Discuss whether potential investors could maximise their rate of return by investing in projects that earn the same or higher rate of return than the market interest rate.

The company is planning to invest in an infrastructure project that will be completed over the next four years, during which the project will require a cost outlay of $600 000 per annum, i.e. a total of $2.4 million over four years. The project will start generating revenue from Year 5, with the revenue being $600 000 per year for Year 5 and Year 6, then $1.2 million per year in perpetuity starting from Year 7.
Assuming an applicable interest rate of 12% per annum, determine the present value of the project.
(8 marks)
b) The company has purchased two types of equipment for use in other investment projects, namely Type 1 and Type 2. Type 1 requires operating costs of $600 000 every four years, and the first payment is paid in two years’ time. Type 2 requires operating costs of $3 million for every five years, and the first payment is also paid in two years’ time.
Assuming an applicable interest rate of 12% per annum, determine which type of equipment is more expensive to operate.
(12 marks)
Question 2 (20 marks)
a) An investor is valuing the ordinary shares issued by two companies Alpha Ltd and Beta Ltd operating in the same industry sector. Alpha’s share price is $10 and its dividend is expected to be 40 cents in the coming year. Alpha’s dividend payout ratio is 65%. Beta’s share price is $17 and its expected dividend is 34 cents in the coming year. Beta’s dividend payout ratio is 60%. The investor feels that dividends paid by Alpha and Beta grow at similar rates, and have similar discount rates.
You are required to determine whether the dividend growth rates and discount rates for Alpha and Beta are the same without calculating the exact values for these rates.
(12 marks)
b) Discuss whether potential investors could maximise their rate of return by investing in projects that earn the same or higher rate of return than the market interest rate.
(8 marks)
Question 3 (30 marks)
Barons Groups Ltd (BGL) is preparing a budget to buy an entertainment park. The relevant information for this investment project is given below.
• The park will return an estimated total revenue of $2 400 000 over the coming four years. That is, the annual revenue will be $600 000 to be received at each year-end.
• Additional facilities costing $320 000 are required for the park immediately. The depreciation for these facilities will be calculated using the straight line method at 15% per annum. The facilities can be detached from the park ground at the end of Year 4 when they will be sold for $250 000 in real dollar value.
• A one-off cost outlay of $60 000 is required at the beginning of Year 1, and will be fully recouped in real dollar value at the end of Year 4.
• Annual running costs of the park will be $420 000 in Year 1, and are expected to increase by 8% inflation rate each year over the remaining three years. Assuming these running costs will be paid at each year-end.
BGL’s management expects to receive 6% as the real rate of return, i.e. after tax and risk adjusted, from the project. The company pays income tax at 30% per annum.
Required:
a) Identify the project annual cash flows in the nominal dollar value, and determine the project net present value (NPV). Should the project be taken based on its NPV?
(15 marks)
b) Identify the project annual cash flows in the real dollar value, and determine the project net present value. Should the project be taken based on its NPV?
(15 marks) Question 4 (15 marks)
The share prices of Brothers Co Ltd and the relevant market index are given in the table below.
Time Price of Share Market Index
End of Quarter 1 13.67 982.0
End of Quarter 2 15.50 990.0
End of Quarter 3 13.55 978.0
End of Quarter 4 14.85 988.0
Required:
a) Determine the beta for the company’s share. Assuming a risk-free rate of 5.5% applies. (10 marks)
b) What information does the beta for the company’s shares calculated in Part (a) indicate? What would a negative beta mean for the company?
(5 marks)
Question 5 (15 marks)
The share price information for Gammas Pty Ltd (GPL) is given in the table below.
$
January 2016 76.84
February 2016 89.10
March 2016 92.20
April 2016 85.96
May 2016 82.30
Required:
a) Determine the standard deviation of returns for GPL’s shares. (5 marks)
b) If the above monthly returns were randomly drawn from a normally distributed population of returns for Gammas Pty Ltd, interpret the level of risk related to
investments in the company’s shares. (5 marks)

c) To what extent do you think the standard deviation of returns calculated in Part (a) reflects the actual risk related to investments in GPL’s shares? (5 marks)
END OF ASSIGNMENT


 

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