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Investment Planning 1
AS3002 Assignment
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Investment Planning 1 AS3002: Assignment

Instructions

Keep a copy of the assignment for your own records. Only Microsoft Word-compatible assignments submitted in this template file will be accepted for marking by Kaplan. PDF assignments will not be accepted. The assignment must be COMPLETED before forwarding it to Kaplan. No addenda will be accepted after it has been submitted. You must make a reasonable attempt to meet the requirements in all questions of your assignment. Failure to do so will mean that your assignment will not be accepted for marking; therefore you will not receive the benefit of feedback on your submission. If you do not meet these requirements, you will be notified. You will then have one month to submit your completed assignment and no resubmissions will be allowed. The one month deadline will apply regardless of whether you have received your notification email. Your assignment must be submitted to Kaplan Professional by email as an attachment (maximum file size is 5MB), in Microsoft Word 2003 format (file extension .doc) on or before your assignment due date. Please check My Kaplan for your due date. One file only to be submitted. Please name and save your assignment submission file in this format: IP1 3002 assignment INT###### .doc Training Managers: if your Training Manager requires a copy of your marked assignment, you must CC that person into your original email submission.

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Investment Planning 1 AS3002: Assignment

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Investment Planning 1 AS3002: Assignment

Investment Planning 1
AS3002 Assignment
This assignment contains six questions based on the information provided in the assignment background. Answer all questions.

Assignment preparation checklist (student to complete)


Step 1. Action Familiarise yourself with the assignment. Think about the questions while reading your subject notes and completing the activities and review questions. Read your subject notes. Complete the required self study, activities and review questions. Read the assignment instructions and background information. While reading, think about the clients situation, needs and goals. Answer questions one to six. Complete your answers in the spaces provided. Email your completed assignment to Kaplan Professional. You must submit the following completed items in this template: the student identification and declaration answers to all six assignment questions Completed?

2. 3. 4. 5.

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Investment Planning 1 AS3002: Assignment

Important instructions

Relevant knowledge: This assignment is based on the Investment Planning 1 subject notes, which are current at the time of publishing. Although legislation changes regularly, students answers should be based on the information provided in the 3002 version of the subject notes. What students must demonstrate: Students must provide sufficient information to answer the questions and demonstrate competence. To demonstrate understanding of the requirements of the question, students must use their own words. Do not quote text directly from the subject notes. Make a reasonable attempt: Students must demonstrate that they have made a reasonable attempt to answer all six assignment questions before their assignment will be considered for marking. Where a reasonable attempt is not evident, the assignment will not be accepted for marking, feedback will not be provided on the first submission and the deadline for resubmission will apply. Use correct rates and thresholds: Students are encouraged to use either up-to-date rates and thresholds in the assignment, which can be found in Kaplans Quick Reference Guide, or those rates and thresholds referred to throughout the subject notes. Make sure that you clearly state the relevant periods for your marker and that you apply figures from the same period consistently throughout your assignment. Include working: Students must answer all the requirements of each question and include all working when directed, as an incorrect answer that shows the students methodology may still earn partial credit. Be careful about assumptions: Students may make assumptions, but they must be listed, appropriate and reasonable. Students assumptions MUST NOT change, or be in conflict with, the specifications of the question. Address all Assignment Fundamentals: It is crucial that you demonstrate understanding of the Assignment Fundamentals, which are presented throughout the subject notes. Failure to adequately address the Assignment Fundamentals assessed in this assignment may result in your submission being deemed not yet competent. SOA not required: A full Statement of Advice is not required to correctly answer the questions in this assignment. Remember that this is an investment planning assignment, so including unnecessary information about risk or superannuation will only make it more difficult to identify your answers to the assignment questions. Only investment-related responses will be considered in the assessment. Provide client-specific advice: You must ensure that your advice is customised to the clients needs as stated in the case study, and that your responses specifically address their issues. Make appropriate investment recommendations: Your investment decisions should be made with consideration to the investment objectives and planning concerns as stated in the case study details. You will not be assessed on your choice of specific product providers or fund brands, but you will be assessed on the general appropriateness of your recommendations and your ability to justify those recommendations. Do not include product disclosure statement documents, prospectuses or product issuer information. Do not plagiarise or collaborate: Although general discussion between students relating to the assignment is allowed, students responses to each of the six questions must demonstrate the students individual effort and original work. Students must acknowledge the statement on the front of the assignment to acknowledge that the assignment is NOT the result of plagiarism or collaboration. Penalties may be imposed where these conditions are breached. Kaplan enforces a Student Misconduct Policy in cases where student misconduct is found to have occurred. For full details, please see:
www.kaplanprofessional.edu.au Study Information Financial Services Policies Student Misconduct Policy

