ACC00716 Finance A2

ACC00716 Finance, Session 1 2017 Assignment 2

Due Date: Monday 10 April, 11pm

This assignment has a 20% weighting in your overall mark for the unit and covers content from Topics 3 to 5. It will be marked out of 20. Marks will be allocated as indicated for each part below. The maximum length is four A4 pages, excluding cover sheet and reference list. Keep your answers concise. Provide the question and, where relevant, part number, and then your answer.

You will be allocated an ASX listed company as the context for many of the questions in this assignment and the next. You can find your allocated company’s ASX ticker code via “View Grades”. You will need to collect real data for all questions except Question 3. Use DatAnalysis to collect company financial data and the RBA site for yield data. Reference all sources of data used.

Question 1

Collect the company’s 5 year growth rate (CAGR) in operating revenue as at the end of the most recent financial year. (If the company has not been listed that long, use the 1 or 3 year rate – whichever is longer – as a proxy.) If this CAGR can be expected to continue, what is your prediction for operating revenue for the 2020/21 financial year? (2 marks)

Question 2

Collect the company’s interest expense from the profit and loss statement for the year ending 30 June 2016 and divide this figure by average long-term debt in the balance sheet for the last two financial years. Use this as a very rough approximation of the quoted annual interest rate that the company would have to pay on new long-term debt. Now hypothetically assume that on 1 July 2016, the company took out a 20 year amortised loan of $800,000 to buy some equipment and that the rate of interest on that loan is fixed for the first 4 years at the rate you calculated above. The loan requires monthly payments, due on the last day of the month. How much interest will the company be able to claim as an annual tax deduction in the first financial year (1 July 2016 to 30 June 2017) and in the fourth financial year? (3 marks)

Question 3

Assume that the company has just received a large amount of cash from selling assets and wants to use this cash to repay $2 million in debt maturing in three years. In the meantime, the necessary cash can be invested into one of the following investments: (1) a fund with a quoted fixed rate of 4.20% compounded semi-annually; (2) a fund with a quoted fixed rate of 4.14% compounded monthly; or (3) zero coupon bonds maturing in three years and currently trading at $88.45 per $100 face value. Which investment fund should be chosen: 1, 2 or 3? (Assume the investments have equivalent risk.) How much cash will be invested? (3 marks)

Question 4

Hypothetically assume that on 27 January 2017 the company issued 10 year, semi-annual fixed coupon bonds at par, which are given a BB rating and have a spread of 325 basis points over the yield on an Australian government bond of equivalent maturity.

a) What is the yield on the company’s bonds? (1 mark)

b) How would the yield have been different if the company’s bonds had been shorter term? Explain with reference to data and to the relevant component(s) of market interest rates. (1.5 marks)

c) You have a pessimistic outlook for the Australian economy over the next year. Given this, what do you predict will happen to the spread on the company’s bonds over the next year and why? Ensure you mention the relevant component(s) of market interest rates in your answer. (1 mark)

d) What do you expect to happen to the price of the company’s 10 year bonds if your prediction in part c is correct? Illustrate your answer with a numerical example. (2 marks)

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ACC00716 Finance A2

Question 5

a) Use CAPM to estimate the required return on the company’s shares as at 30 June 2015. To do this, use the yield to maturity on that date of a 10-year Australian Treasury bond as a proxy for the risk-free rate, assume the market risk premium is 6.80% and use the company’s current beta (thus assuming the beta has not changed since mid-2015). (2 marks)

b) Assuming the market risk premium and beta has not changed from 5a), recalculate the required return on the company’s shares as at 30 June 2016. What has happened to the required return and why? In the absence of any other change, what does theory predict should have happened to share prices? (1.5 marks)

c) Explain would happen to the company’s required return if average risk aversion in the market fell. (1 mark)

Question 6

Collect and evaluate the company’s FCF and ROIC for the two financial years ending 30 June 2015 and 30 June 2016. Assume that the company’s cost of capital (WACC) was the same as the required returns (costs of equity) you calculated in Question 5. (2 marks)

ACC00716 Finance, Session 1 2017 Assignment 2

Due Date: Monday 10 April, 11pm

This assignment has a 20% weighting in your overall mark for the unit and covers content from Topics 3 to 5. It will be marked out of 20. Marks will be allocated as indicated for each part below. The maximum length is four A4 pages, excluding cover sheet and reference list. Keep your answers concise. Provide the question and, where relevant, part number, and then your answer.

