HI5002 Finance for Business Tutorial Questions

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Unit Code

 HI5002

Unit Name

Finance for Business

Assignment Number

 Tutorial Questions

Q 1: Part A:

a) Primary market:

The market in which the securities are issued first time for the purpose of listing in the market is known as primary market. The companies, government agencies, and other organizations issues securities in market for raising the funds and get financial support through debt or equity. The issue of securities in the primary market is known as initial public offering and in which the ownership of company transferred to public (Kakarot-Handtke, 2012).

The market in which the securities are traded from one investor to other investors and sale and purchase of securities take place is known as secondary market in the secondary market the securities are sold and purchased by the investors there is no role of company in the secondary market.

b) Essential job of investment banker:

The essential job of investment banker is to deals with securities in the wholesale market. The share/stock and other securities are issued by the companies with the help of investment bankers.

c) Stock exchange as auction market:

The stock exchange is called auction market as the securities are sold at maximum price which the purchaser willing to pay and purchased at minimum price at which the seller willing to sell the securities. The trading is done using the electronic efficient trading system and demand and supply is used for determining the price of securities in the stock exchange.

d) Five basic principle of finance:

The five principles of finance are as follows:

  • Diversity: For getting the benefits finance the investment should be diversified as there should be investment in different securities and investment options.
  • Liquidity and profitability: The investment has the option of liquidation and there should be profitability on investment option.
  • Cash flow: There is cash flow transactions in the investment option and there should be cash outflow and inflow of funds.
  • Time of earnings: The earnings from finance option should be provided within time as present value of investment is based on the time of returns.
  • Risk and returns: There is co-relation between risk and returns as there is high risk for earnings high returns. The investment should be made in such way as there is high returns with minimum risk.

Q 1: Part B:

a) Return on equity:

Net income      =          $ 5 million * 35%       =          $ 1.75 million

Equity             =          $ 4.5 million * 1/1.45  =          $ 3.103 million

Return on equity         =          Net income * 100 / Value of Equity

1.75 * 100 /3.103        =          56.40%

b) Return on assets:

ROA   =          Net income * 100 / Total Assets

$ 1.75 *100 / $ 4.5                  =          38.89%

c) Earning per share   

EPS     =          Net income / Number of equity shares outstanding

$ 1.75 / 0.05    =          $ 35 per share

(Easton, McAnally, Sommers, & Zhang, 2018)

Q 2:

a) Number of Years:

P          =          A * (1+r)t

Details

Amount

A (Amount invested)

50000

P (Amount required)

150000

R (Interest rate))

7.6%

T (Time)

15 years

b) Amount of investment (A):

Details

Amount

P

150000

Interest rate (r)

7.6%

Time (t)

10 years

Amount invested (A) (150000 / (1.076)10)

72105

c) Interest rate(r):

Details

Amount

Amount required (P)

500000

Time (t)

12 years

Amount invested (A)

$ 150000

Interest rate ((500000/150000)1/t)-1 (t)

10.6%

d) Effective interest rate:

Effective interest rate    = (1 + Interest rate/time)time - 1

ANZ bank semi-annual compounding benefits          = (1 + 0.0485/2)2-1 =  4.91%

Commonwealth bank weekly compounding              = (1 + 0.0483/52)52-1 = 4.94%

Benefits in the ANZ bank.

e) Monthly payment:

Monthly payment = Principle * Rate / (1 - (1+r)-t)

Mortgage loan amount            =          $ 3 million

Lending rate                =          4.83% per year

Monthly annuity         =          $ 3 million * 0.0483 / (1 – (1 + 0.0483)-360) = $ 1866

f) Amount for furniture:

PV        =          Payment * PVF of period

Weekly payment of $ 50

Interest rate applicable            =          8.5%

Present value of weekly payment       = 50 * 49.82 = $ 2491 i.e. amount for furniture

(Lee, & Shin, 2018)

Q 3:

a) Calculation of AAR and GAR:

Year

Interest rate

Product of Interest rate

1

0.14

1.14

2

-0.13

0.87

3

0.156

1.156

4

0.17

1.17

5

0.195

1.195

AAR

11%

1.098973

GAR

 

9.9%

As the Geometric return considered the value of time therefore results of GAR should be considered for decision-making (Mehdipour, Vasile, & Belta, 2019).

b) Valuation of expected returns and standard deviation:

Interest rate(R)

P (Probability)

M = R * P

R – M

(R – M)2

-2.5%

0.25

-0.63%

-1.87%

0.035%

13.50%

0.45

6.08%

7.42%

0.551%

20%

0.30

6%

14%

1.96%

Total

11.45%

 

2.55%

Return based on probability    =          11.45%

Variance                      =          2.55%

Standard deviation = (2.55%)1/2 = 16%

(Bi, Jin, & Meng, 2018)

c) Required rate of return of market using CAPM:

Required rate of return =   Rp = Rf + B (Rm-Rf)         

0.132 = 0.035 +1.2 (Rm – 0.035)

Rm = 11.6%

Q 4: Part A:

a) Current value of bond:

The formula of value of bond is:

Face value of bond (F)            =          $ 1000

Interest rate                 =          10.5%

Interest income ©       =          $ 105

R                                 =          9.7%

Time (t)                       =          16 years

Current value  = (105*(1-((1+0.097)^ -16)/0.097) + (1000 / (1.097)^16)

                        = $ 1064

b) Value of equity shares:

D0       =          $ 6.5

G         =          4.5%

Re        =          11.5%

Value   =          D0 (1+g)/Re-g)

            =          6.5*(1+0.045) / (0.115-0.045)

            =          $ 97 per share

c) Value of preference share:

Dividend         =          15%

Face value       =          100

Rate of return  =          12.5%

Value               =          15% * 100 / 12.5%     =          $ 120 per share

(Rustagi, 2021)

Q 4: Part B:

Market value of company:

The sum of securities of company that include bonds, preference shares, and equity shares market value.

