KOI Trimester 1, 2019 FIN700 - Financial Management Group Assignment 2

This document provides a comprehensive solution to a Financial Management assignment (FIN700) from KOI, Trimester 1, 2019. The assignment covers seven problems, including calculating Karina Adams' dividend income and loan requirements, EMI and amortization for a house loan, present value of cash flows and investment decisions, bond pricing and sensitivity analysis, Altron's share valuation using the dividend growth model, Annual Equivalent Cost (AEC) comparison of investment quotes, and capital budgeting decisions involving NPV, payback period, and present value index. Each question is solved with detailed formulas, step-by-step calculations, and relevant explanations, providing a complete guide for understanding the financial concepts and problem-solving techniques required for the assignment. The document references several financial management texts to support the solutions and recommendations.

FINANCIAL MANAGEMENT
STUDENT ID:
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Question 1
PAT for AAR Ltd for year 2018 = $ 500,000
Ownership of Karina Adams in AAR Ltd = 10%
Dividend payout = 60%
Hence, total dividend paid by the company in 2018 = PAT*Dividend Payout = 500,000*0.6 =
$300,000
Dividend income for Karina Adams on June 1 2019 = (10/100)*300,000 = $ 30,000
Total expenditure expected by Karina in 2019 = 5,000 (Furniture) + 35,000(Billings) = $ 40,000
Since Karina does not have any savings and the dividend income in 2019 is only $ 30,000, hence
for meeting the expenditure of $ 40,000, a loan of $ 10,000 would be taken.
Expected PAT for AAR Ltd for year 2019 = $500,000*1.2 = $600,000
The dividend payout remains the same and hence dividend income expected by Karina on June
1, 2020 = (10/100)*(60/100)*(600,000) = $ 36,000
Interest levied on the loan assumed in 2019 = (8/100)*10,000 = $ 800
Amount available for consumption in June 2020 = 36,000 – 10,000 (repayment of loan) – 800
(payment of interest) = $ 25,600
Question 2
a) Cost price of house = $ 750,000
Down payment required = 20%
Hence, quantum of loan required = 750,000*(1-0.2) = $ 600,000
The EMI (Equal Monthly Installment) can be computed using the following formula.

For the given case, P = $600,000, R = 7.2% pa or 0.6% per month, N=10 years or 120 months
Hence, EMI = (600000*0.006*1.006120)/(1.006120-1) = $7,028.51
Using the above EMI, the amortization table for the first 36 months is listed below.

Relevant Explanation:
1) Closing loan balance = Opening loan balance – Principal repayment
2) Principal repayment = EMI – Interest
3) Interest = Opening loan balance * Interest rate per month
Loan amount outstanding at the end of three year = $ 462,687.16
New interest rate applicable = 9.6% p.a. or 0.8% per month
Loan amount = $ 462,687.16
Time period remaining =7 years or 7*12 =84 months
The following formula can be used to estimate the new EMI.
New EMI = (462,687.16*0.008*1.00884)/(1.00884-1) = $7,585.87
b) Assuming now the EMI remains the same, then the value of N needs to be found for
discharging the loan using the following formula.
Here, EMI = $7,058.21, R=9.6% p.a. or 0.8% per month, P = $ 462,687.16
7058.21 = (462,687.16*0.008*1.008N)/(1.008N-1)
Solving the above N = 94 months
Since three years had already passed, thus the pending loan without any increase in rate would
have been discharged in 84 months. Thus, additional payments required = 94-84 = 10 months

Question 3
a) Based on the given information, the expected cash inflows are listed below.
Cash inflow in year 4 = $120,000
Cash inflow in year 5 = $220,000
Cash inflow from year 6 onwards = $ 300,000
The discount rate is given as 10% p.a.
The present value of the above payment needs to be found using the following formula (Lasher,
2017).
PV = FV/(1+r)n
PV = (120000/1.14) + (220000/1.15) + (300000/(0.1*1.15)) = $ 2,081,328
b) The present value of the given perpetuity which would start paying two years from now =
(220000/(0.1*1.12) = $1,818,182
It is evident that the second investment would not be chosen as the present value of this is lower
than the present value of the first investment.
Question 4
a) The price of a bond would essentially be equal to the present value of all future cash flows
i.e. coupon payment and selling price. The requisite formula for computation of price is
shown below.
For the bond maturing on April 1, 2022, the following input data would be valid.