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Investment Planning 1 AS3002: Assignment

Background
You are a financial adviser with YourPlan Financial Planning, which is a licensed dealer in securities and a registered life insurance broker. Your company specialises in investment and insurance advice, but does not provide stockbroking, real estate services, income tax preparation, superannuation fund accounting or administration, or the preparation of legal documents such as Wills or trusts. You have held a fact finding appointment with a new client, Isabella Matheson. Isabella was referred by her solicitor after selling a property in a regional town that she inherited from her aunt late last financial year. She has $180,000 remaining after paying all associated tax liabilities and costs, which she has deposited in a cash management account. Isabella has been dabbling in investment since her divorce in late 2002, but admits that her knowledge is relatively basic and wants to know more about a number of the key concepts and issues. Her primary driver is how to best invest her inheritance. Isabellas details are given below.

Personal information
Name: Salutation: Status: DOB: Address: Health: Smoker: Occupation: Date of employment: Retirement age: Isabella Rose Matheson Ms Divorced 21 April 1971 233 Dorothy Drive, Rosetown Excellent No Account Manager, CorpTech Pty Ltd. Isabella has no plans to change her employment arrangement in the foreseeable future. 3 February 2006 Preferably age 65.

Family relationships and dependants


Children: Other: None None

Professional relationships
Solicitor: Time span of relationship: Quality of relationship: Elizabeth Donaldson 10 years Excellent

Accountant: Time span of relationship: Quality of relationship:

David Grayson 8 years Good they meet at least annually with a focus on preparing her tax return

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Investment Planning 1 AS3002: Assignment

Income
Salary () $82,000 p.a. gross, comprising: base salary $80,000 p.a. gross car and phone expense allowance $2,000 p.a. gross Employer super () Interest (3) Rent Franked dividends 9% p.a. (Superannuation Guarantee) $9,874 p.a. $24,960 p.a. $1,311 p.a.

Annual expenditure
Food, household, clothes: Holidays: General insurances : Presents and gifts: Income protection insurance: Phone (5): Motor vehicle (5): Accountants fees: Donations to charities: Investment property interest only repayment: Investment property outgoings:
(4)

$26,000 $3,000 $3,750 $2,000 $1,800 $1,000 $3,000 $600 $500 $25,200 $4,295

Notes:

1. 2. 3. 4. 5.

Isabella does not foresee any substantial change in her salary package at this stage. This percentage is based on the base salary income provided and would not change, even if Isabella were to implement a salary sacrifice arrangement. This figure includes the interest earned on the cash management account. This figure includes home, content and private health cover (eligible hospital and extras). The rebate offered for private health cover is taken as a reduced premium. These figures represent the amount spent on work-related phone and car expenses and utilise the expense allowance provided.

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Investment Planning 1 AS3002: Assignment

Assets

Bank transaction account with a balance of $5,000. It pays 3.8% p.a. interest, provides ATM and internet banking facilities. Cash management account of $180,000. It pays 5.25% p.a. interest with online access. Investment property: a one bedroom apartment in St Kilda, Victoria. Isabella used almost all of her accumulated cash savings for the deposit when she purchased the property in 1 July 2010. The property cost $480,000. To fund the difference, she took out a three year fixed-rate interest-only loan at 7.2% per annum and the outstanding balance is currently $350,000. Penalty fees of up to $3,000 apply for early repayment or restructure. Assume that the purchase price is the propertys current market value. Share portfolio: Assume current prices as given in table, 100% franking and dividend yields of 3% per annum.
Current price $5.20 $3.50 $8.50 $1.20 $24.50 $25.50 No. shares 500 1,000 1,200 2,000 500 500 Value $2,600 $3,500 $10,200 $2,400 $12,250 $12,750 Purchase price $8 $3 $18 $2 $16 $12 Date of purchase Feb-06 Feb-03 Jun-07 Mar-06 Aug-03 Apr-04

