Question 1 Total Marks: 25
You have recently been hired by Goff Telecommunications Testing Ltd (GTT). GTT was founded eight years ago by Chris Goff, and currently operates 74 units in the United Kingdom. GTT is privately owned by Chris and his family and had sales of $97 million last year.
GTT develops hardware/software solutions and test methodologies to help shorten customer product development cycles whilst reducing cost and risk. GTT’s growth to date has been financed from its profits. Whenever the company had sufficient capital, it would open a new unit. Relatively little formal analysis has been used in the capital budgeting process. Chris has just read about capital budgeting techniques and has come to you for help. The company has never attempted to determine its cost of capital, and Chris would like you to perform the analysis. Because the company is privately owned, it is difficult to determine the cost of equity for the company. You have determined that to estimate the cost of capital for GTT, you will use Spirent Communications plc as a representative company.
Using the information provided, answer the following questions:
Type your answer here:
Question 2 Total Marks: 25
Hreon SA is an online technology company that provides services in outdated programming languages. As software upgrades, older languages such as VAX become obsolete. However, many organizations still have systems that use these languages and can’t afford to purchase completely new systems. This emerging sector is entering the growth phase of development and so Hreon is considering an increase in its capability effectiveness.
Since the firm has little free cash, it will need to borrow funds to support its investment. The problem facing Hreon is how much to borrow. The company has decided that an appropriate discount rate for its investment is 15 per cent and it wishes to increase its annual cash flows beginning one year from now by $250,000. Because of competition, it is not anticipated that the increased cash flows will last beyond ten years.
Using the information provided, answer the following questions:
Type your answer here:
Question 3 Total Marks: 30
You recently graduatedfrom university, and your job search led you to Coles Group Limited. Since you thought the company’s business was very promising, you accepted their job offer. As you are finishing your employment paperwork, Michel, who works in the Finance Department, stops by to inform you about the company’s new superannuation plan. Australian companies offer membership of a superannuation fund to their employees, where their Superannuation Guarantee contributions are saved.
Superannuation funds have concessional tax arrangements, which saves tax if you save for your retirement through your fund. So, if you can make contributions to the fund from your pre-tax income (known as salary sacrifice), contributions are deducted from your current salary, and no current income tax is paid on the money, and the super fund pays only15%tax on the contributions.For example, assume your salary will be$130 000per year. If you contribute$7200pre-tax to the superannuation fund, you will pay taxes on only$122 800in income. Taxes will be payable on the initial deposits at15%and on any capital gains or fund income while you are invested in the fund, and you will not pay taxes when you withdraw the money at retirement, provided you retire at or after turning 60. At Coles, you can contribute up to6%of your salary to the plan, which will be saved in the fund with your9%Superannuation Guarantee contributions.
The Coles superannuation fund has several options for investments, most of which are managed funds. As you know, a managed fund is usually made up of a portfolio of assets. When you purchase shares in a managed fund, you are actually purchasing partial ownership of the fund’s assets, similar to purchasing shares in a company. The return of the fund is the weighted average of the return of the assets owned by the fund, minus any expenses. The largest expense is typically the management fee paid to the fund manager, which makes all of the investment decisions for the fund. Coles Group Limited uses Down Under Financial Services to manage its superannuation plan.
Michel then explains that the retirement investment options offered for employees are as follows:
Down Under All Ordinaries Index Fund.This fund tracks the All Ordinaries Index. Shares in the fund are weighted exactly the same as they are in the All Ordinaries Index. This means that the fund’s return is approximately the return of the All Ordinaries Index, minus expenses. With an index fund, the manager is not required to research shares and make investment decisions, so fund expenses are usually low. The Down Under All Ordinaries Index Fund charges expenses of0.20%of assets per year.
Down Under Property Trust Fund.This fund invests primarily in property trust shares. As such, the returns of the fund are slightly less volatile than the All Ordinaries Index. The fund can also invest10%of its assets in companies based outside Australia and New Zealand. This fund charges1.70%of assets in expenses per year.
Down Under Bond Fund.This fund invests in long-term corporate bonds issued by companies domiciled in Australia and New Zealand. The fund is restricted to investments in bonds with an investment grade credit rating. This fund charges1.40%in expenses.
