interpretations and recommendations for investment decisions. The analysis includes sensitivity analysis, examining the effects of a decrease in the required rate of return on the NPV and IRR of the projects. The report concludes with a recommendation regarding the most favorable investment proposal based on the financial metrics.

Banking and Finance

Table of Contents
INTRODUCTION...........................................................................................................................1
PART A...........................................................................................................................................1
1.Current price of ordinary/ common shares in AMP and CBA and their evolution..................1
2. Royal Commission inquiring into financial institutions like CBA and AMP.........................3
PART B............................................................................................................................................4
1. Distinguish between required rate of return and internal rate of return..................................4
2. Determine the net present value of both projects and its interpretation..................................5
3. Internal rate of return of both projects....................................................................................6
4. Changes in IRR and NPV, if required rate of return decreased to 10%..................................7
5. Recommendation regarding favourable investment proposal.................................................8
CONCLUSION................................................................................................................................9
REFERENCES..............................................................................................................................10

INTRODUCTION
Banking and Finance refer as a term of money management by investing in either banks
or other financial institutions. Banking is services offered by a bank whereas finance means
management of money by government or large financial companies.
This project report is based on financial markets function. Assignment is consist of two
parts. Part A, focus on analysis of financial instruments of two companies i.e. AMP and
Commonwealth Bank of Australia (CBA) and Part B, evaluate the fundamentals of capital
budgeting (Richards, 2012).
PART A
1.Current price of ordinary/ common shares in AMP and CBA and their evolution
AMP is a company comes under financial sector listed in ASX. It's headquarter in
Sydney, Australia. It deals in various financial services such as investment, financial, insurance
advice & banking products includes saving accounts and home loans.
CBA is an Australian multinational bank comes under banking and financial sector listed
in ASX. It provides several financial services like business, institutional banking, funds
management, insurance, broking and investment services.
The current share price of AMP Limited and Common Bank of Australia shares are 3.12
and 71.10 AUD respectively.
AMP share price are analysed and its evolution share price per book value for past 5-
years are shown below:
Valuation of Share price/Book
Year Share price
2014 2.93
2015 2.39
2016 2.53
2017 3.94
2018 3.6
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Interpretation: AMP share price per book value is highest in 2017 i.e. 3.94 from past
five years. 2.93, 2.39, 2.53, 3.94 and 3.60 are the share price for the years 2014, 2015, 2016,
2017 and 2018 respectively (Venardos, 2012). Company's share price increasing from 2015 to
2017 because of support of internal stakeholders. When a company introduces a new product or
service. Trust and goodwill of automatically increases which attract more customers. It positively
impact on company's operation and growth. By this AMP share price increases and it attract
more stakeholders.
CBA share price are also analysed and its evolution share price per book value for past 5- years
are shown below:
Valuation of Share price/Book
Year Share price
2014 2.84
2015 2.78
2016 2.35
2017 2.23
2018 1.88
2
2014 2015 2016 2017 2018
0
0.5
1
1.5
2
2.5
3
3.5
4
4.5
2.93
2.39 2.53
3.94
3.6
Share price

Interpretation: CBA share price per book value is highest in 2014 i.e. 2.84. It's price of
shares continuously decreasing every year such as 2.84, 2.78, 2.35, 2.23 and 1.88 are share price
of year 2014, 2015, 2016, 2017 and 2018 respectively. Company's share price decreasing every
year that means cost of borrowing and issue of equity rises which reduces the confidence of
employees and stockholders. Therefore it negatively impact on company's image.
2. Royal Commission inquiring into financial institutions like CBA and AMP
Royal commission looks the matters related to public inquiry for a specific issues into a
government and other companies. It also investigate on various financial institution such as
Commonwealth bank and AMP for identifying any misconduct and criminal or legal proceedings
(McAndrews, Sarkar and Wang, 2017). The function of royal commission is to analyse
misconduct in different financial institution like banking, financial services and superannuation
industry.
Commonwealth Bank which is largest organisation in Australia holding an excessive
amount of power over financial systems. Both the institutions provides highly profitable services
to their customers but also has to suffer from systematic and unsystematic risks. Systematic risks
are those which are related to market or industry. For example, AMP and CMP are two financial
institutions which has to face issues of economic instability, political changes and governmental
policies. Unsystematic risks are those risks which are related with the particular firm. For
3
2014 2015 2016 2017 2018
0
0.5
1
1.5
2
2.5
3 2.84 2.78
2.35 2.23
1.88
Share price