Company AMP IAG SUN COU WBC WOW

Employer superannuation fund with a balance of $126,000. Isabella is currently invested in the (default) capital stable option. The fund offers a choice of four diversified options: capital protected (75% income assets, 25% growth assets), capital stable (50% income assets, 50% growth assets), balanced (35% income assets, 65% growth assets), growth (15% income assets, 85% growth assets). You have already determined that Isabellas superannuation balance is sufficient for her needs at this point in time and she would prefer not to undertake any salary sacrifice arrangement at this stage in her life. Main residence, currently valued at $515,000, Isabella purchased her home in 1998 for $180,000. Isabella has $26,000 debt outstanding on this property. She has no plans to move and does not want to sell it. Contents $50,000 (replacement value for insurance purposes). 2007 Subaru Outback motor vehicle, owned outright and valued at $28,000.

Liabilities

Credit card with a credit limit of $5,000. Isabella uses her credit card to pay for all of her expenses and usually clears the outstanding balance every month. Main residence home loan with an outstanding balance of $26,000 and investment property loan of $350,000. The details of the loans are provided above.

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Investment Planning 1 AS3002: Assignment

Investment objectives
Isabella has rated her investment objectives, using a scale ranging from 1 (not concerned) to 5 (very concerned).
Regular income from your investments Easy access to your capital Easy to administer Volatility 1 3 3 2 Legal logical and appropriate tax relief Income to keep pace with inflation Capital growth 5 2 5

Isabella has estimated that she has around $30,000 surplus income to invest annually, but you need to confirm these figures. She is keenly interested in investing and reads financial magazines, newspapers and websites regularly. She has told you that she is comfortable with a moderate amount of risk. Isabella plans to take a six month holiday travelling around Australia with a friend in mid-2011 and has estimated that she needs $10,000 to cover the expenses associated with this. Her employer has agreed to give her five months leave without pay in addition to the four weeks annual leave she will have accumulated at that time. Isabella would like to purchase a new vehicle in two years and plans to spend around $15,000 on the changeover. She would also like to undertake some renovations on her home in about five years, and expects these to cost around $50,000. With the exception of the specific plans identified above, Isabella does not intend to access her investments over the next ten years. Based on the information that Isabella has provided and the results of her investment objectives rating, you have determined that her risk-return profile is Growth (on a scale of Defensive, Conservative, Growth and High Growth).

Estate planning

Isabella has a Will which was prepared five years ago. It states that if she dies everything will go to her brother, Phillip. Isabella has an enduring power of attorney (POA) granted to Phillip. Isabella has advised that she is quite happy with these provisions and has advised that she does not require further information or assistance regarding her estate planning.

Insurance and risk management

Isabella has requested that no advice be given in this area. She is confident her life and total and permanent disablement (TPD) cover offered in her superannuation fund equal to six times base salary is adequate for her needs. She is also happy with her income protection policy and is confident her general insurances are the correct amounts required. On this basis she has not provided any further details of her insurance situation.

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Investment Planning 1 AS3002: Assignment

Planning concerns

Isabella is keen to ensure that she makes the most of the $180,000 from her inheritance. One of Isabellas highest priorities is making sure that the mortgage on her main residence is paid off as quickly as possible. Isabella seeks long-term, tax-effective investment planning. She would prefer a strategy that is simple to manage and administer and has stated that she open to the use of managed funds rather than holding investments directly as she has done in the past. Isabella has expressed concern about the fees that are charged by investment funds and seeks clarification on these, in particular, whether there will be entry, exit and other ongoing fees. Isabella is concerned that her employer superannuation funds are not invested in the most appropriate option, so she seeks your advice on determining the best option for her, i.e. the one that will improve her potential to meet her lifestyle and financial objectives. Isabella has heard of the term derivatives and was interested to know if any of these products would be suitable for her. Isabella is concerned about all the recent superannuation changes but only seeks advice on whether she should alter the asset allocation of her superannuation fund.

