Homework questions

Tutorial 1 Assumed knowledge and basic principles

1.

List some reasons why a basic understanding of finance principles is important to you.

2.

Classify each of the following items into one of the five categories: Asset, Liability, Equity, Revenue,
or Expense. Do these items appear on the Income Statement or on the Balance Sheet?
Item
Account receivables
Depreciation expense
Rent received
Bank overdraft
Retained profits
Trade payables
Stock on hand
Provisions
Brand names
Dividend paid

3.

Statement category

Prepare a balance sheet as at 30/6/15 based on the following:

4.

Account category

Cash $197,000
Patents $863,000
Accounts payable $288,000
Accounts receivable $265,000
Inventory $563,000
Notes payable $190,000
Retained earnings $2,804,000
Long term debt $1,980,000
Net fixed assets $5,300,000
Ordinary shares ???

a) What is depreciation?
b) Where does depreciation appear on the balance sheet?
c) Machinery costing $150,000 is being depreciated over 15 years.
i. What is the machinerys book value (or written down value) after 6 years?
ii. If the machinery is sold for $65,750 after 8 years is there a gain or a loss on disposal?

Continued ..

5.

6.

a) What is working capital and net working capital?

b) Given the following information calculate net working capital:

Total equity = $16.7m

Total assets = $38.4m

Total non-current liabilities = $15.6m

Current assets = $5.6m

Calculate EPS given the following information:

EBIT = $975,000

Sales = $3,560,000

Tax rate = 30%

Number of shares outstanding = 250,000

Interest expense= $256,000

7.

Explain what is meant by a tax deduction.

8.

A company has the following operating results for 2015:

Sales $23,730

Cost of goods sold $16,780

Dividends paid $616

Depreciation expense $2,840

Interest expense $414

If the tax rate is 30%, what is net income for 2015?
9.

a) What is 21% of 492?

b) Increase 1258 by 75.5%.

10.

Solve the equation 5x 7 132(1.0157)6

11.

Substitute i = 0.025 into the equation PV 45

12.

Solve the equation:

1 (1 i)14
and simplify.
i

x 5 5.5x 15
.

720
320

Homework questions

Tutorial 2 Introduction
Questions are to be attempted prior to attending tutorial

1.

Can a profitable firm experience cash flow problems?

2.

Why is the wealth-maximisation rule a better one for corporate managers to follow than the profitmaximisation rule?

3.

What is risk? Why must risk as well as return be considered by the financial manager?

4.

Distinguish between the investment decision and the financing decision. Which is more important?
Why?

5.

Why are most very large businesses (such as mining companies, supermarket chains and banks)
structured as companies? What disadvantages arise from this form of business structure?

6.

Suppose you own shares in a company. The current share price is $25. Another company has just
announced that it wants to buy your company and will pay $35 per share to acquire all shares
outstanding. Your companys management immediately begins fighting off this hostile bid. Is
management acting in the shareholders best interests? Why or why not?

7.

(a) Buying shares listed on the Australian Securities Exchange (ASX) is a primary market transaction.
True or False? Explain.
(b) Primary market transactions are helped by good secondary markets. True or False? Explain.

Homework questions

Tutorial 3 Time Value of Money 1

Questions are to be attempted prior to attending tutorial

1.

Briefly explain the time value of money concept.

2.

What happens to a future value if you increase the interest rate? What happens to a present value?

3.

You place $1000 into a bank account at an interest rate of 7% p.a. How much would you
accumulate after 5 years assuming (i) simple interest, and (ii) compound interest with annual
compounding? Explain the difference between (i) and (ii).

4.

What principal will accumulate to $15,000 in 6 months if the simple interest rate is 9% pa?

5.

Accumulate $50,000 for three years at:

(a) 6% p.a. compounding yearly
(b) 6% p.a. compounding quarterly
(c) 6% p.a. compounding monthly

6.

You have just established a self-managed super fund with a $20,000 contribution. Assuming you
earn an 8% p.a. rate of return and make no additional contributions, what will your account be
worth when you retire in 40 years? What if you wait 12 years before contributing? (Does this
suggest an investment strategy?)

7.

How much would have to be deposited today in a term deposit paying 4.3% p.a. compounding
quarterly to have $20,000 in 3 years time?

8.

Find the total value on 1 June 2015 of payments of $1mil on 1 June 2020 and $1.5mil on 1 June
2023 at 8% p.a.

9.