You will be allocated an ASX listed company as the context for many of the questions in this assignment and the next. You can find your allocated company’s ASX ticker code via “View Grades”. You will need to collect real data for all questions except Question 3. Use DatAnalysis to collect company financial data and the RBA site for yield data. Reference all sources of data used.

Question 1

Collect the company’s 5 year growth rate (CAGR) in operating revenue as at the end of the most recent financial year. (If the company has not been listed that long, use the 1 or 3 year rate – whichever is longer – as a proxy.) If this CAGR can be expected to continue, what is your prediction for operating revenue for the 2020/21 financial year? (2 marks)

Question 2

Collect the company’s interest expense from the profit and loss statement for the year ending 30 June 2016 and divide this figure by average long-term debt in the balance sheet for the last two financial years. Use this as a very rough approximation of the quoted annual interest rate that the company would have to pay on new long-term debt. Now hypothetically assume that on 1 July 2016, the company took out a 20 year amortised loan of $800,000 to buy some equipment and that the rate of interest on that loan is fixed for the first 4 years at the rate you calculated above. The loan requires monthly payments, due on the last day of the month. How much interest will the company be able to claim as an annual tax deduction in the first financial year (1 July 2016 to 30 June 2017) and in the fourth financial year? (3 marks)

Question 3

Assume that the company has just received a large amount of cash from selling assets and wants to use this cash to repay $2 million in debt maturing in three years. In the meantime, the necessary cash can be invested into one of the following investments: (1) a fund with a quoted fixed rate of 4.20% compounded semi-annually; (2) a fund with a quoted fixed rate of 4.14% compounded monthly; or (3) zero coupon bonds maturing in three years and currently trading at $88.45 per $100 face value. Which investment fund should be chosen: 1, 2 or 3? (Assume the investments have equivalent risk.) How much cash will be invested? (3 marks)

Question 4

Hypothetically assume that on 27 January 2017 the company issued 10 year, semi-annual fixed coupon bonds at par, which are given a BB rating and have a spread of 325 basis points over the yield on an Australian government bond of equivalent maturity.

a) What is the yield on the company’s bonds? (1 mark)

b) How would the yield have been different if the company’s bonds had been shorter term? Explain with reference to data and to the relevant component(s) of market interest rates. (1.5 marks)

c) You have a pessimistic outlook for the Australian economy over the next year. Given this, what do you predict will happen to the spread on the company’s bonds over the next year and why? Ensure you mention the relevant component(s) of market interest rates in your answer. (1 mark)

d) What do you expect to happen to the price of the company’s 10 year bonds if your prediction in part c is correct? Illustrate your answer with a numerical example. (2 marks)

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ACC00716 Finance A2

Question 5

a) Use CAPM to estimate the required return on the company’s shares as at 30 June 2015. To do this, use the yield to maturity on that date of a 10-year Australian Treasury bond as a proxy for the risk-free rate, assume the market risk premium is 6.80% and use the company’s current beta (thus assuming the beta has not changed since mid-2015). (2 marks)

b) Assuming the market risk premium and beta has not changed from 5a), recalculate the required return on the company’s shares as at 30 June 2016. What has happened to the required return and why? In the absence of any other change, what does theory predict should have happened to share prices? (1.5 marks)

c) Explain would happen to the company’s required return if average risk aversion in the market fell. (1 mark)

Question 6

Collect and evaluate the company’s FCF and ROIC for the two financial years ending 30 June 2015 and 30 June 2016. Assume that the company’s cost of capital (WACC) was the same as the required returns (costs of equity) you calculated in Question 5. (2 marks)

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