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Investment Planning 1 AS3002: Assignment

Assignment questions
Question 1
a) Identify and explain the legislation that defines what constitutes a financial product. What financial products are specifically included? What financial products are specifically excluded?

The corporation Act 2001 and The Financial Service Reform Act 2001 provides regulation for financial products in Australian financial market. These acts explicitly mention products that are included in and excluded from the list of financial products. Before the introduction of Financial Service Reform Act 2001, the Corporation Act used to cover limited financial products leaving other financial products unregulated. Now Corporation Act, including new provisions introduced in FSRA covers wide range of products that were previously excluded by CA 2001. Following are the products that are specifically included in the financial product definition

Deposit taking facilities by ADIs Foreign exchange transactions that are settled immediately Derivatives Securities Superannuation funds Managed fund services Insurance Retirement Saving Accounts Bonds and debentures issued by the government Following are the products that are specifically excluded from the list of financial product definition

Health insurance Insurance facility provided by employer to employee Insurance done by state and central commonwealth government Reinsurance Funeral benefits State bank facilities Foreign currency transaction which are settled immediately Credit facilities provided by financial institution like LC, loan, bank guarantees etc A payment facility for making non-cash payments to a credit facility Unregistered managed investment schemes

b)

Discuss how financial services industry participants are regulated and licensed. In your answer, include details of what the primary obligations of financial services licensees are, and what responsibilities licensees have with regard to the actions of their representatives?

Financial products and services, act of investments advisor and financial product providers, investment services provided by firms and individuals are collectively regulated by Corporation Act 2001 and FSRA 2001. To provide financial services and carry related business, individual has to obtain Australian Financial Service License. For that, one has to meet requirements and conditions specified by ASIC. Primary obligations of a financial advisor as defined in the act are as follows:

Ensure that financial services covered by license one has obtained are provided efficiently, honestly and fairly. Ensure that proper dispute resolution system is in place Ensure that proper risk management system is in place Ensure proper financial resource available Have financial arrangement to compensate clients in the event of breach of any provisions specified by Corporation Act specified by Corporation Regulation 2001 or ASIC Ensure that representative are adequately trained and are competent to perform their responsibilities Ensure that representative abide by the law specified in the Corporation Act and FSRA Kaplan Education Pty Limited. All Rights Reserved

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Investment Planning 1 AS3002: Assignment

Comply with the conditions of licence Maintain competency while providing financial services All representatives other than employees and board of directors must be authorized to provide financial services by license holder in writing. Such representatives are known as authorized representatives. License holder has to ensure that their representatives are trained adequately and competent enough to provide financial services to their clients. It is responsibility of license holder to supervise if representatives are following rules and regulations stated by corporation act and FSRA 2001. Licensee is liable for and answerable to any action taken by his representatives.

[insert student response]

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Investment Planning 1 AS3002: Assignment

Question 2

a)

During your fact finding interview, Isabella asked you to explain the difference between financial planners and stockbrokers. Prepare an answer for Isabella explaining:

the role and function of stockbrokers the relationship between client and stockbroker how this is different to the role played by financial planners how stockbrokers and financial planners can work together for the benefit of clients.

Role and function of stockbrokers


Stockbrokers are intermediary between investor and stock exchange. By sitting between stock exchange and investor, they provide various services to the investor related to stock trading. Stockbrokers, acting as agents for their clients, are the only entities permitted to operate in stock exchange market, they are ASX market participants. Their role and function can be summarized in following points:

