Compare the risk analysis techniques covered

Assignment Help Corporate Finance

Reference no: EM134021984

Finance for Business

Question 1

a) Financial markets play a crucial role in modern economies by facilitating the flow of funds between savers and borrowers, while also providing platforms for trading financial instruments.

Financial markets can be differentiated based on their purpose, maturity of instruments, and the nature of participants involved.

Required: Distinguish between the different types of financial markets covered in the unit, clearly explaining the typical participants, the purpose of each market, and the types of financial instruments traded in each.

b) Reflecting on the group assignment completed by your group, you are required to:

i. Provide a summary of the main tasks required in the assignment.

ii. Describe what you believe to be the overall objective of the group assignment.

iii. Discuss how completing the group assignment enhanced your understanding of evaluating a firm's financial performance.

Question 2

a) An investor is choosing between two retirement investment options. The stated annual rate for both is 12%, but with different compounding structures.

• Option A: Deposit $500 at the end of each month for 5 years with monthly compounding
• Option B: Deposit $1,500 at the beginning of each quarter for 5 years with quarterly compounding

Required:
i. Determine which option is more advantageous.

ii. What monthly payment in Option A would make the investor indifferent between the two options?

iii. Explain how the size and timing of contributions, and compounding frequency interact to influence the total accumulated value?

b) A company is evaluating a potential investment project in a highly uncertain market. Management is concerned about the variability of future cash flows and the potential impact of different economic conditions on project performance.

As a financial analyst, you are considering using different risk analysis techniques before making a final investment decision.

Required: Compare the risk analysis techniques covered in this unit by discussing their key advantages and limitations and explain how each method contributes to evaluating the risk of a project. Consider concepts related to risk aversion where relevant.

Question 3

a) The Capital Asset Pricing Model (CAPM) provides a simple framework to relate risk and return, helping investors decide whether an investment offers adequate compensation for its level of risk.

HarbourTech Ltd is a listed technology company. An investor is evaluating whether to invest in its shares. The following information is available:

• Expected return on HarbourTech Ltd: 14%
• Risk-free rate (government bonds): 3.5%
• Expected return on the market portfolio: 11.5%

Required: Using CAPM covered in the unit, you are required to:

a) calculate the beta (β) of HarbourTech Ltd.

b) interpret the calculated beta and explain what it indicates about HarbourTech Ltd's systematic risk relative to the market.

c) determine whether HarbourTech Ltd is overvalued, undervalued, or fairly valued, if an investor requires a return of 13%. Justify your.

b) Taylor is a young professional aiming to build a diversified long-term investment portfolio that balances stable income with growth potential. She is evaluating two financial instruments:

1. Silverpeak Ltd. Bond (Non-callable)
• Face value: $1,000
• Coupon rate: 7.5% per year
• Interest payments: semi-annually
• Time to maturity: 18 years

2. Siriam Corporation Ordinary Share
• Last dividend paid: $3.50 per share
• Dividends expected to grow at:
o 5% annually for the next 3 years, then
o 2.5% perpetually thereafter

Taylor wants to determine which investment offers the best value relative to her required return, while also considering long-term income stability and growth.

Required: Using formulas and steps taught in the unit, you are required to:
(Note: Show all formulas and calculation steps)

a) calculate the current market value of the Silverpeak bond, assuming the required rate of return for similar bonds is 8.5% per year.

b) estimate the current value of the Siriam share, if the required rate of return for shares of this type is 9.5%.

c) recommend which investment Taylor should choose, assuming that the current market prices of the securities are as follows:
• Silverpeak Ltd. bond is currently trading at $880
• Siriam Corporation share is currently trading at $55

Question 4

Investment decision criteria are financial methods used by firms to evaluate and compare investment projects in order to decide whether they should be accepted or rejected. They help assess whether a project will create value, recover its cost, and meet the required rate of return, taking into account the timing and risk of cash flows.

VoltEdge Technologies Ltd has a maximum investment budget of $100,000. It is considering two mutually exclusive projects with the following expected cash flows:

Project 1

Project 2

Initial Cost

$100,000

$50,000

Future Cash Flows

Year 1

Year 2

Year 3

Year 4

Year 5

Year 6

Salvage value

$20,000

$22,000

$25,000

$28,000

$30,000

$35,000

$10,000

$11,000

$14,000

$16,000

$18,000

$20,000

Required:

a) Select a suitable investment criterion for the projects and justify your choice by evaluating its strengths and weaknesses compared to other methods, assuming there are capital rationing constraints.

b) Using the required rate of return of 10% and a maximum acceptable payback period of 3 years, evaluate the projects using your chosen investment criterion from part (a).

c) Due to changing market conditions, the company expects that the required rate of return may increase to 13% in the near future. Explain how a change in the discount rate could influence the investment decision, with reference to your evaluation in part b).

Question 5

a) Olii Ltd, a listed company, is evaluating whether its current capital structure optimises its Weighted Average Cost of Capital (WACC). The company finances its operations through a mix of debt, ordinary equity, and preference shares, with the following details:

• Debt: $2,500,000 paying 8.5% coupon bonds outstanding with an annual before-tax yield to maturity of 8.3% on a new issue. The bonds currently sell for 101.2% of the total face value.
• Ordinary shares: 30,000 shares outstanding currently selling for $90 per share. The firm just paid a $4.75 dividend per share and is projecting a 5.2% growth rate in dividends, which it expects to continue indefinitely.
• Preference shares: 30,000 preference shares with a 5.8% dividend, outstanding at a market price of $56 a share. The preference shares have a par value of $100.

Required:

i. Calculate the current market value and capital structure of the company and compute the total weight of equity funding in the capital structure.

ii. Calculate Olii Ltd's weighted average cost of capital, using the company tax rate of 30%.

b) Olii Ltd is considering adjusting its capital structure after the initial analysis. Management believes that increasing the proportion of debt may reduce the overall cost of capital due to the tax shield benefit but is concerned about the impact on financial risk and interest rates.

Olii Ltd proposes the following change: issue an additional $1,000,000 of debt at 8.3% YTM (before tax) and use the proceeds to repurchase ordinary shares at market value ($90 per share).

Assuming:

• The cost of debt, preference shares and ordinary shares remain unchanged
• Tax rate remains at 30%
• Preference shares are not affected

Required:

a) Explain conceptually how changes in the proportion of debt and equity can influence WACC and overall firm value.

b) Compute the new Weighted Average Cost of Capital (WACC) after the change.

c) Compare the new WACC with the original WACC and discuss the potential risks of continuously increasing leverage in pursuit of a lower WACC, including broader considerations affecting the business market.

Reference no: EM134021984

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