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FNCE90065 Fundamental of Finance
Instructions to Students:
Due week 11: October 9th at any time.
You need to submit your assignment in an Excel spreadsheet (I need to see how you are arriving at your answers). If you submit only the final answers, you won’t receive credit. For example:
· EAR = (1 + 0.1040)^12 − 1
· 42,000 * (1 + 5%)^1 = 44,100
· '= 700 / (1 + 0.09) + 700 / (1 + 0.09)^2 + 700 / (1 + 0.09)^3 + 700 / (1 + 0.09)^4 + 700 / (1 + 0.09)^5
You can use Excel functions, for example, =-PV(rate, nper, FV, ,) only to check your answers. For full credit, you need to show the formulas you are using and the steps to get your answers.
Please note that there is not much time left, so I can’t postpone the assignment due date. You have almost 3 weeks to complete your work.
Bottom of Form
· There are 10 questions in total. Answer ALL questions (all group members of 5)
· Groups with 3 members please ignore Q1, Q3, Q6, Q7 , Q9(A,B, and E) and Q10 (answer the remaining 5 questions + Q9 C, D, and F)
· Groups with 6 members I will send you separately 2 extra questions
· Q9 is based on the Harvard case study: LIZ MOTOR CORP. I am posting the case and the Excel spreadsheet template that you will use to answer question 9 from parts A to F.
· For Q9D, you are asked to create different scenarios, similar to what's shown in window number one of the Excel spreadsheet. Read the case carefully and try to understand the problem. In Week 10, we will cover capital budgeting, and you will then be able to input the necessary data into the Excel spreadsheet.
· For Q7, you can solve it because, in principle, IRR is the same as YTM. You should be able to complete all the questions before meeting me in Week 10, except for question 9.
· Please make sure group members’ names and student numbers are at the top of the assignment.
· Please save your group Assignment with your group name (example, Group XYZ_Assignment 2).
· Submit your excel spreadsheet to LMS and in case you have any problem submit to my email: [email protected] within 5 minutes of the deadline. I can’t accept assignments after the deadline.
Total marks = 100 F I N E ��
1. (Total marks 3+2+2 = 7) You have just bought a newly issued $1,000 five-year Target company bond at par. This five-year bond pays $60 in interest semi-annually. You are also considering in buying another Target Company bond that returns $30 in semiannual interest payments and has six years remaining before it matures. This bond has a face value of $1,000.
a. What is the yield on the five-year bond (expressed as an effective annual yield)?
b. Assume that the rate you calculated in part (a) is the correct rate for the bond with six years remaining before it matures. What should you be willing to pay for that bond?
c. How will your answer to part (b) change if the five-year bond pays $40 in semiannual interest?
2. (Total marks 2+1.5+1.5+1.5+1.5+1.5+1.5 =11) FIAT has issued a bond with the following characteristics: Principal $1,000 , Term to maturity 20 years, Coupon rate 8% and Semi-annual payments. What is the price of FITA’s bond if the stated annual interest rate is:
a. 8 percent
b. 10 percent
c. 6 percent
d. Do you have any observations on the coupon rate?
Fiat also has an opportunity to invest in one of the three bonds listed below. The interest rate is assumed to be 7% for evaluating these bonds. which of the three bonds (A, B, or C) would be the best investment for FIAT.
Bond Face Value Annual Coupon Rate Maturity Price
A $1,000 4% 1 year $990
B $1,000 7.5% 17 years $990
C $1,000 8.5% 25 years $990
3. (total marks 3+3 =6) Luna Enterprises sells Burrata. Gross revenues last year were $3 million, and total costs were $1.5 million. Luna has 1 million shares of common stock outstanding. Gross revenues and costs are expected to grow at 5 percent per year. Luna pays no income taxes, and all earnings are paid out as dividends.
a. If the appropriate discount rate is 15 percent and all cash flows are received at year’s end, what is the price per share of Luna stock?
b. The president of Luna decided to begin a program to produce bocconcini . The project requires an immediate outlay of $15 million. In one year, another outlay of $5 million will be needed. The year after that, net cash inflows will be $6 million. This profit level will be maintained in perpetuity. What effect will undertaking this project have on the price per share of the stock?
4. (total marks 2+2+2=6) Vandelay Industries expects to earn $100 million per year in perpetuity if it does not undertake any new projects. The firm has an opportunity that requires an investment of $15 million today and $5 million in one year. The new investment will begin to generate additional annual earnings of $10 million two years from today in perpetuity. The firm has 20 million shares of common stock outstanding, and the required rate of return on the stock is 15 percent.
a. What is the price of a share of the stock if the firm does not undertake the new project?
b. What is the value of the growth opportunities resulting from the new project?
c. What is the price of a share of the stock if the firm undertakes the new project?