Publish research reports that help clients select best stocks (not applicable to discount brokers) Advise clients regarding equities and fixed interest securities Take order from clients to buy and sell equities Execute the order Ensure that payment is received from the buying clients and equities are registered as per instruction Ensure that selling client deliver authentic papers Ensure that while buying and selling takes place, all applicable benefits related to sold equities flow to buyer Act as underwriter in new share issue Advise on company takeover and mergers Transact business as a principal and arbitrage between markets The relationship between client and stockbroker Client cannot directly trade in stock exchange, client either authorize stockbroker to transact on his behalf or trade on the platform provided by stockbroker. Client cannot get involved in clearing and settlement process after trading the share, it is done by stockbroker. On this basis, relationship between client and their stockbroker is that of agent and principal. Here client is the principal and stockbroker is an agent. When broker takes order he views client as an principal and himself act as an agent. The agent/ principal relationship is based on trust. An agent is required to always deal with principal in the outmost good faith. How this is different to the role played by financial planners Stockbrokers specializes only one financial product i.e. stock and they advise clients on the purchase and sale of shares. Some of the stockbrokers share market research, economic data and market analysis helping client to select best stock. Whereas financial planner is concerned about overall financial planning of an individual considering his goals and objectives, financial and personal background and risk profile. Financial planner advise about various products as per his specialization like insurance, retirement planning, investment, estate planning. Stockbrokers are ASX market participants whereas financial planner are not.

How stockbroker and financial planner can work together for the benefit of clients Function of stockbroker and financial planner supplements each other. A financial planner may be specialized in area other than stock investment. In such case financial planner has to work with stock broker to provide best service to his client. Similarly, stockbroker provides only service related to stock treading. If his client ask for some other services he has to work with financial planner. A financial planner builds a referral relationship with stock broker than he can provide one more financial service to his client (which does not fall under his expertise) from same window. Say a client appoints a financial planner, who does not deal on the ASX, to do purchase share on his behalf. In such case, good referral with stock broker helps to provide prompt and reliable service to the client. Same applies to stockbroker. It helps them to retain the client. Whereas, it is much safer for the client to visit stockbroker (or financial planner) recommended by financial planner (or stockbroker).

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Investment Planning 1 AS3002: Assignment

b)

Isabella was also interested in the returns offered by the four major asset classes. She specifically enquired about fixed interest investments and sought an explanation of how it is possible that an investor can make or lose money on fixed interest investments. Provide a brief response to Isabella which covers the following:

An overview of the different asset classes, the risks and returns offered by each The role of primary and secondary markets for debt and equity securities

How prices of fixed interest investments can change, illustrating the main concepts by calculating the purchase price of a 10-year government bond parcel with the following features:

three full years remaining until maturity the bonds coupon rate is 6.95% per annum, paid half-yearly prevailing market interest rate is 7.20% per annum Parcel price of $100.

Four major type of asset classes are 1. Cash 2.Fixed interest 3. Property 4. Equities. These instruments have different risk and return characteristics, cash has least risk (and hence offers least return) where as equities have high risk (and hence high return) among these four asset classes. Risk and return relationship of these assets can be best described by following graphs: Fund in hand or in bank account that is easily accessible is cash. There is trade off between high accessibility and risk. Short term government Equity notes and bank bills also falls in this group and known as near cash investments. In this case terminal payment is certain. R e t u r n
Property Fixed interest Cash

Risk

Fixed interest can be understood as loan to an entity, which gives fixed return periodically, fixed term and guarantee return of loaned amount. Borrower has primary obligation to pay the stated rate of return, known as interest income, to the investor in certain frequency and paying borrowed money when term ends. In case of winding up of the company, lenders in this group are paid first. Due to these characteristic, it has low risk as compared to other asset class. There can be a chance that borrower may bankrupt, hence unable to pay returns as committed. Investing in land and building or purchasing units in property trust/ fund is investment in property.

Individual gets two types of return from the property, in the form of rent/ lease and capital appreciation over the time. Property investment is very illiquid and propertys value is affected by various economic factors. Return is not as certain as that offered by fixed interest products. Hence it holds higher risk. Equities represents ownership in a company. There is not certain return and terminal value. Company may not declare dividend for years or value of share may decrease over the time whereas there is equal possibility for reverse to happen. While winding up the company, equity holders are paid last of all investors. Hence it has highest risk among these groups of assets. Primary market is where borrower issues the securities to raise capital. It allows borrower directly collect fund from investor. Whereas in the secondary market, investor can buy/ sell the securities from/ to another investor. Process when company enters primary market to raise capital is known as initial public offering (IPO) or float. Primary and secondary market exist for both equity and bond. Secondary market allows investor to restructure securities, exit the investment or make the investment in particular securities when there is no IPO for that security. After purchasing security from primary market, an investor may want to purchase additional security if they think that the value of security will increase in future. Or they may sell the security if they believe company is not performing well and value of security may decrease. Investor may also want to sell off the security for some cash requirement. In this manner, secondary market provides liquidity to particular security. Original investors purchase security directly from borrower enthusiastically because of the liquidity confidence of the secondary market.