Explain the difference between a nominal and an effective interest rate.

10.

The outstanding debt on a credit card is charged at an interest rate of 1.25% per month. What is
the nominal annual rate? What is the effective interest rate?

Homework questions

Tutorial 4 Time Value of Money 2

Questions are to be attempted prior to attending tutorial

1.

Many financial arrangements are structured as annuities. What are some examples? Can you think
of any financial arrangements that form perpetuities?

2.

An annuity consists of quarterly payments of $200 for 10 years.

(a) Calculate the annuitys future value at (i) 4% p.a. compounding quarterly and (ii) 8% p.a.
compounding quarterly. What relationship between FV and i do you observe?
(b) Calculate the annuitys present value at (i) 4% p.a. compounding quarterly and (ii) 8% p.a.
compounding quarterly. What relationship between PV and i do you observe?

3.

A woman deposits $1000 every year into a savings account that pays interest at 5% p.a. If she made
her first deposit in 1992, how much will she have in her account just after she makes her deposit in
2015?

4.

You wish to buy your first house and have a deposit of $150,000 saved up. Based on your income
and living expenses, the most you can afford to repay each month is $3000. How much can you
borrow if you can expect to pay interest at 7.2% p.a. compounding monthly with repayments for 20
years?

5.

What is the present value of $15,000 per year, at a discount rate of 9% p.a., if the first payment is
received six years from now and the last payment is received 20 years from now?

6.

Southern Life Insurance Co. is trying to sell you an investment policy that will pay you and your
heirs $25,000 per year forever.
(a) If the required return on this investment is 6% p.a., how much will you pay for the policy?
(b) Suppose Southern Life told you the policy costs $450,000. At what interest rate would this be a
fair deal?

7.

In ten years time, your parents plan to buy a house and retire in Byron Bay. The type of house they
want currently costs around $500,000 but property prices are expected to increase at a rate of 5%
p.a. Assuming they can earn 10% p.a. on their investments, and that they currently have $175,000
saved, how much must they invest at the end of each of the next ten years to be able to retire as
planned?

8.

A loan of $10,000 is to be repaid by 4 equal annual payments at 12% p.a.

(a) Calculate the annual repayment.
(b) Complete the loan amortisation schedule.
(c) What is the total amount of interest payable over the loans term?

Homework questions

Tutorial 5 Debt and Valuation

Questions are to be attempted prior to attending tutorial

1.

Summarise the main features of debt.

2.

Identify some of the approaches used by lenders to reduce the credit (or default) risk they face
when making loans.

3.

(a) Is the yield to maturity on a bond the same thing as the required return? Is it the same as the
coupon rate?
(b) Suppose today an 8% coupon bond sells at par. Two years from now, the required return on the
same bond is 7%. What is the coupon rate on the bond in two years? The YTM?

4.

With the assistance of the Commonwealth Bank, Daryls Delights Ltd will issue 90 day bank bills
with a face value of $2 million.
(a) Calculate the price if the bank bills are initially purchased by the Macquarie Cash Fund at a yield
of 3.25% p.a.
(b) 40 days later the Macquarie Cash Fund decide to sell the bank bills. Market yields have
increased to 3.5% p.a. How much do they receive?

5.

Pelican Pharmaceuticals Ltd requires approximately $250,000 for 180 days to finance inventory
purchases and ANZ Bank have offered to arrange the financing through a bill facility using 90 day
bills. ANZ will obtain the initial funds by selling the bill to City Investments Ltd.
(a) If the current 90 day bank bill rate is 5.25% p.a., what price will Pelican Pharmaceuticals receive
for the bill?
(b) If the 90 day bank bill rate in 90 days is 5.15% p.a., what will be the net inflow or outflow for
Pelican Pharmaceuticals at the end of the first 90 day period?
(c) Who is the drawer of this bill and who is the acceptor?

6.

A $1000 bond that pays half-yearly coupons at 8% pa will mature in exactly 5 years. Find the
purchase price if the bond is traded at:
(a) 6% p.a. compounding half-yearly
(b) 8% p.a. compounding half-yearly
(c) 10% p.a. compounding half-yearly

7.

Mount Shank Ltd issued bonds several years ago which now have 14 years to maturity. The bonds
have a face value of $200,000 and make half-yearly coupon payments at 6.5% p.a. If the YTM on
these bonds is now 5.3%, what is the current bond price?

