Assignment:
Overall, the assignment comprises two parts:
Part 1 consists of 5 (five) questions on time value of money, bond valuation and expected return which needs to be completed on an excel spreadsheet. A template has been provided and can be found in the ‘Assessment Tasks and Submission' / ‘Business case study 1' section on the unit's MySCU Learning site.
Make sure your submitted spreadsheet file name is in this format otherwise your spreadsheet may not be marked.
Part 2 consists of a risk and return analysis which must be completed as a word document. Further details are provided on page 4 of this document.
Part 1 - TVM and Bond Valuation Questions
Data to complete these questions is provided on page 3. Please complete and submit these questions on the Case Study 1 spreadsheet template provided.
a) Company XYZ has debt maturing in three years (amount shown in Table 1 on page 3 of this document). How much should the company invest now in an account paying 5% APR, compounded monthly, to ensure it has sufficient funds to repay the debt when it matures?
b) Company XYZ has several alternative long-term cash investment options available to it, Investment A, B or C. The interest rates (APR) for these options are given in Table 1. What is the EAR of each investment option? If EAR was the only factor in the decision highlight which Investment option Company XYZ should choose.
c) Company XYZ is buying new equipment for the amount given in Table 1. To finance this, Company XYZ's bank has offered an amortised loan at 4.5% APR, monthly compounding, with 20 years of monthly payments. What monthly payment will Company XYZ have to make on this loan? Assume that the entire equipment cost is financed and that payments are made at the end of each period.
d) Company XYZ has an issue of $1,000 par value annual coupon bonds with 10 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?
e) Company XYZ has an issue of $1,000 par value bonds with an 8% coupon rate and quarterly coupons. The bonds have 7 years remaining until maturity. The current required return on these bonds is given in Table 1. What is the current price of the bonds?
f) An investor is considering investing in Fly Safely Limited. This is a relatively new company and there is limited data on the actual returns. They have however provided the following return estimates:
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Economic Conditions
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Estimated return
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Recession
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-25%
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Expansion
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12%
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Boom
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40%
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While the investor would be very satisfied with the return during "boom" times they would not be satisfied with the estimated return during a recession. To try and assist their decision making the investor speaks to a well-regarded economist who advises that the latest economic forecasts suggest that there is a 12% probability of a recession, a 70% probability of an expansion and an 18% probability of a boom.
Using the probabilistic approach calculate the expected return and the standard deviation of Fly Safely Limited.
Table 1: Company XYZ data
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Company XYZ
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Debt maturing in 3 years
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$198.7 ($millions)
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Investment A
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7.00%, (APR, compounding semi-annually)
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Investment B
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6.95%, (APR, compounding monthly)
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Investment C
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6.97%,(APR, compounding quarterly)
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New equipment cost
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$740 ($millions)
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10 year bond annual coupon rate
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7.13%
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10 year bond current price
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$1,240.00
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7 year bond required rate of return
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4.50%
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Part 2 - Risk and Return Analysis
Part 2 is to be completed and submitted in a word document through the Assignment 2 Turnitin Link
Assume Fly Safely Limited, a fictitious company, is part of the airline industry. It has a beta of 1.43. While it has only been operating for 10 years its financial results to date have been pleasing returning a profit most years. Over the past six years it has paid its shareholders the following returns:
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Year
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Return %
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2012
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5%
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2013
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1%
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2014
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7%
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2015
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2%
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2016
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13%
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2017
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2%
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Recently Fly Safely Limited has compared itself to a well-established airline company Always Reliable Limited. Always Reliable Limited has a beta of .88 and has a long history of paying consistent returns to its shareholders. The average shareholder returns have been 8% with a standard deviation of 1.7%.
Fly Safely Limited is currently investigating options for raising finance to expand its operations. It is considering two options, either long term bank finance or issuing corporate bonds. Currently the 10-year Australian Treasury bond rate (proxy for risk free rate) is 2.1%. Fly Safely Limited has reviewed the Annual Report published by Always Reliable Limited and have noted that their average cost of debt is 7.5%.
Required:
Prepare a report analysing and comparing the risk and return for Fly Safely Limited and Always Reliable Limited. Your report needs to consider the following
a. The overall industry context in relation to the risk profile of the comany
b. Risk and return theory
c. The meaning and relevance of beta in risk analysis
d. The relationship between risk and return
e. The relationship between company risk and the cost of debt.