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Investment Planning 1 AS3002: Assignment

There is negative relationship between market interest rate and fixed interest security price. When market rate falls price of fixed interest security rises, and when rate rise price of the fixed interest security falls. Taking the given example, $100 bond with coupon rate is 6.95% per annum for 10 years. If some company issues a $100 bond 8% per annum then bond offering 6.95% becomes less attractive to investor as they can get better return in todays day from the investment of $100. Now to attract investors, 6.95% bond holder has to offer the bond in lower price (hence increase the bond yield to match with yield that of similar bond prevailing in the market). Reverse is true if the rate decreases. Here prevailing market rate is 7.2% whereas bond offer 6.95% so, to attract investors, the holder of the bond should reduce the price of the bond to the level so that return from 6.95% bond matches with the return from 7.2%. There is a formula that calculates the value to match this return which is as follows: PV =

N=1

N=t

C / (1+R) ^N-1
N-1

+ [C

+ FV

] /(1+R) ^N

Where C = coupon payment in successive year R= interest rate (required yield or prevailing market rate for similar security) FV = Race Value t = number of coupon period Here remaining tenure is 3 yrs, interest paid semi-annually, hence t=6, rate = 7.2%/2 and coupon payment is received every six months at the rate of 6.95%. Using this formula, for the given scenario, price of the coupon would be as follows: PV = (3.475/1.036^1) + (3.475/1.036^2) + (3.475/1.036^3)+ (3.475/1.036^4)+ (3.475/1.036^5)+ ((3.475+100)/1.036^6) = $99.33 Since, prevailing market rate of similar bond is lesser than the return offered by bond in hand, bond holder of this particular bond has to offer the bond at $99.33, which is price that matches the yield or return of existing bond prevailing in the market at 7.2%. Now lets see what happens when market prevailing rate is 5% i.e. lower than rate that our bond offers. In this scenario, bond holder has to increase the price of the bond to match its yield or return with the existing bond in the market. This opportunity to sell the bond in appreciated price is profit to the bondholder. PV = (3.475/1.025^1)+ (3.475/1.025^2)+ (3.475/1.025^3)+ (3.475/1.025^4)+ (3.475/1.025^5) + ((3.475+100)/1.025^6) = $101.983

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Investment Planning 1 AS3002: Assignment

Question 3
a) Isabella has asked you to explain why different discounted cash flow (DCF) calculations use different discounting rates. Use the provided information below to frame your explanation. Isabellas current investment property was purchased on 1 July 2010 for $480,000 in an area that she believes has high growth prospects. She has an interest-only loan of $350,000 attached to this property. Isabella hopes to sell the property at the end of year 3 for at least $575,000. Cash flows from the property are:
Current year (Year 1) Rent income Less Cash expenses Net Income $24,960 ($4,295) $20,665 Year 2 $25,709 ($4,402) $21,307 Year 3 $26,352 ($4,490) $21,862

Note: In year 2, rent income is expected to increase by 3% compared to year 1 and cash expenses are expected to increase by 2.5% compared to year 1. In year 3, rent income is expected to increase by 2.5% compared to year 2 and cash expenses by 2.0% compared to year 2.