example: AMP has to suffer issues of excessive debt. Royal commission is the authority which
controls the affairs of financial institutions. Their policies and laws also affect the functioning of
these companies.
Systematic risks and unsystematic risks can be controlled by implementing various
strategies such of investment appraisal such as net present value method, average rate of return
method, pay back period method and internal rate of return method. Royal commission is a
governmental authority which has authority to control the affairs of financial institution and
companies listed on Australian securities exchange. This commission is authorised to control
AMP and CMP which are financial institutions (Venardos, 2012).
The inquiry of royal commission has roiled various banking and fund management
industries so as it has also affects the market image of common wealth bank of Australia.
According to royal commission's report CBA has been failed to comply with the law introduced
in 2014. This enquiry has also exposed how Sydney based bank overcharged and
misappropriated funds from customers. This reports has also affected the shares of CBA and
when the report of royal commission has bees disclosed CBA shares begun trading ex dividend
(Jones,2012).
Australia's largest superannuation provider AMP has hammered by Royal commission.
Here high costs, low returns, conflict and efficiencies of interest are negative points mentioned in
report. The bank also have to face profit falls which is because of royal commission's report and
it was the first time in almost a decade when it has faced a loss. It also loose its provisions to
cover the cost related to the long enquiry of royal commission.
PART B
Capital budgeting is an investment appraisal technique used for determining and
evaluating potentials large expenditures or investments. Company should pursue all projects and
opportunities which enhance stakeholders value. Below are the evaluation of both projects
proposals based on capital budgeting that Henry Property Ltd wants to choose one favourable
project. Company determine profitable project on the basis of below statements.
1. Distinguish between required rate of return and internal rate of return
Basis Required rate of return Internal rate of return
Meaning It is a minimum level of rate of t is a discounting rate that
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return which investors agree to
accept for a specific
investment.
makes net present value of
cash flows equal to zero and
generates the percentage of
return which the project is
expected to make.
Aim It determine the percentage
increase or decrease of an
investment over a specific time
period. Therefore, it is also
known as return on investment
It focus on break even cash
flow level of project which
provides accurate return rate.
Decision New project is profitable and
accepted only when its
required rate of return is less
than internal rate of return.
It help in investment decision-
making when internal rate of
return is higher than required
rate of return.
Outcomes It provide information to
investors about total growth
from starting to ending (Hall,
2012).
It details only annual growth
rate of investment.
2. Determine the net present value of both projects and its interpretation
Net Present Value: It is used in capital budgeting to determine the profitability of project
in which money is invested. It is calculated by the difference between the present value of cash
inflows and outflows over a period of time. The positive NPV indicates the income generated by
the project or investment is more than its anticipated costs (Net present value, 2018). Therefore,
an investment with positive net present value will be profitable and negative NPV will results to
loss.
The formula of calculating NPV is given below:
NPV = F / [ (1 + I) ^n ]
where, F = future cash flow
I = discount rate
n = number of periods in the future cash flow
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Net Present Value of project X
Years present value @ 12% Project X Net Present Value
0 -300000 -300000.00
1 0.8928571429 80000 $ 71428.57
2 0.7971938776 140000 $ 111607.14
3 0.7117802478 130000 $ 92531.43
4 0.6355180784 160000 $ 101682.89
5 0.5674268557 0 0.00
6 0.5066311212 0 0.00
Net Present Value $ 77250.04
Interpretation: The present value of cash inflow are $71428.57, $111607.14, $92531.43,
$101682.89 and initial investment is $ 300000.Net present value of project X is positive i.e. $
77250.04, which indicate cash inflow in project is more than its cash outflow. Therefore, it is
considered as a favourable investment decision.
Net Present Value of project Y
Years present value @ 12% Project Y Net Present Value
0 -300000 - $ 300000.00
1 0.8928571429 160000 $ 142857.14
2 0.7971938776 160000 $ 127551.02
3 0.7117802478 160000 $ 113884.84
4 0.6355180784 160000 $ 101682.89
5 0.5674268557 160000 $ 90788.30
6 0.5066311212 160000 $ 81060.98
Net Present Value $357825.17
Interpretation: The present value of cash inflow are $142857.14, $127551.02,
$113884.84, $101682.89, $90788.30 and $81060.98 for 1st, 2nd, 3rd, 4th, 5th and 6th year
respectively and initial investment is $ 300000. Net present value of project Y is positive i.e. $
357825.17, which shows cash inflow in project is same in all six years which is more than its
cash outflow. Therefore, it is considered as good investment decision.
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3. Internal rate of return of both projects
Internal rate of return is used in capital budgeting to determine the profitability of
potential investments. It is an annualized effective compounded rate which makes the net present
value of all inflows and outflows from the investments equals to zero. It evaluate the
