IMPORTANT INSTRUCTIONS:
- This individual assignment is due by above date and time.
- Show all working to demonstrate you have understood how to solve each problem.
- If you use a financial calculator, state the sequence of steps to solve the problem.
- Please present your answers in at least 4 decimal places.
- Students are to submit their assignments onto Blackboard. The assignment must be typed (Word or PDF).
Question 1
AMCOR Limited has a corporate bond outstanding with a 7% coupon, semi-annual interest, 15 years to maturity and a face value of $1,000. Similar bonds currently yield 13%. By prior agreement, the company will skip the coupon payments in years 6, 7 and 8 (6 payments in total; the payments at time 6 through to 8.5). These payments will be repaid, without interest, at maturity. What is the corporate bond's value (the price for AMCOR's bond)?
Question 2
Storico Co. just paid a dividend of $3.85 per share. The company will increase its dividend by 20 percent next year and will then reduce its dividend growth rate by 5 percentage per year until it reaches the industry average of 5 percent dividend growth, after which the company will keep a constant growth rate forever. If the required return on Storico stock is 13 percent per annum, what will a share of Storico's stock sell for today?
Question 3
Huawei is considering replacing an existing production line with a new line that has a greater output capacity and operates with less labour than the existing line.
Existing Production line
The book value is $100,000 and the asset will be depreciated by $20,000 per year for the next 5 years. If you sell the existing production line now, it is expected to be sold for $80,000. Both the book value and market value of the line at the end of year 5 will be zero.
New Production line
The new line would cost $800,000, have a 5-year life, and would be depreciated using the straight-line depreciation method over 5 years. At the end of 5 years, the new line could be sold for $200,000. Because the new line is more automated, it would require fewer operators, resulting in a saving of operating expense of $40,000 per year. Additional sales with the new machine are expected to result in additional net cash inflows of $60,000 per year. The new line is however expected to have a negative impact on other side of the business and an annual operating cost of this side-effect is expected to be $10,000 per year.
If Huawei invests in the new line, a one-time investment of $10,000 in additional working capital will be required. Huawei will get back the additional working capital at the end of year 5. The tax rate is 30 percent, the opportunity cost of capital is 10 percent. What is the NPV of the new production line? Should Huawei take on the new production line?
Question 4
A share has a beta of 1.4 and an expected return of 16%. A risk-free asset currently earns 6.25%.
a. What is the expected return on a portfolio that is equally invested in the two assets (share and risk free asset)?
b. If a portfolio of the two assets has a beta of 0.8, what are the portfolio weights for the share and risk free asset?
c. If a portfolio of the two assets has an expected return of 12%, what is beta of the portfolio?
d. If a portfolio of the two assets has a beta of 2.80, what are the portfolio weights?
How do you interpret the weights for the two assets in this case? Explain.
Question 5
Corporate ownership varies around the world. In the US, individual investors own most of the shares in public listed firms. However, in Germany, the majority of shares in listed firms are owned by investment banks and other large financial institutions. Which country do you think has more severe agency problem? Discuss the reasons why and explain. (Word limit: 400 words, excluding references)
Question 6
The role of financial managers is maximizing shareholders' wealth. In order to achieve this, a financial manager would like to increase the firm's stock price. Therefore, the goal of financial managers is to maximize the current share price. If we assume that the financial market is efficient, why is the goal of a financial manager to maximize the firm's current share price rather than future share price? In other words, are there any differences between the goal of maximizing current share price and the goal of maximizing future stock price? Discuss the reasons why. (Word limit: 300 words, excluding references)