Equity shares value     =          68000 * $ 35   =          $ 2.38 million

Preference share value            =          15000 * $ 75   =          $ 1.125 million

Bonds value                =          850000 * 1196.4/1000=          $ 1.017 million

Total value of company          = 2.38 + 1.125 + 1.017           =          $ 4.522 million

b) Capital structure:

The capital structure refers to total value of securities / total market value of company

Equity shares   =          2.38 / 4.522     =          53%

Preference share =      1.125 / 4.522   =          25%

Bonds value    =          1.017 / 4.522   =          22%

c) WACC:

Details

Cost

Capital structure

Cost * Capital structure

Equity Shares (1.85 * (1+0.025) / 35) + 0.025

0.08

53%

4%

Bonds (0.08 * (1 – 0.35)

0.05

22%

1%

Preference shares (0.08 * 100 / 75)

0.11

25%

3%

WACC

   

8%

(Khan, Qureshi, & Davidsen, 2020)

Q 5:

a) Net present value:

The project of Gold:

Period

PVF @ 9%

FCF

PV of FCF

Initial year

1

($485000)

($485000)

1

0.92

$105850

$ 97382

2

0.84

$153250

$ 128730

3

0.77

$225650

$ 173751

4

0.71

$245000

$ 173950

5

0.65

$250350

$ 162710

NPV

$251523

The project of Diamond:

Period

PVF @ 9%

FCF

PV of FCF

Initial year

1

($520000)

($520000)

1

0.92

$117050

$107686

2

0.84

162400

$136416

3

0.77

275500

$212135

4

0.71

255000

$181050

5

0.65

260000

$169000

NPV

$286287

Based on thee NPV the project of diamond should be selected by the company.

b) Discounted pay-back period:

 

Gold

Diamond

Period

PV of FCF

CV of FCF

PV of FCF

CV of FCF

Initial year

($485000)

($485000)

($520000)

($520000)

1

$ 97382

($387618)

$107686

($412314)

2

$ 128730

($258888)

$136416

($275898)

3

$ 173751

($85137)

$212135

($63763)

4

$ 173950

$88813

$181050

$117287

5

$ 162710

$251523

$169000

$286287

As the CV of free cash flow of both project convert in positive after 3 years therefore both project cannot accept by the company (Egbunike, 2017).

Q 6:

a) Dividend-payout:

As per dividend residual policy the dividend is paid by the company after adjustment of capital expenditures from income as per capital structure of the company.

The net income of the company                     =          $ 3.546 million

Less: Capital expenses (1.045 * 0.65)            =          0.67925 million

Profit available for distribution                      =          $ 2.86675 million

Dividend pay-out (3.546 / 2.86675)   =          81%

b) Ex-dividend price:

The value of shares are affected by the dividend payment. The value before payment of dividend is considered as cum-dividend while after payment of dividend it is known as ex-dividend. The ex-dividend is cum-dividend price less dividend per share after tax.

Dividend per share      =          $8

Tax rate                       =          15%

Dividend after tax       =          $ 8 * 0.85        =          $6.8

Cum-dividend price    =          $ 72

Ex-dividend price       =          $ 65.2 per share

c) Present value of equity based on dividend:

Value of Equity          =          Present value of total dividend paid

Dividend paid in current year             =          $ 8.5 million

Dividend paid in next year (12.5 / 1.12) =     $ 11.16 million

Total present value of dividend                      =          $ 19.66 million

Number of share outstanding             =          1.5 million

Value per share                                               =          $ 13.11 per share

(Lavista, 2018)

References:

Kakarot-Handtke, E. (2012). Primary and secondary markets. Levy Economics Institute of Bard College Working Paper, (741).

Mehdipour, N., Vasile, C. I., & Belta, C. (2019, July). Arithmetic-geometric mean robustness for control from signal temporal logic specifications. In 2019 American Control Conference (ACC) (pp. 1690-1695). IEEE.

Egbunike, W. S. I. P. A. USE OF INVESTMENT APPRAISAL TECHNIQUES AND CAPITAL INVESTMENT DECISIONS OF CROSS RIVER STATE GOVERNMENT OF NIGERIA.

Lavista, E. (2018). STOCK PRICE BEHAVIOR AROUND CUM-DIVIDEND DATE OF INDONESIA BLUE CHIPS STOCKS. Review of Management and Entrepreneurship2(1), 49-60.

Khan, A., Qureshi, M. A., & Davidsen, P. I. (2020). A system dynamics model of capital structure policy for firm value maximization. Systems Research and Behavioral Science.

Rustagi, R. P. (2021). Investment Management Theory and Practice. Sultan Chand & Sons.

Bi, J., Jin, H., & Meng, Q. (2018). Behavioral mean-variance portfolio selection. European Journal of Operational Research271(2), 644-663.

Easton, P. D., McAnally, M. L., Sommers, G. A., & Zhang, X. J. (2018). Financial statement analysis & valuation. Boston, MA: Cambridge Business Publishers.

Lee, I., & Shin, Y. J. (2018). Fintech: Ecosystem, business models, investment decisions, and challenges. Business Horizons61(1), 35-46.

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