Down Under Money Market Fund.This fund invests in high-quality debt instruments, which include bank bills and government bonds. As such, the return on money market funds is only slightly higher than the return on government bonds. Because of the credit quality and nature of the investments, there is only a very slight risk of negative return. The fund charges0.60%in expenses.
Using the information provided, answer the following questions:
DOWN UNDER FUND |
TEN-YEAR ANNUAL |
STANDARD DEVIATION |
All Ordinaries Index Fund |
9.15% |
19.35 |
Property Trust Fund |
14.05 |
26.82 |
Bond Fund |
9.53 |
23.82 |
Money Market Fund |
8.73 |
11.45 |
Type your answer here:
Question 4 Total Marks: 20
Dick Davies, the owner of Davies Gold Mining, is evaluating a new gold mine in Tanzania. Barry Koch, the company's geologist, has just finished his analysis of the mine site. He has estimated that the mine would be productive for eight years, after which the gold would be completely mined. Barry has taken an estimate of the gold deposits to Andy Marshall, the company's financial officer. Andy has been asked by Dick to perform an analysis of the new mine and present his recommendation on whether the company should open the new mine.
Andy has used the estimates provided by Barry to determine the revenues that could be expected from the mine. He has also projected the expense of opening the mine, and the annual operating expenses. If the company opens the mine, it will cost $500 million today, and it will have a cash outflow of $80 million nine years from today in costs associated with closing the mine and reclaiming the area surrounding it. The expected cash flows each year from the mine are shown in the following table. Davies Gold Mining has a 12 per cent required return on all of its gold mines.
Year |
Cash flow ($) |
|
0 |
-500,000,000 |
|
1 |
60,000,000 |
|
2 |
90,000,000 |
|
3 |
170,000,000 |
|
4 |
230,000,000 |
|
5 |
205,000,000 |
|
6 |
140,000,000 |
|
7 |
110,000,000 |
|
8 |
70,000,000 |
|
9 |
-80,000,000 |
Using the information provided, answer the following questions:
Type your answer here:
______________________________
END OF THE EXAMINATION
I have solved only half of it, it is for question no. 3 and question no. 4
Answer I.
We need to calculate the coefficient of variation and the formula is as follows
= Standard Deviation / Mean * 100
Coefficient of variation for All Ordinaries Index Fund = 19.35/9.15 * 100
= 211.48%
Coefficient of variation for Bond Fund = 23.82/9.53 * 100 = 249.95 %
Advantage and Disadvantage of choosing the All Ordinaries Index Fund is as follows :
Hence by comparing all the above points we can make a conclusion that if we want to invest at least part of company we will be giving priorities into investing into All ordinaries index funds of companies based in Australia Over and above the investing into the bond fund of long term corporate bond issues by the companies domiciled in Australia as well as New Zealand.
Answer of II.
Calculation of coefficient of variation for all the fund investments .
DOWN UNDER FUND |
TEN YEAR ANNUAL AVEARGE RETURNS |
STANDARD DEVIATION |
COEFFICIENT OF VARIATION = SD/MEAN * 100 |
FUND MANAGEMENT EXPENSES |
All ordinaries Index Fund |
9.15 |
19.35 |
211.48 % |
0.20 % |
Property Trust Fund |
14.05 |
26.82 |
190.89% |
1.70 % |
Bond Fund |
9.53 |
23.82 |
249.95 % |
1.40 % |
Money Market Fund |
8.73 |
11.45 |
131.15% |
0.60 % |
From the above table we are able to see that returns from Down Under property Trust fund are less volatile than the all ordinaries fund but more volatile than the Money market fund, It is also less volatile than the Bond funds. But we are able to see from the above calculation that property trust Fund return is highest among the all types of investment funds. It gives us all most 5 % approx. estra return than any other funds. It comes to almost increase in the returns of 50 % approx.. compare to all other funds. Yes together with the average return it standard deviation is highest among the all types of funds but when we have calculated the COEFFICIENT OF VARIATION, we found that its coefficient of variation is lesser than the ordinaries index fund as well as money market fund hence it is advisable into the property trust fund. The expenses of fund will not have any impact because when we calculate the returns it is deducted hence the rate of expenses will not have any impact of the decisions.
