Reference no: EM132304210
Business Finance Assignment -
Brief: Previously you provided advice to a client who had little knowledge of finance. As a result of your advice on financial theory and investment options, the client has again contacted you to provide further advice on additional aspects of finance, though this time at a much higher level of financial literacy. Again it will be your responsibility to provide the mathematical calculations for the investment(s) they provide and the theoretical questions they pose.
Background: Your client, for whom you are writing the report, is a data scientist by profession. His knowledge of financial theory and financial mathematics is now at an intermediate level after some transitional study. His financial position has not changed in that he wishes to retire in 10 years, and is in a position to invest into sound investments for both short-term and long-term returns. He has done some research and has found a number of investments that he wishes to have analysed. As such, you do not have to search for viable investments for him.
He has also explicitly communicated that the report should identify and detail the viability of the securities and that he is not expecting you to identify any additional investments. While we can garner a degree of information as to your client's financial position, you do not know his financial position. In the same manner as the previous report you presented to him, it is impossible to know how many of these investments he can purchase / invest. Therefore you are expected to provide advice on each investment in isolation from the other investments, i.e. not as a portfolio of investments.
Requirements: The report should contain the following information:
- Introduction (100 words) - Comprising a discussion on the purpose and context of the report.
- Discussion / Workings - Consisting of a discussion regarding your client's financial questions and full workings regarding your client's investment suggestions.
- Conclusion (100 words) - Summarising the discussion and possible investments and providing guidance and recommendations to the queries provided by your client.
- References
Client's Financial Questions:
- What is the Capital Asset Pricing Model (CAPM) and how is it used to evaluate whether the expected return on an asset is sufficient to compensate the investor for the inherent risk of the asset?
- What is an efficient capital market and why market efficiency is important to financial managers?
- Identify the assumptions that are necessary to make the general dividend valuation model easier to use, and, in doing so, to be able to use the model to calculate the value of a company's ordinary shares.
- Explain net present value (NPV) as a capital budgeting tool and how NPV is used for the evaluation of a capital project.
Client's Investments:
1. Your client is closely following a publicly listed Australian company, however your client does not have the requisite skills to evaluate the company and, as such, has provided you with the following information. Your client indicates that the company is closely integrated with the Australian economy and that he is happy for you to use the rates of return for the Australian economy as a whole in the evaluation process.
You have researched the following returns and other characteristics for this company:
- Australian Treasury bills currently pay a return of 3% p.a.
- Australian stock market return over the same period has averaged 8% p.a.
- Australian stock market standard deviation of returns is 13% p.a.
- This company's beta is estimated at 1.10.
- Historical returns and dividends (below).
|
Year
|
Price
|
Dividend
|
|
2010
|
$15.62
|
$0.00
|
|
2011
|
$12.77
|
$0.80
|
|
2012
|
$11.96
|
$0.00
|
|
2013
|
$14.08
|
$0.85
|
|
2014
|
$14.45
|
$0.00
|
|
2015
|
$15.82
|
$0.95
|
|
2016
|
$17.31
|
$0.00
|
|
2017
|
$24.01
|
$1.20
|
Using the above information, identify whether it is a good idea, for your client, to invest in this company. Explain your reasoning for your decision
2. Your client wishes you to investigate a telecommunications company with the following balance sheet and details (below):
|
Long-term debt
|
$
|
|
Bonds: Par $1,000, annual coupon 7% p.a., 3 years to maturity
|
10,000,000
|
|
Equity
|
|
|
Preference shares
|
5,000,000
|
|
Ordinary shares
|
15,000,000
|
|
Total
|
30,000,000
|
Notes: The Company's bank has advised that the interest rate on any new debt finance provided for the projects would be 6% p.a. if the debt issue is of similar risk and of the same time to maturity and coupon rate.
There are currently 1,000,000 preference shares on issue, which pay a dividend of $0.75 per share. The preference shares currently sell for $5.89.
The company's existing 5,000,000 ordinary shares currently sell for $2.34 each. You have identified that the company has recently paid a $0.35 dividend. Historically, dividends have increased at an annual rate of 2% p.a. and are expected to continue to do so in the future.
The company's tax rate is 30%.
Your client wishes to understand, with the use of workings, the following aspects of this company and states that their required rate of return for investment in a company with similar characteristics to this particular company would be 10% p.a.
Advise the client on whether you believe this to be a good or bad investment and the rationale for investment (or not investing).
a) Determine the market value proportions of debt, preference shares and ordinary equity comprising the company's capital structure.
b) Calculate the after-tax costs of capital for each source of finance.
c) Determine the after-tax weighted average cost of capital for the company.
d) Indicate, using all applicable information, whether you would recommend this telecommunications company to your client (or not).
3. Your client is investigating two established companies that operate in the same tourism sector in Australia. These two companies are investigating similar investment projects (not both) in which they will invest. However, your client is not sure which is better and has sent the relevant details to you to advise upon. The characteristics of the two projects are given below:
|
|
Project 1
|
Project 2
|
|
Initial Outlay (IO)
|
$74,000,000
|
$52,000,000
|
|
Annual Cash Flows (CF)
|
$19,000,000
|
$12,000,000
|
|
Life of system
|
9 years
|
15 years
|
Notes: 1) All annual cash flows are after tax and depreciation.
2) A flat rate of 18% is estimated as the risk in both of these projects.
Your client wishes you to provide detailed calculations indicating which project you believe to be the best. The client will then decide whether to invest into the company looking to invest in the project.