The appropriate discount rate is 7.5%. (The discount rate includes the interest rate for the property loan of 7.2%). In your response, you should address the following points: i) Explain why DCF is used to evaluate investments and what impact increasing the discount rate will have on the results of a DCF valuation. ii) Calculate to the nearest dollar the present value (PV) and net present value (NPV) of Isabellas investment property. Please provide the formula used and all workings. iii) Calculate the internal rate of return (IRR) of this investment to one decimal place. Please provide all workings. Answer to i: Generally while making an investment, we commit fixed amount in the beginning of the investment and are promised periodic income in return for fixed period of time. Take a simple example, while purchasing bond worth $ 100, coupon rate 10% p.a paid semiannually for 3 yrs, we commit $100 upfront and are promised return of $5 semiannually for 3 yrs. Investor wants to find if the investment is worthwhile or not or may want to compare with other investment opportunities before committing money. While dealing with future cash flows (receipt or payments) time value of money has to be taken under consideration. Money is worth less at the present time if it is not payable until sometime in future as compared to equivalent amount that is payable today. These future returns are devalued by using discount rate, as compared to an equivalent amount of cash received at the present time. DCF uses this concept to evaluate investment of similar nature, hence it is used. Discount rate is the minimum return that investor requires from the investment. In bond example, discount rate is 10% p.a paid semiannually. Now returns given by the bond in every 6 months for 3 yrs are discounted using this rate to find their present values and compared with the present outflow of $100. If present value of all 5 dollars paid semiannually is greater than $100 than it is worth investing else not. Formula used by DCF to use this concept is as follows: PV =

N=1

N=t

C / (1+R) ^N-1
N-1

+ [C

+ FV

] /(1+R) ^N

Where C = coupon payment in successive year


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Investment Planning 1 AS3002: Assignment

R= interest rate (required yield or prevailing market rate for similar security) FV = Race Value t = number of coupon period Application of this formula is illustrated below by taking Isabellas investment property example to explain DCF further. Discount rate should be the rate that compensates investor for the risk associated with that investment. Since different investments have different returns and risk associated, different discount rates are applicable to different investment to investment. Higher the discount rate, higher will be the discount applicable to future cash flow and hence lower will be its present value. It is illustrated in example below by taking 6%, 7.5% and 8%. It should be noted that, unlike the given example, returns from investment may be different within its life time. Answer ii: Present cash outflow: $480,000 (including $350000) Sales Value after 3 yrs: $575,000 Cash inflow and outflow in three yrs is captured in table below:

Year 1 Rental Income Less Expense Net Income Sale of property Total net income 24960 -4295 20665 0 20665

Year 2 25709 -4402 21307 0 21307

Year 3 26352 -4490 21862 57500 0 59686 2

Calculating the present value of these future inflows: PV = (20665/1.075^1) + (21307/ 1.075^2) + (596862/1.075^3) = $518111 NPV of the investment in the property = PV of all net cash inflows in 3 yrs cash outflow during investment. = $518,111-$480,000 = $ 38111.27 Since NPV is positive, it is considered to be a good investment. Let us see how different discount rates impact PV and NPV. Increase (decrease) in discount rate decrease (increase) the present value. Let us consider above example by taking 6% and 8% as well. Using PV formula given above, present value would be as follows: As illustrated in the table, PV calculated for 6% discount Discount rate is higher as compared to PV calculated for 8% and Rate 8% 7.5% 6% 7.5% respectively. Table also reflects NPV which is higher 51120 51811 539595 for 6% as compared to other rates. Higher the discount rate PV 9.9 1.3 .3 used, lower will be the PV and hence lower will be NPV. Fund 48000 48000 Outflow 0 0 480000 31209. 38111. 59595. NPV 88 27 28
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Answer iii: Internal rate of return is that rate which makes the PV of future cash flows equal to PV of cash outflow. Therefore IRR makes NPV zero. Hence IRR is taken as a benchmark figure. We can find IRR for investment above using following formula. Trial and error can be used till we get NPV = 0. Cash outflow = C1/(1+R) + C2/ (1+R)^2 + C3 / (1+R)^3 Cn is net cash flow from the investment. We have to find R that satisfies above equation for the figures given in question. IRR should greater than 8% lets try for 10.5% 480000 = (20665/1.105^1) + (21307/ 1.105^2) + (596862/1.105^3) We get NPV of -1477.09. We can conclude that IRR should be lesser than 10.5%. Table below presents NPV for different discount rates. NPV is negative at 10.40% where as positive at 10.30%. we can conclude that IRR should be between 10.4% and 10.3% approximately 10.35%