M = $100,000, i =10% p.a. or 5% per half year, n = 3 years or 6 half years, C =
(8/100)*(100000) = $ 8000 per year or $ 4000 per half year
Hence, bond price = 4000*(1-(1/1.056))/0.05 + (100000/1.056) = $94,924.31
For the bond maturing on April 1, 2026, the following input data would be valid.
M = $100,000, i =10% p.a. or 5% per half year, n = 7 years or 14 half years, C =
(8/100)*(100000) = $ 8000 per year or $ 4000 per half year
Hence, bond price = 4000*(1-(1/1.0514))/0.05 + (100000/1.0514) = $90,101.36
b) It is apparent that the deterioration in price is more for the bond with the longer maturity
period in comparison to the bond with lower maturity period. Typically for duration for the
longer maturity bond is higher which makes the underlying bond price more sensitive to
changes in the interest rate as compared to bonds with shorter maturity periods (Damodaran,
2015).
Question 5
a) The relevant formula to be used is stated as follows.
Dt=D0× ( 1+g ) t
The timeline for the expected dividends is shown below.

b) The value of Altron’s share can be estimated using the above dividends and the dividend
growth model suggested by Gordon.
Considering that after year 7, the dividend growth rate would be 5% forever, hence the following
formula would be used.
P0= D0× ( 1+ g )
( RE−g ) = D1
( RE−g )
Terminal value of all dividends after year 7 = (1.77/(0.13-0.05)) = $22.125
The present value of the share can be estimated by the present value of all dividends and the
terminal value with 13% as the discount rate.
Price of Altron’s share = (1.62/1.13) + (1.46/1.132) + (1.31/1.133) + (1.39/1.134) + (1.47/1.135) +
(1.58/1.136) + (1.69/1.137) + (22.125/1.137) = $ 16.02
Question 6
The relevant formula for computation of AEC is shown below.
First Quote
Asset price = $100,000
Annual maintenance cost = $ 3,000
Number of time periods = 3 years
Discount rate = 9% p.a.
Hence, AEC = 100,000*(0.09/(1-1.09-3)) + 3000 = $ 42,505.48

Second Quote
In the given case, the servicing cost tend to vary, hence the following formula would be used.
AEC = NPV/Annuity Factor
The formula for Annuity Factor is shown below.
The requisite cash flows for the machine are as follows.
Year 0 = -$ 90,000
Year 1 = -$ 8,000
Year 2 = -$9,000
Year 3 & Year 4 = -$ 10,000 each
Hence, NPV = -90,000 + (-8000/1.09) + (-9000/1.092) + (-10000/1.093) + (-10000/1.094) = -
$119.720.7
Therefore AEC = (119720.7*0.09)/(1-1.09-4) = $36,954.03
Conclusion
Since the AEC for the second quote is lower, hence it would be preferred over the first quote
(Petty et. al., 2016).
Question 7

a) It is imperative to note that the money spent on the feasibility study to the tune of $ 25,000.
Based on the other information, the incremental cash flow is shown below.
Explanation:
1) Annual Depreciation = (500000/4) = $ 125,000
2) Salvage value would be taxable owing to the capital gains as the book value was reduced to
0. This capital gains also assumed to be taxed at 30%.
3) Loss of rent is an opportunity cost as if this project was not undertaken, the company would
derive the lease rentals
4) Payment for termination of lease rentals = 30000*1.1 = $ 33,000. Since it is not taxable,
hence it has been taken separately.
b) The initial investment = $ 568,000
Total amount recovered during the first three years = $ 438,000
Amount required to be still recovered in the 4th year = (568000-438000) = $ 130,000
Time required in the 4th year to recover the pending amount = (130,000/198500) = 0.65
Hence, payback period = 3+0.65 = 3.65 years

c) The formula for NPV is stated below.
NPV=−C0+∑
t=1
T Ct
( 1+ r )t
The cost of capital is given as 12% using which the NPV is computed as shown below.
NPV = -568000 + (149500/1.12) + (139000/1.122) + (149500/1.123) + (198500/1.124) = -$
91,146.4
d) The formula for present value index is shown as follows.
Present value index = NPV/Initial Outlay
Here NPV = -$91,146.4
Initial Outlay = $568,000
Present value index = (-91146.4/568000)= 0.16
e) The company should not purchase the equipment as the NPV of the project is negative and
thereby the project would not create wealth for the shareholders and would instead destroy
the same (Brealey, Myers and Allen,2014).

References
Brealey, R.A., Myers, S.C. and Allen, F. (2014) Principles of corporate finance. 2nd ed. New
York: McGraw-Hill Inc, pp. 176
Damodaran, A. (2015) Applied corporate finance: A user’s manual. 3rd ed. New York: Wiley,
John & Sons, pp.155
Lasher, W. R., (2017) Practical Financial Management. 5th ed. London: South- Western
College Publisher, pp. 191
Petty, J.W., Titman, S., Keown, A., Martin, J.D., Martin, P., Burrow, M., and Nguyen, H. (2016)
Financial Management, Principles and Applications. 6th ed. NSW: Pearson Education, French
Forest Australia, pp. 178