Homework questions

Tutorial 6 Equity and Valuation

Questions are to be attempted prior to attending tutorial

Prepare a clear but brief summary of the advantages and disadvantages of debt and equity to help
your boss assess the companys financing choices.

2.

Why are preference shares referred to as hybrid securities?

3.

What is the difference between a rights offer and an IPO?

4.

A disadvantage of a private placement as a source of additional equity is:

(a) It is slow relative to a rights issue.
(b) It dilutes the proportionate claims of existing shareholders.
(c) The price per share is usually less than the subscription price in a rights issue.
(d) The placement can be made to an investor who supports the current management.
(e) It is more expensive than a rights issue.

5.

A company whose shares are trading at $25.20 is conducting a 1-for-2 renounceable rights issue
with a subscription price of $20. Calculate the value of a right and the theoretical ex-rights price.

6.

Manly Engineering Company (MEC) requires $2,600,000 in order to buy equipment for the mining
project they have just accepted. They have decided to raise the funds through a rights issue. There
are currently 8,000,000 shares on issue with a market price per share of $3.25. The company plans
to issue the new shares at a subscription price of $2.60 each.
(a) How many rights will the company issue?
(b) How many shares does a MEC shareholder need to own to be offered one new share?
(c) What is the value of a right?
(d) What is the theoretical ex-rights share price for MEC?

7.

Calculate the estimated share price for the following companies assuming a required return of 12%
p.a.
(a) Roosters dividends have been $1.80 per share for some time. It does not reinvest any of its
earnings and therefore is not expected to grow in the foreseeable future.
(b) Tigers just paid a dividend of $1.80 per share. Dividends are expected to continue to grow at
3% p.a. indefinitely.

8.

Eumerella Cheese will pay a dividend of $2.72 next year. The company has stated that it will
maintain a constant growth rate of 4.5% a year forever. If you want a return of 14%, how much will
you pay for one Eumerella Cheese share? What if you want a return of 16%? What does this tell you
about the relationship between the required return and the share price?
Continued ..

9.

The next dividend payment by Tamar Coffee Ltd will be $2.30 per share. The dividends are
anticipated to maintain a growth rate of 4.5% forever. If one Tamar share currently sells for $39.85,
what is the required return?

10.

Auckland Ltd. is growing quickly. Dividends are expected to grow at a 20% rate for the next two
years, with the growth rate falling off to a constant 4.5 percent thereafter. If the required return is
13 percent and the company just paid a $0.50 dividend, what is the current share price?

Homework questions

Tutorial 7 Capital Budgeting 1

Questions are to be attempted prior to attending tutorial

1.

What is capital rationing?

2.

Consider the following cash flows for a new business investment.

Year 0
-$1,500

Project cash flows

Year 1
$560

Year 2
$758

Year 3
$540

(a) Calculate the NPV, payback period and IRR assuming a 15% discount rate.
(b) For what range of discount rates is the project acceptable? Illustrate your answer with an NPV
profile. What happens when the discount rate is zero and infinite?
3.

A company is considering investing in one of two projects. The projects, known as Ashworth and
Blake, each cost $8,500 today and have the following cash flows.
Year

Project Ashworth

Project Blake

$0

$3,750

$0

$3,750

$0

$3,750

$0

$3,750

$0

$3,750

$37,500

$3,750

(a) If the required return on both projects is 11.5%, what is the PI and the NPV for each project?
(b) What is the payback period for each project? Is the payback period a sensible method to
evaluate a project like Ashworth?
4.

ABC Ltd is listed on the ASX and has 15,000 shares outstanding that are currently trading at $35
each. It is an all equity firm. ABC has four independent business ventures under consideration, all
with a risk level requiring a return of 12% pa.
IRR

NPV @ 10%

Venture W

8.9%

-$4,356

Venture X

15.3%

$9,730

Venture Y

23.5%

$2,560

Venture Z

13.3%

$8,550

(a) Which is the best business venture and why?

(b) What is the effect on share price if all valuable ventures are accepted?
5.

The internal rate of return is the same thing as the discount rate. Is this statement true or false?
Explain.

Homework questions

Tutorial 8 Capital Budgeting 2

Questions are to be attempted prior to attending tutorial

1.

Depreciation is not a cash flow item so it can be totally ignored in a capital budgeting analysis. True
or False? Explain.

2.