5. (total marks 2+2+3+3=10) Kramerica Industries (today) expects to earn $4.00 per share for each of the future operating periods (beginning at time 1) if the firm makes no new investments (and returns the earnings as dividends to the shareholders). However, Kramer, President and CEO, has discovered an opportunity to retain (and invest) 25% of the earnings beginning three years from today (starting at time 3). This opportunity to invest will continue (for each period) indefinitely. He expects to earn 40% (per year) on this new equity investment (ROE of 40), the return beginning one year after each investment is made. The firm’s equity discount rate is 14% throughout.
a. What is the price per share (now at time 0) of Kramerica Industries. stock without making the new investment?
b. If the new investment is expected to be made, per the preceding information, what would the value of the stock (per share) be now (at time 0)?
c. What is the expected capital gain yield for the second period, assuming the proposed investment is made? What is the expected capital gain yield for the second period if the proposed investment is not made?
d. What is the expected dividend yield for the second period if the new investment is made? What is the expected dividend yield for the second period if the new investment is not made?
6. (Total marks 3+3 = 6) Consider Cheker Energy Company and Kliper, Inc., both of which reported recent earnings of $800,000 and have 500,000 shares of common stock outstanding. Assume both firms have the same required rate of return of 15 percent a year.
a. Cheker Energy Company has a new project that will generate cash flows of $100,000 each year in perpetuity. Calculate the P/E ratio of the company.
b. Kliper has a new project that will increase earnings by $200,000 in the coming year. The increased earnings will grow at 10 percent a year in perpetuity. Calculate the P/E ratio of the firm
7. (total marks 3+3 = 6) The Newcrest Mining – Australia’s largest gold mining company is set to open a gold mine near Melbourne. According to the treasurer, Dan O’Connell, “This is a golden opportunity.” The mine will cost $600,000 to open. It will generate a cash inflow of $100,000 during the first year and the cash flows are projected to grow at 8 percent per year for 10 years. After 10 years the mine will be abandoned. Abandonment costs will be $50,000.
a. What is the IRR for the gold mine?
b. The Australia Mining Company requires a 10 percent return on such undertakings. Should the mine be opened?
8. Calculate the Intrinsic Value of Zefir, Inc. Using DCF (total marks 4+2+2+2= 10) Zefir, Inc., is considering investing in a machine to produce computer keyboards. The price of the machine is $400,000, and its economic life is five years. The machine will be fully depreciated by the straight-line method over the life of the project. The machine will produce 10,000 units of keyboards per year. The price per keyboard in the first year will be $40 and will increase by 5% each year. The cost to produce each keyboard in the first year will be $20, increasing by 10% annually. The corporate tax rate is 34%, and the company’s discount rate is 15%. You need to:
a. Estimate the company’s annual Free Cash Flows (FCF) for the five-year period.
b. Calculate the Terminal Value at the end of the five-year period, assuming a perpetual growth rate of 3%.c. Calculate the intrinsic value of the company by discounting the FCFs and the Terminal Value.
d. If the company has 100,000 shares outstanding, determine the intrinsic stock price.
9. (Total marks 3+3+7+10+3+4= 30)
Case study: LIZ MOTOR CORP.: CAPITAL BUDGETING FOR AN ESG PROJECT
A . Why was Anthony considering this ESG project? What criteria should she use for evaluation?
B. What hurdle rate would you use for this project?
C. Base model: project the cashflows for 2023 to 2035 and evaluate the investment decision by calculating the NPV, payback period, IRR, and PI.
D. Sensitivity analysis: complete the sensitivity analysis based on the list of uncertainties given in the case.
E. Consider all the qualitative factors for an ESG project. Which ones are most relevant and important for this particular project?
F. What recommendation should Anthony bring to the chief executive officer and the board at their upcoming meeting? Summarize your analysis and make a decision
10. (total marks 3+3+2 = 8 ) COSCO, is considering the purchase of a $4 million building to lease. The economic life of the building will be 20 years. Assume that the building will be fully depreciated by the straight-line method and its market value in 20 years will be zero. The company expects that annual lease payments will increase at 3 percent per year. The appropriate discount rate for cash flows of lease payments is 13 percent, while the discount rate for depreciation is 9 percent. The corporate tax rate is 34 percent. What is the least COSCO should ask for the first-year lease? Assume that the annual lease payment starts right after the signature of the lease contract.