Comprehensive Financial Management Assignment Solution - BHM206

This document provides a comprehensive solution to a financial management assignment, covering a range of core concepts including time value of money, portfolio analysis, bond valuation, and the Capital Asset Pricing Model (CAPM). The assignment includes detailed calculations for future value, expected return, variance, and standard deviation of a portfolio. It also delves into the valuation of preference shares, the determination of market returns using CAPM, and the comparison of loan interest rates using effective annual rates. Furthermore, the solution addresses annuity and perpetuity calculations, bond pricing under different interest rate scenarios, and the application of the Gordon Dividend Model for share valuation. The document provides step-by-step solutions to each question, demonstrating a strong understanding of financial principles and their practical application.

FINANCIAL MANAGEMENT
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Question 1
Principal = $ 5,000
Interest rate = 2% per quarter
Time period = 5 years or (5*4) = 20 quarters
The compounding of interest is being done. Hence the relevant formula is shown below.
A = P (1+r)n
Here, P = $ 5,000, r=2%, n= 20
Hence, A = 5000*1.0220 = $ 7,429.74
Question 2
(a) Expected return on portfolio = 0.18*0.49 + 0.42*0.37 + 0.23*0.22 + 0.17*(-0.12) =
0.2738 or 27.38%
(b) The variance on the portfolio can be computed using the computations shown below.
Variance = 0.0893 or 8.93%
Standard deviation = √Variance = √0.0893 = 0.2988 or 29.88%
Question 3
a) Expected return on the preference shares = (Fixed dividend/Price)*100
Hence, expected return on Rio Tinto preference shares = (3.60/43.50)*100 = 8.28% p.a.

b) Now the return expected by the investor is 9.5%, hence let the price that investor would be
willing to pay be P. Using the above formula, we get
9.5 = (3.6/P)*100
Solving the above, we get P = $ 37.89
Question 4
The requisite formula as per CAPM approach is given below.
Expected return on share = Risk free rate + Beta*(Expected market return – Risk free rate)
In the given case, expected return on share = 13.1%, beta = 0.87 and risk free rate = 5.7%
Hence, 13.1 = 5.7 + 0.87*(Expected market returns – 5.7)
Solving the above, we get expected market returns = 14.21% p.a.
Question 5
The requisite formula as per CAPM approach is given below.
Expected return on share = Risk free rate + Beta*Market Risk Premium
In the given case, expected return on share = 12.2%, market risk premium = 7.1% and risk
free rate = 3.5%
Hence, 12.2 = 3.5 + Beta*7.1
Solving the above, beta of share = 1.23
Question 6
The effective annual rate needs to be found for both the loans so that a comparison can be
done.
Effective annual rate for the monthly compounded rate = [(1+(7.8/1200))12-1] *100 = 8.08%

Effective annual rate for the semi-annual compounded rate = [(1+(7.8/200))2-1] *100 =
8.16%
With regards to taking loan, a lower interest rate is preferable and hence the loan at 7.8% p.a.
compounded monthly would be preferred over 8% p.a. compounded semi-annually.
Question 7
a) The present value of the annuity of the cash flows would be the most amount that would be
paid for the five year annuity. The relevant formula is stated below.
In the given case, P = $ 2,000, r = 7% p.a., n = 5 years
Hence, the most amount payable = 2000*(1-1.07-5)/0.07 = $ 8,200.4
b) This is perpetuity since the annuity payments would continue forever.
Hence, amount to be paid = (Annual cash inflows/Return rate) = (25000/0.06) = $ 416,666.7
Question 8
a) At maturity the value of the bond must be equal to the face value of $ 700,000
Let the current price be P
Then, P (1+ (2.9/36500))110 = 700000
Solving the above, we get P = $ 693,909.09
b) Since the bill has been held for 80 days, hence the remaining maturity period is 30 days
30 days bill yields = 2.30% p.a.

Hence, P(1+ (2.3/1200))12 = $ 700000
Solving the above, we get P = $ 684,098.8
Question 9
(a) In the given case EAR = 6.2%
The nominal rate needs to be found considering semi-annual compounding. Let the nominal
rate be X% per half year
Then, (1+ (X/100))2 – 1= 0.062
Solving the above, we get X = 3.053%
The above would be used as a discount rate for the future cash flows expected from the bond
in order to estimate the current value of bond.
Face value of bond = $ 1000
Coupon = 7% of 1000 = $ 70 payable semi-annually i.e. $ 35 after six months each
Maturity period = 20 years or 40 semi-annual periods
The relevant formula for finding the current price of bond is shown below.
Here C = $ 35, i = 3.053% , n = 40, M = $ 1000
Therefore, bond price = [35*(1-(1/1.0305340))/0.03053] + 1000/1.035340 = $ 1,102.35
It is apparent that the bond is trading at a premium since the current price of bond exceeds the
face value of bond.
(b) If the quoted interest rate is 6.2 % p.a., then this is nominal rate which would imply that
for six months, the applicable interest rate would be 3.1%. The revised price computation of
the bond is shown below.

Here C = $ 35, i = 3.1% , n = 40, M = $ 1000
Therefore, bond price = [35*(1-(1/1.03140))/0.031] + 1000/1.03140 = $ 1,090.98
Clearly, the price of the bond has declined which is on expected lines considering that the
discount rate was increased.
Question 10
The relevant formula is shown below.
Average Real Return = Average Nominal Return – Average Inflation
Hence, average real return in ANZ = 3.1 – 1.1 = 2 %
Question 11
THe relevant formula to be used is shown below.
Dn = D0 (1+r)n
Based on the given information, D0 =$ 3, r= 2.5% p.a, n = 8 years
Hence, D8 = 3 *(1.0258) = $ 3.66
Question 12
The relevant formula for Gordon Dividend model is shown below.
Intrinsic share price = Next year dividend/(Required return – Dividend perpetual growth rate)
Next year dividend = $ 8, Required Return = 11% p.a., Dividend growth = 5% p.a.
Hence, current share price (P0) = 8/(0.11-0.05) = $133.33

Let the share price after 5 years be P5
Then, P0 = P5/(1+required return)5
Hence, 133.33 = P5/(1.115)
Solving the above, we get P5 = $ 224.67
Question 13
Based on the given data, the following information is relevant.
D1 = $ 2
D2 = $ 5
D3 = $ 7
D4 = $ 8
D5 = $ 4.5
D6 = 4.5*1.035 = $ 4.66
Required return = 12% p.a.
Perpetual dividend growth from year 6 onwards = 3.5% p.a.
The stock price can be found by finding the present value of dividends from year 1 to year 5
along with the value of future dividends from 6th year onwards determined by the Gordon
Dividend Approach.
Hence, stock price of ABC share = (2/1.12) + (5/1.122) + (7/1.123) + (8/1.124) + (4.5/1.125) +
[(4.66/(0.12-0.035))/1.125] = $ 49.48
Thus, the current price of ABC share is $ 49.48.