Jacksons Ltd is deciding whether to replace and upgrade their metal-press. They have been advised
that a new one would cost $560,000 and have an estimated useful life of 5 years.
Their existing press has a current book value of $120,000 and can be sold for $95,000 today.
The cash operating costs of the old press are $155,000 a year. The new, more efficient, press has
annual operating costs of only $60,000 because it requires less workers to operate it.
The old press is being depreciated at $24,000 a year and has a remaining life of five years at which
time its scrap value will be zero. The new press will be depreciated on a straight-line basis over a 5
year life and is expected to be sold for $150,000 at the end of 5 years. The ATO have advised for tax
purposes the machine should be depreciated to zero over its 5 year life.
If the tax rate is 30% and the discount rate is 13.5%, should Jacksons Ltd buy the new press?

3.

Anchor Ltd paid $15,000 last quarter for a feasibility study regarding the demand for motor-boat
replacement parts which would require the purchase of a new metal-shaping machine. Today, they
wish to conduct an analysis of the proposed project.
The machine costs $250,000 and will operate for five years. However, the tax rules allow the
machine to be depreciated to zero over a four year life. The machine is expected to produce sales
of $135,000 annually for the five years. Anchor has already agreed to sell the machine in five years
time to an unrelated firm for $80,000.
The project will result in a $35,000 increase in accounts receivable and require an increase in
inventory levels by $20,000. Anchor has negotiated with its bank to borrow $180,000 to help pay
for the project. Loan repayments will be $48,000 each year for five years.
If Anchor buys the machine they will be able to use some equipment that they currently own. This
is part of the driving force in the decision making as it enables the company to save money in not
buying additional new equipment. This equipment was bought for $120,000 six years ago and
could be sold today for $63,000. This equipment has been written off for tax purposes and would
be worthless in five years time.
If the company tax rate is 30% and the appropriate discount rate is 19.5%, should Anchor buy the
new machine?

Continued ..

4.

Tennyson Ltd is constructing a town in northwest South Australia where it is developing a tungsten
mine. The town will be abandoned when the tungsten has been fully extracted from the mine
which is estimated to be in eight years time. Management of Tennyson have been given the
following estimates that relate to the provision of housing and services for the town over the eight
year life of the mine.
1) They will purchase land for $380,000, demountable buildings for $220,000 and other equipment
for $420,000. When project ends (at the end of eight years) they expect to sell the land for
$200,000, the buildings for $65,000 and the equipment for $95,000.
2) The project will also require an investment in inventory of $95,000 at the start of the project.
3) The annual cash sales are estimated to be $1,375,000 and cash operating costs are estimated to
be $895,000.
4) Management wants to depreciate all assets over the mine life of 8 years. The taxation office has
provided advice that for tax purposes, buildings are depreciated over 20 years straight-line to
zero and equipment at 15 years straight-line also to zero. Land cannot be depreciated for tax
purposes and in this case there are no tax effects from gains and losses on land.
Will the project prove worthwhile for Tennyson Ltd given that the required rate of return is 25% pa
and the company tax rate is 30%?

Homework questions

Tutorial 9 Risk and Return

Questions are to be attempted prior to attending tutorial

1.

Your friend has been successfully engaging in day-trading ASX securities and has made a profit of
243% in the last six months. Does your friends performance indicate a market inefficiency?

2.

Consider the following information:

State of
Economy
Boom
Bust

Probability of
State of Economy
55%
45%

Share A
Rate of Return
12.5%
7.5%

Share B
Rate of Return
17.5%
2.5%

Share C
Rate of Return
21.5%
5%

(a) What is the expected return on an equally-weighted portfolio of these three shares?
(b) Calculate the standard deviation of this equally-weighted portfolio.
3.

Why is beta the appropriate measure of risk in a diversified portfolio?

4.

What is the SML? Draw a graph of the SML and be sure to label all axes.

5.

Estimate RIOs required rate of return if the current risk-free rate of interest is 2.75% p.a., the
expected market return is 13% p.a. and RIOs beta is 1.45. If RIO will pay a dividend of $0.60 next
year, and dividends are expected to increase by 3% p.a. indefinitely, how much do you estimate RIO
shares are worth?

6.

Consider a portfolio with the following statistics. Assume the shares are priced in equilibrium and
the government bond rate is 4% pa.

(a)
(b)
(c)
(d)

Share

Amount invested

Expected return

Beta

X
Y

$10,500
$19,500

7%
13%

0.5
1.5

What is the expected return on this portfolio?

