Application of Time Value of Money and CAPM Model in JB Hi-Fi

Desklib provides past papers and solved assignments for students. This case study analyzes JB Hi-Fi's financial decisions.

Business Case Studies
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Table of Contents
Introduction:................................................................................................................................................3
1 a................................................................................................................................................................4
1 b................................................................................................................................................................5
1c.................................................................................................................................................................6
1d.................................................................................................................................................................8
1e.................................................................................................................................................................9
1f...............................................................................................................................................................11
2 a..............................................................................................................................................................12
2 b..............................................................................................................................................................13
3 a..............................................................................................................................................................14
Conclusion:................................................................................................................................................16
References:................................................................................................................................................17
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Introduction:
The project report is designed to understand the time value of money and analyse the impact of
the time value of money on the investment and expenditure made by the company. It has been
done by providing solutions to the problems mentioned in the assignment. The report is divided
into different parts: Part 1 shows the practical approach of solving the questions relating to the
time value of money and bond valuation. And in the Part 2 estimates are calculated relating to
the risk and return of two companies by using the CAPM model. The company allocated in the
given assignment is which JB HiFi which is an ASX Listed company and another-another
company has taken for the assignment is a hypothetical company named Company X. The data
provided for the company JB HiFi is used for doing the calculation of this assignment problem.
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1 a
Your case company has just made a large sale on an instalment contract. The contract requires to
pay you are shown in Table 1 (page 4 of this document) at the end of every month for 4 years.
Your case company would like the cash now for investment and so has asked its bank to discount
the instalment contract and pay it the discounted value. The bank will discount the contract at 7%
APR, compounded monthly. How much cash will your case company receive from the bank?
Installment No. Instalment PVF (7/12) DCF @ 0.58% Present Value
1 32.9 0.58% 0.994 32.7026
2 32.9 0.58% 0.989 32.5381
3 32.9 0.58% 0.983 32.3407
4 32.9 0.58% 0.977 32.1433
5 32.9 0.58% 0.971 31.9459
6 32.9 0.58% 0.966 31.7814
7 32.9 0.58% 0.96 31.584
8 32.9 0.58% 0.955 31.4195
9 32.9 0.58% 0.949 31.2221
10 32.9 0.58% 0.944 31.0576
11 32.9 0.58% 0.938 30.8602
12 32.9 0.58% 0.933 30.6957
13 32.9 0.58% 0.928 30.5312
14 32.9 0.58% 0.922 30.3338
15 32.9 0.58% 0.917 30.1693
16 32.9 0.58% 0.912 30.0048
17 32.9 0.58% 0.906 29.8074
18 32.9 0.58% 0.901 29.6429
19 32.9 0.58% 0.896 29.4784
20 32.9 0.58% 0.891 29.3139
21 32.9 0.58% 0.886 29.1494
22 32.9 0.58% 0.881 28.9849
23 32.9 0.58% 0.875 28.7875
24 32.9 0.58% 0.87 28.623
25 32.9 0.58% 0.865 28.4585
26 32.9 0.58% 0.86 28.294
27 32.9 0.58% 0.855 28.1295
28 32.9 0.58% 0.851 27.9979
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29 32.9 0.58% 0.846 27.8334
30 32.9 0.58% 0.841 27.6689
31 32.9 0.58% 0.836 27.5044
32 32.9 0.58% 0.831 27.3399
33 32.9 0.58% 0.826 27.1754
34 32.9 0.58% 0.821 27.0109
35 32.9 0.58% 0.817 26.8793
36 32.9 0.58% 0.812 26.7148
37 32.9 0.58% 0.807 26.5503
38 32.9 0.58% 0.803 26.4187
39 32.9 0.58% 0.798 26.2542
40 32.9 0.58% 0.793 26.0897
41 32.9 0.58% 0.789 25.9581
42 32.9 0.58% 0.784 25.7936
43 32.9 0.58% 0.78 25.662
44 32.9 0.58% 0.775 25.4975
45 32.9 0.58% 0.771 25.3659
46 32.9 0.58% 0.766 25.2014
47 32.9 0.58% 0.762 25.0698
48 32.9 0.58% 0.758 24.9382
Total 1374.9239
The cash inflows of four years have been discounted using the discount rate of 7% p.a. as given in
the problem. The sum total of the Present Value of these future cash inflows comes out to be
$1374.9239. Thus, JB HiFi will receive $ 1374.9239 from its respective bank.
1 b
Your company has annual operating revenue as shown in Table 1. Assume this revenue will grow
continuously at the annual rate shown in Table 1. What is your prediction for annual operating
revenue in 5 years?
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Amount ($) Growth Rate Cumulative Amount ($)
6854.3 15.30% 7903.01
7903.01 15.30% 9112.17
9112.17 15.30% 10506.33
10506.33 15.30% 12113.80
12113.80 15.30% 13967.21
JB HiFi will have annual operating revenue of $ 13967.21 in 5 years as per the calculations made
with the given growth rate of 15.30% annually.
1c
Your company needs to borrow funds and has several options available to it, Loans A, B
and C. The interest rates (APR) for these options are given in Table 1. What is the EAR
of the loan option the company should choose?
