ASSIGNMENT
This assignment is to be completed in groups of three and carries 30 per-cent of the marks in this unit.
Part A. (12 marks)
Information concerning raising new capital
Bonds $1,000 Face value
12% Coupon Rate (Annual Payments)
20 Term (Years)
$30 Discount offered (required) to sell new bonds
$20 Flotation Cost per bond
Preference Shares 11% Required rate to sell new preference shares
$100 Face Value
$4 Flotation cost per share
Ordinary Shares $83.33 Current Market Price
$10.00 Discount on share price to sell new shares
$5.40 Flotation Cost per bond
$5.00 2015 - Proposed Dividend
Dividend History $4.63 2014
$4.29 2103
$3.97 2012
$3.68 2011
$3.40 2010
Current Capital Structure
Extract from Balance Sheet $1,000,000 Long-Term Debt
$800,000 Preference Shares
$2,000,000 Ordinary Shares
Current Market Values $1,000,000 Long-Term Debt
$500,000 Preference Shares
$4,000,000 Ordinary Shares
Tax Rate
40%
a) Calculate the cost associated with each new source of finance. The firm has no retained earnings available.
b) Calculate the WACC given the existing weights
The financial controller does not believe the existing capital structure weights are appropriate to minimise the firm’s cost of capital in the medium term and believes they should be as follows
Long-term debt 40%
Preference Shares 15%
Ordinary Shares 45%
c) What impact do these new weights have on the WACC?
The firm is considering the following investment opportunity. (2015-2022)
Data is as follows
Initial Outlay $1,600,000
Upgrade $750,000 End of Year 4
Upgrade - 400,000 Increased sales units per annum - (Year 5-8)
Working Capital $40,000 Increase required
Estimated Life 8 Years
Salvage Value $50,000
Depreciation Rate 0.125 For tax purposes
The machine is fully depreciated by the end of its useful life
Other Cash Expenses $60,000.00 Per annum (Years 1-4)
Other Cash Expenses $66,000.00 Per annum (Years 5-8)
Production Costs $0.13 Per Unit
Sales price $0.73 Per Unit (Years 1-4)
Sales price $0.98 Per Unit (Years 5-8)
Prior sales estimates
Year Sales
2004 500000
2005 550000
2006 540000
2007 560000
2008 565000
2009 590000
2010 600000
2011 610000
2012 615559
2013 669000
2014 700000
d) Calculate the Net Present Value, Internal Rate of Return and Payback Period
The financial controller is considering the use of the Capital Asset Pricing Model as a surrogate discount factor. The risk-free rate is 5 per cent.
Year Stock Market Share
Index Price
2004 2000 $15.00
2005 2400 $25.00
2006 2900 $33.00
2007 3500 $40.00
2008 4200 $45.00
2009 5000 $55.00
2010 5900 $62.00
2011 6000 $68.00
2012 6100 $74.00
2013 6200 $80.00
2014 6300 $83.33
e) Calculate the CAPM
f) Explain why this figure may differ from that calculated above (i.e. Cost of equity – Ordinary Shares)
Part B. (5 marks)
You have discovered the following figures that you have derived by questionnairing several thousand investors. They were asked to distinguish between a pair of choices for the following two problems.
Problem 1.
Decision 1 – choose between receiving (a) $240 now or having a (b) 25% chance of receiving $1000 now.
Decision 2 – choose between losing (c) $750 now or a (d) 75% chance of losing $1,000 now.
Your results indicate that 84% of respondents chose (a) in Decision 1 whilst 87% chose (d) in Decision 2.
Problem 2.
Decision 1 – Assume you are $300 richer than what you are today. Then choose between either receiving (e) $100 now or having a (f) 50% chance of receiving $200 now.
Decision 2 – Assume you are $500 richer than what you are today. Then choose between either losing (g) $100 now or having a (h) 50% chance of losing $200 now.
Your results indicate that 72% of respondents chose (e) in Decision 1 whilst 64% chose (h) in Decision 2.
What explanation would you give to explain your findings?
Part C. (7 marks)
The homo economicus view of man’s behaviour as applied to the bulk of finance theory portrays decision makers as being both self-interested and rational. This view elicits both a macro and micro view of behaviour that helps construct aggregate models of the economy and financial markets.
Neoclassical economics makes some fundamental assumptions about people. Explain
Part D. (6 marks) “Fast and frugal Heuristics” “Adaptive Toolbox”
Consider the following images and discuss in terms of heuristics and decision making.
