University Business Finance Assignment: Knowledge and Valuation

This document presents a detailed solution to a Business Finance assignment, addressing key concepts such as agency costs, systematic and unsystematic risks, and various valuation methods. The solution includes calculations for future value, the number of years to grow a fund, risk assessment of assets, realized yield of a zero-coupon bond, and share valuation using dividend discount models. Additionally, the document analyzes two case studies, covering holding period return calculations for different shares and loan amortization schedules. The solution is meticulously presented with formulas, calculations, and explanations, making it a valuable resource for students studying business finance. The assignment covers topics like agency costs, systematic risks, future value, and share valuation, along with two case studies. The solution provides step-by-step calculations and explanations for each problem, ensuring clarity and understanding. The document is well-structured, providing a comprehensive guide to understanding and solving business finance problems. It includes the formulae, figures inserted into the formulae and then calculation steps. The final answer is shown up to two decimal places as per instructions given in the assignment brief.

Running head: BUSINESS FINANCE
Business Finance
Name of the Student:
Name of the University:
Author’s Note:

1BUSINESS FINANCE
Table of Contents
Answer to question 1:.................................................................................................................2
Sub part (a):............................................................................................................................2
Sub part (b):............................................................................................................................3
Answer to question 2:.................................................................................................................3
Answer to question 3:.................................................................................................................5
Sub part (a):............................................................................................................................5
Sub part (b):............................................................................................................................5
Sub part (c):............................................................................................................................5
Sub part (d):............................................................................................................................6
Sub part (e):............................................................................................................................6
Answer to case study 1:..............................................................................................................8
Sub part (a):............................................................................................................................8
Sub part (b):............................................................................................................................8
Answer to case study 2:..............................................................................................................8
Sub part (a):............................................................................................................................8
Sub part (b):............................................................................................................................9
Sub part (c):............................................................................................................................9
References and bibliography:...................................................................................................10

2BUSINESS FINANCE
Answer to question 1:
Sub part (a):
Agency cost means an internal company expenses to eliminate the conflict between
the principal and the agent. Here, the principal means the stakeholders mainly the
shareholders of a company and the agent means the management personnel who are
effectively working in the practical field to achieve the overall goal of the business as well as
the objectives of the shareholders. If any disruption or conflict of interest arises between
them, then the shareholders may need to appoint reappoint directors in the board, or may give
certain monetary or non monetary incentives to the management personnel. That increased
expenditure in the forms of incentives or in relation to resolving such disruptions, is known as
the agency cost. There are several ways in which such agency costs can be reduced to a
certain extent, which can be listed as follows (Gilson & Gordon 2013).
1. Financial incentives: Management personnel can be motivated to work according to
the interest and objectives set by the shareholders, through stock options, and profit
sharing schemes. In stock option scheme, they are allowed to buy company’s shares at
a predetermined and at a lower price. I profit sharing scheme certain percentage of
profit is allowed to them for achieving a predetermined target. Though these schemes
itself increases the agency cost, but still it can reduce the overall agency by achieving
the objectives of the shareholders (Gilson & Gordon 2013).
2. Non-financial incentives and measures: There are various non-financial incentives
and measures, which can reduce the conflict between shareholders and the
management personnel. For example, enhancing the work environment by the way of
new office and improved office facilities, Employee training and learning
opportunities. Recognition and reward from the shareholders for the works and
achievement of the management (Gilson & Gordon 2013).