Loan A
I = [1+(r/n)] ^ (n-1)
Where,
R = Annual Interest Rate = 4.26%
N = Number of Compounding Periods = 2
I = [1+ (0.0426/2)]^(2-1)
I = 4.3054%
Loan B
I = [1+(r/n)] ^ (n-1)
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Where,
R = Annual Interest Rate = 4.25%
N = Number of Compounding Periods = 4
I = [1 + (0.0425/4)] ^ (4 – 1)
I = 4.3182%
Loan C
I = [1+(r/n)] ^ (n-1)
Where,
R = Annual Interest Rate = 4.24%
N = Number of Compounding Periods = 365
I = [1+ (0.0424/365) ^ (365-1)
I = 4.3309%
The table below shows the summary of the calculation of EAR for all the loan options; A, B and
C:-
Particul
ars
Compounding
Freq. n Rate
=i i/n (1+i/n) (1+i/
n)^n
(1+i/
n)^n-1 EAR
Loan A semi-annually 2 4.26
% 0.0213 1.0213 1.04305
4
0.043053
69
4.3054
%
Loan B quarterly 4 4.25
%
0.0106
25
1.0106
25
1.04318
2
0.043182
15
4.3182
%
Loan C daily 36
5
4.24
%
0.0001
16
1.0001
16
1.04330
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0.043309
15
4.3309
%
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Loan A 4.3054%
Loan B 4.3182%
Loan C 4.3309%
It can be seen that the EAR (Effective Interest Rate) of Loan A source is minimum among all the
three available sources. So the company, JB HiFi should choose Loan A source because of least
cost associated with it (Vanneste, et .al ., 2015).
1d
Your Company is buying a new property for the amount given in Table 1. To finance this, the
company's bank has offered an amortized loan at 3.8% APR, quarterly compounding, with 10
years of monthly payments. What quarterly payment will the company have to make on this
loan? Assume that the entire property cost is financed and that payments are made at the end of
each period.
Cost of Property = $619000
Effective Interest Rate= [(1+ (k/m)] ^m-1
Where,
k=Coupon Rate Annually= 3.8%
m= Number of Period= 4
Effective Interest Rate = [1+ (0.038/4)] ^4-1
Effective Interest Rate = 3.854%
If compounded monthly then,
Effective Monthly Interest Rate = 3.854/12
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Effective Monthly Interest Rate = 0.3211%
Monthly Payment to be made on this Loan = Cost of Asset/Annuity Factor of Effective
Interest Rate
Monthly Payment to be made on this Loan = 619000/99.454
Monthly Payment to be made on this Loan = 6223.9829
Quarterly Payment to be made = 6223.98*3
Quarterly Payment to be made = 18671.95
Thus the quarterly payment that the company will have to make on the loan will be $ 18671.95
1e
Your company has an issue of $100 par value annual coupon bonds with 8 years remaining until
maturity. The annual coupon rate is given in Table 1, along with the current price of the bonds.
What is the yield to maturity on the bonds?
Particulars Amount
Par Value 100
Number of Years to Maturity 8
Annual Coupon Rate 5.90%
Current Price 98.95
YTM 6.06%
YTM or yield until maturity is that rate of interest which a person will earn if he/she holds the
bond until its maturity (Ballotta and Kyriakou, 2015). It is that discount rate at which the current
price of a bond is equal to the future cash flows. It can be calculated with the short- cut formula
given as below:
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YTM
=
Coupon Payment
+
Face Value - Price
N
Face Value + Price
2
YTM= 5.90+ (100-98.95/8)
(100+98.95)/2
= 6.063%
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1f
Your company has an issue of $1,000 par value bonds that offer a 7% coupon rate paid semi-
annually. The bonds have 6 years remaining until maturity. The market’s required return on these
bonds is given in Table 1. What is the amount of each coupon payment?
The par value of the bond is given as $ 1000 and the coupon rate is 7% which is paid semi-
annually. The amount of coupon payment is always calculated on the par value of a bond; $1000
at the rate of 7% p.a. which is $ 70 per annum. However, the bond in the problem is semi-annual
and that is why the annual payment would have to be divided by 2 to get the semi-annual
payment amount which is $ 70 / 2 = $ 35. Hence the interest payment of the bond is $ 35 which
is paid twice in a year. The calculation for the present value for coupon payment is calculated in
the table below:
Year
Coupon
Amount
PVF @
2.45%
Present
Value
1 35 0.976 34.16
2 35 0.953 33.34
3 35 0.930 32.55
4 35 0.908 31.77
5 35 0.886 31.01
6 35 0.865 30.27
7 35 0.844 29.54
8 35 0.824 28.84
9 35 0.804 28.15
10 35 0.785 27.48
11 35 0.766 26.82
12 35 0.748 26.18
Total 360.09
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2 a
Use CAPM to estimate the expected return for the shares of :
i) Your case company and ii) a hypothetical company with a negative beta of -0.20 as of 5 April
2019. To do this, use the yield to maturity on that date of a 10-year Australian Government bond
as a proxy for the risk-free rate, assume the market risk premium is 6% and use the company's
most recent 5-year beta.
Particulars Company X JB HiFi
Beta Value (0.20) 0.26
Market Return Rate - 7.90
Risk-free rate 1.90 1.90
Premium 6.00 6.00
(1.20) 1.56
Expected Return Rate 0.70 3.46
The formula for CAPM = Risk free Rate + Beta (Market Return – Risk-Free Risk-Free
Rate)
CAPM model is the process whereby the relationship between the systematic risks (Beta) and the
expected return for the assets for the investors. It is a widely used tool among the financial
experts to calculate returns for risky securities and the cost of capital for the company. Not only
it is used for calculation of return for the shares, but also helps to ascertain if the share is under-
priced or overpriced by comparing the expected rate of return with the offered rate of return by
the company and hence aiding the investors in making investment decisions(Jaggi, et., al., 2016).
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