attractiveness of an investment or project. If the internal rate of return of project is more than
company's required rate of return, that proposal is accepted. When IRR falls below the required
rate of return, then project should be rejected (Law and Singh, 2014).
The formula of calculating Internal rate of return is given below:
IRR = P0 + P1/(1+IRR) + P2/(1+IRR)2 + P3/(1+IRR)3 + . . . +Pn/(1+IRR)n
where, P0 = Initial investment
P1 to Pn = Cash inflows
IRR = Project's internal rate of return
Internal rate of return of project X
Years present value @ 12% Project X Net Present Value
0 -300000 - $ 300000.00
1 0.8928571429 80000 $ 71428.57
2 0.7971938776 140000 $ 111607.14
3 0.7117802478 130000 $ 92531.43
4 0.6355180784 160000 $ 101682.89
5 0.5674268557 0 0.00
6 0.5066311212 0 0.00
Net Present Value $77250.04
Internal Rate of Return 9.43%
Interpretation: In this project initial investment is $300000 and cash inflow in 1st, 2nd, 3rd,
4th year are $80000, $140000, $130000, $160000 respectively. There was no cash inflow after 4th
year which negatively impact on investments decisions. Internal rate of return is 9.43% which is
less than rate of return. Therefore, project X is not desirable (Callen and Fang, 2013).
Internal rate of return of project Y
Years present value @ 12% Project Y Net Present Value
0 -300000 - $ 300000.00
1 0.8928571429 160000 $ 142857.14
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2 0.7971938776 160000 $ 127551.02
3 0.7117802478 160000 $ 113884.84
4 0.6355180784 160000 $ 101682.89
5 0.5674268557 160000 $ 90788.30
6 0.5066311212 160000 $ 81060.98
Net Present Value $ 357825.17
Internal Rate of Return 32.43%
Interpretation: In project Y, the initial investment is $300000 and there is regular amount
of cash inflow in all six years i.e. $160000. The internal rate of return is 32.43% which is more
than rate of return i.e. 12%.. Therefore, this project is considered as positive investment proposal.
4. Changes in IRR and NPV, if required rate of return decreased to 10%
Calculation of revised internal rate of return when required rate of return decreased from
12% to 10%.
Years present value @ 10% Project X Net Present Value
0 -300000 - $300000.00
1 0.9090909091 80000 $72727.27
2 0.826446281 140000 $115702.48
3 0.7513148009 130000 $97670.92
4 0.6830134554 160000 $109282.15
5 0.6209213231 0 0.00
6 0.5644739301 0 0.00
Net Present Value $95382.83
Internal Rate of Return 11.42%
Interpretation: The present value of all cash inflows are $72727.27, $115702.48,
$97670.92, $109282.15 for 1st, 2nd, 3rd, 4th year respectively which is more than initial investment
$ 300000 when revised rate of return is 10%. Therefore, NPV is $ 95382.83 and IRR is 11.42%
which is more than previous net present value and internal rate of return.
Years present value @ 10% Project Y Net Present Value
0 -300000 - $ 300000.00
1 0.9090909091 160000 $145454.55
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2 0.826446281 160000 $132231.40
3 0.7513148009 160000 $120210.37
4 0.6830134554 160000 $109282.15
5 0.6209213231 160000 $99347.41
6 0.5644739301 160000 $90315.83
Net Present Value $396841.71
Internal Rate of Return 34.84%
Interpretation: The present value of all cash inflows are $145454.55, $132231.40,
$120210.37, $109282.15, $99347.41 and $90315.83 for 1st, 2nd, 3rd, 4th, 5th and 6th year
respectively and initial investment is $ 300000. The all six years cash inflow is more than initial
investments. Therefore, Net present value is $396841.71 and internal rate of return is 34.84 %
which is more in revised rate of return i.e. 10%.
5. Recommendation regarding favourable investment proposal
Both the projects were analysed and it is concluded that Henry Property Ltd should
consider project Y because there is a regular cash inflow with same amount of $ 160000 in all six
years whereas project X cash inflow is different in all years such as $ 80000, $140000, $130000
and $160000 in 1st, 2nd, 3rd and 4th year.
Net Present Value of Project X is $ 77250.04 in first case when required rate of return is
12%. In second case, when revised rate of return is 10% then NPV is $ 95382.83 which more is
case second. Whereas in project Y is $ 357825.17 with 12% required rate of return whereas NPV
is $396841.71 with revised rate of 10%. Therefore NPV is more after revising interest rate.
Henry Property Ltd should consider proposal of project Y because in both cases net present
value of project is higher than Project X (Attig and et. al., 2012).
Internal Rate of Return of Project X is 9.43% with required rate of return of 12% whereas
IRR is second case i.e. 10% rate is 11.42% . In project Y internal rate of return is 32.43% in first
case where required rate of return is 12% and IRR is 34.84% with 10% revised rate of return.
Therefore, company should adopt project Y because internal rate of return is high in this project
as compare to X.
From above comparison it is concluded that Henry Property Ltd should consider Project
Y for new capital budgeting proposals because net present value and internal rate of return is
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higher than project X and as initial investment of both proposal is same but cash inflows in
second project i.e. Y is more than X.
CONCLUSION
In this project report. It has been concluded that AMP and CBA share price are analysed
on the basis of past five years information. Royal commission investigates regarding systematic
and unsystematic risk in both companies. At last, company evaluate both project proposal on the
basis of net present value and internal rate of return technique. It consider project Y as a best
capital budgeting proposal.
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