3BUSINESS FINANCE
Sub part (b):
Agency cost arises from the conflict between management interests and interests of
shareholder or the stakeholders. If in any time the interest of shareholder do not match with
the interest of the management, and the management tends to perform according to their own
interest and goals, a loss may arise due to loosing of the potential profitable opportunities. In
another there may be some increased costs for assurance services to scrutinise and check the
management’s works. To reduce such agency costs, certain measures can be taken in the form
of monetary and non-monetary incentives and schemes (Pepper & Gore 2015).
In my opinion reducing agency cost will ensure the management or the business to
behave ethically. Conflict is a result of unethical behaviour. If that can be reduced by certain
initiatives, automatically the management personnel will be coming to an end of unethical
practices and start working to fulfil the shareholders’ goals. The best ethics for management
practices is to perform their duties and always strive to achieve the objective of shareholders
wealth maximization. If reducing agency costs through monetary and nonmonetary ways can
motivate management personnel to work towards achieving the shareholders’ goal, it will
meet their ethical standards in their professional areas. Therefore, a sound strategy to
minimize conflicts can motivate management personnel to achieve overall objective of the
business through the ethical practices of the management.
Answer to question 2:
Systematic risks are associated with the market as a whole and the unsystematic risks
are associated with the respective industry. Systematic risks cannon be diversified, but the
unsystematic risks can be diversified through optimal combination of investments in the
portfolio. Diversification means, constructing the portfolio with combination of shares from
various industry sectors and risky and non-risky investments, which reduces the risk

4BUSINESS FINANCE
coefficient of the portfolio to the lowest possible level. Systematic risks are more related with
the market factors rather than the industry factors. In the given case study, the investor is
planning to invest in the shares of various companies, which are in the same industry. It may
a portfolio strategy of the investor, but it may create some systematic risk for the investor or
it may influence the systematic risks. There of such instances can be outlined as below
(Waemustafa & Sukri 2016).
1. Economic downtown: If the economy is going through a downtown, and the industry
is performing poor in which the investor has invested, can create such type of
problems, which cannot be eliminated through diversification.
2. Poor performance of the industry: If the industry is performing poor, then it could
create a systematic risk for the portfolio, as it could not be avoided because all the
shares constituting the portfolio are from the same industry.
3. Changes in Government policies for the industry: If the Government brings certain
changes related to the industry, it may influence the systematic risk for the portfolio,
which could not be diversified by changing the combination of shares as all the shares
are in the same industry.

5BUSINESS FINANCE
Answer to question 3:
Sub part (a):
Computation of Future Value of the investment
Investment amount $ 5,000.00
Interest rate per annum 2.20%
Number of years 5
Interest compounding period 365
Furure Value=5000∗(1+ 2. 20 %
365 )5∗365
Amount would be grown to $5,581.37
Sub part (b):
Computation of number of years to grow the fund to a required amount:
Investment amount $ 2,000.00
Interest rate per annum 7.00%
Interest compounding period 4
Future Value $ 3,500.00
3500=2000∗( 1+ 7 %
4 )
n∗4
Solving “n” from the above equation, we can get the required
number of years 8.06 Years
Sub part (c):
Computation of risk of assets
Probability Return
Expectation
=
Probability
* Return
Square of
return
Probabil
ity *
Square
of return
35% 10% 0.0350 0.0100 0.0035
40% 17% 0.0680 0.0289 0.0116
25% 7% 0.0175 0.0049 0.0012
Total 0.1205 0.0163
Variance (0.0163-0.1205^2) 0.002
Standard Deviation/Risk of assets 0.042

6BUSINESS FINANCE
(Square root of Variance)
Sub part (d):
Computation of realized yield of the Zero coupon bond
Number of years to maturity 10
Face value of the bond 100
Interest compounding period in a year 2
Current market price 79
Holding period in years 5
Selling price after 5 years 85
Realized yield in 5 years ¿ ( 85
79 ) 1
5 −1 1.47
%
Sub part (e):
Basic information
Growth rate for the first three years 14%
Growth rate for the following two years 10%
Uniform growth rate after 5 years 5%
Dividend per year ¥ 220
Required rate of return 17%
Market price per share ¥ 2,500
Computation of value of shares
Number of Dividend Dividend PV Factor @17% Present Value =
Div.*PV Factor
D1 (220*114%) ¥ 250.80 0.8547 ¥ 214.36
D2 (250.80*114%) ¥ 285.91 0.7305 ¥ 208.86
D3 (285.91*114%) ¥ 325.94 0.6244 ¥ 203.51
D4 (325.94*110%) ¥ 358.53 0.5337 ¥ 191.33
D5 (358.53*110%) ¥ 394.39 0.4561 ¥ 179.88
Total present value of dividends till 5 years ¥ 997.94
D6 (394.39*105%) ¥ 414.11 0.3898 ¥ 1,345.29

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Total Value of share (PV of Dividends for the five years + PV
of 6th year’s dividend) ¥ 2,343.23
The intrinsic value of the shares as computed above is ¥ 2,343.23 and the market
value of the share is ¥ 2,500. The market price of the shares will tend towards the intrinsic
value of the share in future and will come to the intrinsic value. Hence, it is not desirable to
purchase the shares at a market price of ¥ 2,500.

