Question1)
Write a short essay of 300-350 words, using appropriate illustrative examples and references, on each of the following.
a. Explain the ‘maximisation of shareholder wealth’ concept and contrast it with the notion of ‘maximisation of profit’.
b. ‘Risk aversion implies that corporate managers will only invest in low risk investments’. Critically evaluate this statement, indicating the extent to which you agree or disagree.
c. Is it possible for an ordinary annuity to have the same present value as a perpetuity if the cash flows and discount rates are identical? Explain.
Question2)
Provide detailed answers to each of the following problems, including, where appropriate, a brief description of the problem, formulae used, and progressive and final answers.
a. Mary owns a business that generates $20,000 per annum for the next five years. Given an annual interest rate of 5%, would she be willing to sell this business today for $100,000?
b. Sam expects to receive the following stream of cash flows from an investment over the next five years:
End of year Cash flow ($)
1 400
2 800
3 500
4 400
5 300
If the relevant annual rate of interest is 9%, how much should he pay for this investment opportunity?
c. An investment scheme pays $200 at the end of each of the next four years, $400 at the end of year 5, $300 at the end of year 6 and $500 at the end of year 7. Given that other investments of equal risk earn 10% per year, calculate the present and future values of this investment.
d. A loan of $100,000 with a nominal annual interest rate of 10% is to be paid off in 20 equal quarterly payments; the first of which is due today. Find the size of the quarterly payments.
e. Greg won a lottery of $200,000. He invested the entire amount in an annuity of 150 equal monthly payments commencing in two years. If the expected annual return is 10% (effective annual rate), what will be the amount of each payment?
f. Firm A pays 10% interest per annum, compounded quarterly. To remain competitive, the manager of another firm (Firm B) is willing to match the interest rate offered by Firm A, but interest will be compounded monthly. What nominal rate of interest must Firm B offer to its clients?
g. An amount of $28,974 is required at the end of ten years from now. Regular contributions can be made into an investment scheme that pays 8% per year compounded annually:
i. What single payment could be made at the beginning of the first year to achieve the objective?
ii. What amount could you pay at the end of each year annually for ten years to achieve this same objective?
Question 3
The following table provides the share return forecasts and associated probabilities for Advanced Limited and Bright Limited. Answer parts a. to d. using the information provided. Detailed worked solutions should be presented in your answers, including formulae used, and progressive and final answers to the questions.
Advanced Limited Bright Limited
Return (%) Probability (%) Return (%) Probability (%)
15.5 30 20.3 20
12.0 30 10.5 50
9.5 40 7.0 30
a. Calculate the expected rate of return on each share.
b. Calculate the variance and standard deviation of the expected rates of return for each share.
c. A portfolio comprises 60% invested in Advanced Limited and 40% invested in Bright Limited. The coefficient of correlation between the returns on each company is assumed to be 0.10. Calculate the expected rate of return and standard deviation of this portfolio. Compare your answers with those reported in parts a. and b. and state your conclusion(s).
d. Which of the following investments would you recommend?
i. The portfolio defined in Part c.
ii. 100% in Advanced Ltd.
iii. 100% in Bright Ltd.
Fully explain your answer.