Assignment:
Q: Brandon Ltd is considering the following expansion.
Details are as follows:
| |
|
Stock
|
Stock A
|
Sales
|
|
Working
|
|
| |
Year
|
Market
|
Share
|
Units
|
Year
|
Capital
|
|
| |
t
|
Index
|
Price
|
|
|
Outlays
|
|
| |
1993
|
2005
|
5.00
|
510000
|
0
|
$ 2,100
|
|
| |
1994
|
2201
|
5.50
|
550000
|
1
|
$ 2,600
|
|
| |
1995
|
2410
|
5.75
|
540000
|
2
|
$ 3,200
|
|
| |
1996
|
2520
|
5.90
|
560000
|
3
|
$ 3,700
|
|
| |
1997
|
2602
|
6.00
|
565000
|
4
|
$ 4,100
|
|
| |
1998
|
2835
|
6.10
|
590000
|
5
|
$ 4,500
|
|
| |
1999
|
2650
|
6.00
|
600000
|
6
|
$ 4,000
|
|
| |
2000
|
2502
|
5.90
|
610000
|
7
|
$ 3,500
|
|
| |
2001
|
2854
|
6.50
|
615559
|
8
|
$ -
|
|
| |
2002
|
3210
|
7.00
|
669000
|
|
|
|
| |
2003
|
3420
|
7.25
|
700000
|
|
Project Life: 8 years
Capital outlays are as follows:
Beginning of project: $1,500,000
Upgrade at end of third year: $700,000
Scrap / Salvage value: $25,000
The firm applies the reducing balance method of depreciation to its projects. For tax purposes the Tax Commissioner allows the use of straight line depreciation.
The investment analyst has decided to forecast the sales (units) by using time-trend projections. These are to be adjusted from year four onwards to account for the increased sales resulting from the upgrade, which is estimated as 0.5 million units per year.
Product price is expected to be 55 cents per unit for the first five years, and 80 cents thereafter. Production cost is estimated to be 12 cents per unit. Other operating costs (which do not include depreciation) are $55,000 per year for the first five years and $60,000 per year for the rest of the project life.
Company tax rate is 34%
Government bond yield is 5.2%
The managers believe that the degree of risk of the proposed project is basically the same as that of the existing business' risk. The analyst would like to use a risk-adjusted discount rate calculated by employing the CAPM.
Required:
Calculate the Accounting Rate of Return (ARR), Payback Period, NPV and IRR. ARR has many variants and you are required to define your method used for your calculation.
Consider a portfolio comprising of a $3 million investment in Ariel Ltd and a $5 million investment in in Snowy Ltd. Assume that the standard deviations of the returns for the shares are 0.4 and 0.25 respectively. Assume also that the correlation between the returns on the shares in these companies is 0.7. Assume a 4% chance of abnormally bad market conditions and that returns follow a normal probability distribution.
Required:
a. Explain the ‘Value at Risk' (VaR) approach to examining risk
b. Calculate the value at risk of each individual investment and then of the portfolio.
c. Calculate the value of risk for the portfolio if the correlation between investments increases to .85
d. Calculate the value of risk for the portfolio if the correlation between investments increases to 1
e. Calculate the value of risk for the portfolio if the correlation between investments decreases to .55
f. Discuss your findings