What is the risk of this portfolio?
What is the equation of the SML?
Share Z is priced in such a way that it will yield an expected return of 11%. It has a beta of 1.2. Is
Share Z overpriced, underpriced or fairly priced?

Continued ..

7.

You want to create a portfolio with the same level of systematic risk as the market, and you have
$1,000,000 to invest. Given this information, fill in the rest of the following table:
Asset
Share A
Share B
Share C
Risk-free asset

8.

Investment
$320,000
250,000

Beta
.70
1.10
1.50

When an investor holds a fully diversified portfolio they have eliminated all risk. True or False?
Explain your answer.

Homework questions

Tutorial 10 Cost of Capital

Questions are to be attempted prior to attending tutorial

1.

On the most basic level, if a firms WACC is 10 percent, what does this mean?

2.

When calculating the WACC, the required return for each type of capital should be multiplied by
(1 tc). True or False? Explain.

3.

Jackson Limited, has 10 million ordinary shares outstanding. The current share price is $43, and the
book value per share is $14.
Jackson also has two bond issues outstanding. The first issue matures in 8 years, the second in 5
years.
The first bond issue has a face value of $27 million, has a 3.5 percent coupon, and sells for 106
percent of par.
The second issue has a face value of $29 million, has a 4.25 percent coupon, and sells for 109
percent of par.
(a) The weights in the weighted average cost of capital can be based on market or book values.
Which is better? Why?
(b) Calculate the weights that should be used in Jacksons WACC.

4.

Tangent Motors Limited (TML) wants you to estimate its WACC. TML has a policy of financing all its
assets with 37% debt, 18% preference shares and the balance with ordinary shares. The company
has been advised that a new bank loan would cost 8.9%. TML preference shares have a market yield
of 12% and the ordinary shares have a market price of $13.80, they just paid a dividend of $1.20
and this dividend has been growing at 5% a year. If TML tax rate is 30% what is their WACC?

5.

Fastrack Ltd. is a transportation company wanting to know if they should proceed with a particular
investment. They have extracted some information from their balance sheet and also provided
some other relevant data. The figures reflect their target capital structure. The tax rate is 30%.
Calculate the WACC given the following information.

Corporate bonds of $2m (face value $100 each and 10% pa coupon, paid annually, issued 6
years ago and maturing in 4 years). Yield to maturity is 11% pa.

Non-redeemable preference shares of $1m (preference dividend 15% pa of $1 issue price, paid
annually in arrears). The preference shares are currently trading at $1.25.

Ordinary shares of $2m (issue price $2 each ordinary share). Next year's dividend is expected to
be $0.50. The current price implicitly implies a dividend growth rate of 6% pa indefinitely. The
current return on the market is 15% and the market risk premium is 6%. Fastrack's beta is 1.2.

Homework questions

Tutorial 11 Capital Structure

Questions are to be attempted prior to attending tutorial

1.

What is a firms target capital structure?

2.

Why is firm value maximised somewhere between the extremes of 0% debt and 100% debt?

3.

Why is the use of debt financing referred to as using financial leverage?

4.

A firm has a current capital structure consisting of $1,400,000 of 9% (annual interest) debt and
500,000 ordinary shares. The firms tax rate is 30%. If the EBIT is expected to be $1,200,000,
calculate the firms earnings per share.

5.

We Mine Copper (WMC) Ltd is proposing to change its capital structure and has asked you for some
advice. WMC currently finances its assets with $2,000,000 of debt that has a fixed 8 percent
interest rate each year. The market value of the firm's equity is $3,000,000 based on the current
75,000 shares outstanding.
WMCs proposed capital structure consists of issuing $1,000,000 of equity at the current market
price and using the proceeds to repay debt. The company tax rate is 30%.
(a) What is the breakeven EBIT?
(b) Plot the two financing plans on a set of EBIT-EPS axes.
(c) If WMC expects a maximum EBIT figure of $350,000, which capital structure would you advise?

6.

Delta Ten Limited (DTL) is a new company and management are trying to decide on a financing
structure. The first option DTL is considering is all equity financed firm, DTL would issue 4,000,000
ordinary shares at $3.00. The second option is funding 30% of the firm with debt and the balance
with ordinary shares (at an issue price of $3 per share). DTL has been advised that the cost of debt
finance would be 15% pa due to its relative risk and they will be paying tax at the 30% company tax
rate.
(a) How many shares will be issued under each option?
(b) What is the breakeven EBIT?
(c) If DTL expects EBIT to be $750,000 what option would you recommend?