8BUSINESS FINANCE
Answer to case study 1:
Sub part (a):
Computation of holding period return
Shares
Adjuste
d
closing
price
Adjuste
d
closing
price Dividend Holding period return
4-Jan-
17
4-Jan-
19
BHP Billiton Ltd 22.88 32.69 2.623095
((32.69-22.88)+2.623095)/22.88 =
54.34%
Rio Tinto Ltd 53.46 74.84 7.0071
((74.84-53.46)+7.0071)/53.46=
53.10%
Telstra
Corporation 4.524 2.844 0.46
((2.844-4.524)+0.46)/4.524=
-26.97%
Sub part (b):
Computation of expected return of the shares
Shares
Investment
Holding
Period
Return
Expected
return =
Investment
* Holding
period
return
BHP Billiton Ltd 2500 54.34% 1358.51
Rio Tinto Ltd 2500 53.10% 1327.49
Telstra Corporation 5000 -26.97% -1348.36
Total 10000 1337.64
Expected return of the portfolio = (1337.64/10000) 13.38%
Answer to case study 2:
Sub part (a):
Computation of Cash to be paid from the savings
Investment Amount $ 8,000.00
Number of years 4
Interest compounding period in a year 4
Interest rate 4.70%

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Value of investment after 4 years ¿ 8000∗( 1+ 4.70 %
4 )
4∗4
$9,644.09
Sub part (b):
Computation of loan amount and Installment amount
Cost of the Car 28000
Less: Amount paid from savings $9,644.09
Loan Amount $18,355.91
Add: Loan application fees 100
Total Loan amount $18,455.91
Interest rate on loan 7%
Number of years 2
Interest compounding period in a year 2
Installment amount
¿
18455.91∗7 %
2 (1+ 7 %
2 )2∗2
( (1+ 7 %
2 )2∗2
−1 ) $5,024.64
Sub part (c):
Loan Amortization schedule
Yea
r
No of
Installment
Beginning
balance =
Ending
balance of
the last
month
Installment
Amount
Interest
Payment =
Beginning
Balance *
7 %
2
Principle
Payment =
Total
Installment-
Interest
Payment
Ending
Balance =
Beginning
balance –
Principal
Payment
1 1 $18,455.91 $5,024.64 $645.96 $4,378.68 $14,077.22
2 $14,077.22 $5,024.64 $492.70 $4,531.94 $9,545.28
2 3 $9,545.28 $5,024.64 $334.08 $4,690.56 $4,854.73
4 $4,854.73 $5,024.64 $169.92 $4,854.73 ($0.00)

10BUSINESS FINANCE
References and bibliography:
Bosse, D. A., & Phillips, R. A. (2016). Agency theory and bounded self-interest. Academy of
Management Review, 41(2), 276-297.
Pepper, A., & Gore, J. (2015). Behavioral agency theory: New foundations for theorizing
about executive compensation. Journal of management, 41(4), 1045-1068.
Gilson, R. J., & Gordon, J. N. (2013). The agency costs of agency capitalism: Activist
investors and the revaluation of governance rights. Colum. L. Rev., 113, 863.
Goetz, M. R., Laeven, L., & Levine, R. (2013). Identifying the valuation effects and agency
costs of corporate diversification: Evidence from the geographic diversification of US
banks. The Review of Financial Studies, 26(7), 1787-1823.
Gagliardini, P., & Gouriéroux, C. (2013). Granularity adjustment for risk measures:
Systematic vs unsystematic risks. International Journal of Approximate Reasoning, 54(6),
717-747.
Waemustafa, W., & Sukri, S. (2016). Systematic and unsystematic risk determinants of
liquidity risk between Islamic and conventional banks.