10.50% NPV -1477.09

10.40 % 225.3 42

10.30% 1030.8 94

b. Isabella owns 1,200 Suncorp shares that she received when the company purchased Promina in 2007. Suncorp has reported net profit after tax available to shareholders (NPAT) of $364 million with 1,262.6 million shares on issue. Assume its market price is $8.50. i) Calculate the price/earnings ratio for Suncorp based on its reported NPAT and stated market price (to one decimal place). Please provide formulas used and all workings. ii) Isabella has received investment research from an equities broker that forecasts SUNs EPS for the coming financial year to be $0.618 per share. The current industry average P/E ratio is 12.33 times. Calculate SUNs fair price based on the earnings forecast. Please provide formula used and all workings. iii) Discuss whether, based on your calculations, SUN warrants a buy, hold or sell recommendation. Identify and explain other general and company-specific factors that may be relevant to making an investment decision about this stock. You must discuss some performance drivers that are specific to Suncorp.
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Investment Planning 1 AS3002: Assignment

c)

Isabella has received a hot tip off a friend regarding a company that is due to list on the ASX. It is a biotechnology company, Advantage Health Services, which has been researching and developing vaccines. Isabellas friend is a pharmaceutical rep who has heard positive things about the companys trials from an employee. According to the companys prospectus, which Isabella has obtained, the estimated future maintainable earnings have been projected at $50 million per annum. The discount rate for companies in the same industry 12% and the company plans to issue 100 million shares through the initial public offering at a price of $3 per share. The minimum investment is 2,000 shares. i) Estimate the correct issue price for these shares. Please provide formula used and all workings. ii) Explain whether, based on your calculations, this IPO has been priced correctly. iii) This company has significantly lower levels of debt than other companies in the same industry. Discuss the impact this could potentially have on the discount rate used to price this IPO. iv) Outline sources of information Isabella could access to research this company. v) Discuss whether you think Isabella should purchase shares in this IPO.

[insert student response]

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Question 4
a) Isabella has had limited experience with managed investments, having only held shares and property directly. Define managed investments and discuss the advantages, disadvantages and appropriateness of managed investments with specific reference to Isabellas circumstances and needs.

[insert student response]

b)

Address Isabellas enquiry regarding the suitability of derivatives in her portfolio by briefly discussing the concept of a derivative and how they would/would not fit into her portfolio. As an example, provide an overview of options and futures, how they are commonly used and by whom.

[insert student response]

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Investment Planning 1 AS3002: Assignment

Question 5
Detail your recommendations and investment strategies for Isabella. You are required to include:

advice as to the most effective use of Isabellas inheritance, addressing:


debt management superannuation strategies non-superannuation strategies derivatives strategies.

You may wish to outline your proposed distribution of the inheritance money in table format, with one column showing the category, and another column showing the dollar ($) amount you would allocate to it

discussion of whether you think Isabellas employer superannuation fund option is appropriate for her and why. If you recommend that she switch to another option offered by her employer superannuation fund, explain why you think that option would be more appropriate type(s) of investments needed to implement your proposed investment strategy, including the debt management, superannuation, non-superannuation and derivatives strategies. You should include a discussion of the various fees that may be associated with these investments. You will not be assessed on any specific brand choices, but you will be assessed on the appropriateness of the strategies and types of investments recommended supporting commentary explaining the following with respect to the investment recommendations you have made:

assumptions on which the recommendations are based advantages, including forecast investment returns disadvantages, including risks the pros and cons of using managed investments, where recommended, compared to directly owning assets, and the most appropriate managed fund asset allocation for Isabella discussion of how each aspect of the overall investment strategy helps Isabella to meet her investment objectives and to resolve her planning concerns, as stated in the case study details.

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Investment Planning 1 AS3002: Assignment

Question 6
a) In the course of meeting and advising Isabella, you might need to provide her a number of documents. Explain to Isabella what the purpose of each of the following documents is, including details of the circumstances under which you would be obligated to supply them:

financial services guide product disclosure statement Statement of Advice.

[insert student response]

b)

A prospectus is a commonly used form of securities documentation. i) When is a prospectus required? What regulator administers the lodgement and registration of a prospectus? What contents and requirements does the regulator check for when reviewing a prospectus? When must a prospectus be both lodged and registered? Under what circumstance is registration not required?

ii)

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c)

Describe the purpose of and inclusions in each type of prospectus listed below: i) ii) full prospectus short-form prospectus

iii) supplementary prospectus iv) fixed interest prospectus.


[insert student response]

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