This assignment is to be completed in groups of three and carries 30 per-cent of the marks in this unit.
Part A. (12 marks)
Information concerning raising new capital
Bonds $1,000 Face value
12% Coupon Rate (Annual Payments)
20 Term (Years)
$30 Discount offered (required) to sell new bonds
$20 Flotation Cost per bond
Preference Shares 11% Required rate to sell new preference shares
$100 Face Value
$4 Flotation cost per share
Ordinary Shares $83.33 Current Market Price
$10.00 Discount on share price to sell new shares
$5.40 Flotation Cost per bond
$5.00 2015 - Proposed Dividend
Dividend History $4.63 2014
$4.29 2103
$3.97 2012
$3.68 2011
$3.40 2010
Current Capital Structure
Extract from Balance Sheet $1,000,000 Long-Term Debt
$800,000 Preference Shares
$2,000,000 Ordinary Shares
Current Market Values $1,000,000 Long-Term Debt
$500,000 Preference Shares
$4,000,000 Ordinary Shares
Tax Rate
40%
a) Calculate the cost associated with each new source of finance. The firm has no retained earnings available.
b) Calculate the WACC given the existing weights
The financial controller does not believe the existing capital structure weights are appropriate to minimise the firm’s cost of capital in the medium term and believes they should be as follows
Long-term debt 40%
Preference Shares 15%
Ordinary Shares 45%
c) What impact do these new weights have on the WACC?
The firm is considering the following investment opportunity. (2015-2022)
Data is as follows
Initial Outlay $1,600,000
Upgrade $750,000 End of Year 4
Upgrade - 400,000 Increased sales units per annum - (Year 5-8)
Working Capital $40,000 Increase required
Estimated Life 8 Years
Salvage Value $50,000
Depreciation Rate 0.125 For tax purposes
The machine is fully depreciated by the end of its useful life
Other Cash Expenses $60,000.00 Per annum (Years 1-4)
Other Cash Expenses $66,000.00 Per annum (Years 5-8)
Production Costs $0.13 Per Unit
Sales price $0.73 Per Unit (Years 1-4)
Sales price $0.98 Per Unit (Years 5-8)
Prior sales estimates
Year Sales
2004 500000
2005 550000
2006 540000
2007 560000
2008 565000
2009 590000
2010 600000
2011 610000
2012 615559
2013 669000
2014 700000
d) Calculate the Net Present Value, Internal Rate of Return and Payback Period
The financial controller is considering the use of the Capital Asset Pricing Model as a surrogate discount factor. The risk-free rate is 5 per cent.
Year Stock Market Share
Index Price
2004 2000 $15.00
2005 2400 $25.00
2006 2900 $33.00
2007 3500 $40.00
2008 4200 $45.00
2009 5000 $55.00
2010 5900 $62.00
2011 6000 $68.00
2012 6100 $74.00
2013 6200 $80.00
2014 6300 $83.33
e) Calculate the CAPM
f) Explain why this figure may differ from that calculated above (i.e. Cost of equity – Ordinary Shares)
Part B. (5 marks)
You have discovered the following figures that you have derived by questionnairing several thousand investors. They were asked to distinguish between a pair of choices for the following two problems.
Problem 1.
Decision 1 – choose between receiving (a) $240 now or having a (b) 25% chance of receiving $1000 now.
Decision 2 – choose between losing (c) $750 now or a (d) 75% chance of losing $1,000 now.
Your results indicate that 84% of respondents chose (a) in Decision 1 whilst 87% chose (d) in Decision 2.
Problem 2.
Decision 1 – Assume you are $300 richer than what you are today. Then choose between either receiving (e) $100 now or having a (f) 50% chance of receiving $200 now.
Decision 2 – Assume you are $500 richer than what you are today. Then choose between either losing (g) $100 now or having a (h) 50% chance of losing $200 now.
Your results indicate that 72% of respondents chose (e) in Decision 1 whilst 64% chose (h) in Decision 2.
What explanation would you give to explain your findings?
Part C. (7 marks)
The homo economicus view of man’s behaviour as applied to the bulk of finance theory portrays decision makers as being both self-interested and rational. This view elicits both a macro and micro view of behaviour that helps construct aggregate models of the economy and financial markets.
Neoclassical economics makes some fundamental assumptions about people. Explain
Part D. (6 marks) “Fast and frugal Heuristics” “Adaptive Toolbox”
Consider the following images and discuss in terms of heuristics and decision making.
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