Solution Q no. 4
Years/ Cash Flows |
Cash Flows ( $) |
Cumulative Cash Flows |
0 |
-500,000,000 |
|
1 |
60,000,000 |
60,000,000 |
2 |
90,000,000 |
150,000,000 |
3 |
170,000,000 |
320,000,000 |
4 |
230,000,000 |
|
5 |
205,000,000 |
|
6 |
140,000,000 |
|
7 |
110,000,000 |
|
8 |
70,000,000 |
|
9 |
-80,000,000 |
In the fourth year we need additional cash flow for pay back period
= $ 500,000,000 – $ 320,000,000 = $ 180,000,000
Pay Back Period = 3 years + 180,000,000/230,000,000
= 3 years + 0.783 years
= 3.783 years
= 3 years & 10 months approx..
Years/ Cash Flows |
Cash Flows ( $) |
Discounting Factor @ 12 % |
Present Value |
0 |
-500,000,000 |
1.000 |
-500,000,000 |
1 |
60,000,000 |
0.893 |
53,580,000 |
2 |
90,000,000 |
0.797 |
71,730,000 |
3 |
170,000,000 |
0.712 |
121,040,000 |
4 |
230,000,000 |
0.636 |
146,280,000 |
5 |
205,000,000 |
0.567 |
116,235,000 |
6 |
140,000,000 |
0.507 |
70,980,000 |
7 |
110,000,000 |
0.452 |
49,720,000 |
8 |
70,000,000 |
0.404 |
28,280,000 |
9 |
-80,000,000 |
0.361 |
-28,880,000 |
NPV |
133,965,000 |
Years/ Cash Flows |
Cash Flows ( $) |
Discounting Factor @ 15 % |
Present Value |
0 |
-500,000,000 |
1.000 |
-500,000,000 |
1 |
60,000,000 |
0.870 |
52,200,000 |
2 |
90,000,000 |
0.756 |
68040000 |
3 |
170,000,000 |
0.658 |
111860000 |
4 |
230,000,000 |
0.572 |
131560000 |
5 |
205,000,000 |
0.497 |
101885000 |
6 |
140,000,000 |
0.432 |
60480000 |
7 |
110,000,000 |
0.376 |
41360000 |
8 |
70,000,000 |
0.327 |
22890000 |
9 |
-80,000,000 |
0.284 |
-22720000 |
NPV |
67555000 |
( Amount in $)
Years/ Cash Flows |
Cash Flows ( $) |
Discounting Factor @ 20 % |
Present Value |
0 |
-500,000,000 |
1.000 |
-500,000,000 |
1 |
60,000,000 |
0.833 |
49980000 |
2 |
90,000,000 |
0.694 |
62460000 |
3 |
170,000,000 |
0.579 |
98430000 |
4 |
230,000,000 |
0.482 |
110860000 |
5 |
205,000,000 |
0.402 |
82410000 |
6 |
140,000,000 |
0.335 |
46900000 |
7 |
110,000,000 |
0.279 |
30690000 |
8 |
70,000,000 |
0.233 |
16310000 |
9 |
-80,000,000 |
0.194 |
-15520000 |
NPV |
-17480000 |
At 15% our NPV = $ 67,555,000
At 20% our NPV = - $ 17,480,000
IRR = 15 % + 67,555,000/ 85035000* 5
= 15 + 4.96
= 19.96 %
Conclusion :
Our NPV @ 12 % = + $ 133,965,000
Our IRR = 19.96%
Our Pay Back Period Is = 3 years & 10 months
The life of the project is 8 years and pay back period is just 3 years & 10 months hence according to pay back period the project must be selected .
NPV = is + $ 133,965,000 so according to NPV project must be selected and it is advisable for Davies Gold Mining to invest into this projects.
IRR = 19.96% and it is much more than the cost of capital that is 12 % hence according to this approach the project must be selected.
Now comparing with all the tools we will rank first to IRR as it calculate the exact return of the project and give us the real picture of exact return. NPV is ranked second and Pay back period is ranked third as pay back period is not considering the future cash flows after the pay back period .
Strength :
Weakness:
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