FIN2601/202/1/2019

Tutorial Letter 202/1/2019

Financial Management
FIN2601

Semester 1

Department of Finance, Risk Management and

Banking
This tutorial letter contains the
solutions to Assignment 02 for this module.

BARCODE
 CONTENTS

Page

1 INTRODUCTION .......................................................................................................................... 3
2 CONTACT DETAILS .................................................................................................................... 3
2.1 Lecturers....................................................................................................................................... 3
3 SUGGESTED SOLUTIONS TO ASSIGNMENT 02 ...................................................................... 3
4 IMPORTANT INFORMATION..................................................................................................... 18
4.1 Answer books ............................................................................................................................. 18
4.2 Examination format ..................................................................................................................... 18
4.3 Assignments ............................................................................................................................... 18
5 CONCLUDING REMARKS ......................................................................................................... 19

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Dear Student

1 INTRODUCTION
The purpose of this tutorial letter is to provide the correct answers to the questions in Assignment
02. Your prescribed book for this module is:

Gitman, LJ, Smith, MB, Hall, J, Makina, D, Malan, M, Marx, J, Mestry, R, Ngwenya, S & Strydom,
B. 2016. Principles of managerial finance: global and Southern African perspectives. 2nd edition.
Cape Town: Pearson.

2 CONTACT DETAILS
2.1 Lecturers

Primary lecturer: Ms KD Sindane Secondary lecturer: Dr AB Sibindi

E-mail: sindakd@unisa.ac.za E-mail: sibinab@unisa.ac.za

Telephone: +27 12 429 8589 Telephone: +27 12 429 3757

Secondary lecturer: Mr MN Bhomoyi Postgraduate assistant: Ms K Mlaudzi

E-mail: bhomomn@unisa.ac.za E-mail: mlaudk@unisa.ac.za

Telephone: +27 12 429 6555 Telephone: +27 12 429 2041

3 SUGGESTED SOLUTIONS TO ASSIGNMENT 02

Please work through the suggested solutions and note where you made mistakes. We provide
page references to the second edition of Gitman et al. (2016) to assist you with the solutions to
the assignment questions.

Question 1

The correct option is 4.

This question required you to calculate the return.

Return = (Cash expected + End of period value) – (Beginning of period value ÷ Beginning of
period value)

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 = (R800 000 + R200 000) – R580 000 ÷ R580 000

= 72,41%

Prescribed book reference: chapter 8, page 303

Question 2

The correct option is 1.

This question required you to calculate the coefficient of variation.

Returns Probability Expected return Variance

rj Pj rj × Pj ( rj − r̅ )2 × Pj
20% 0,30 6% 10,8

12% 0,50 6% 2

10% 0,20 2% 3,2

r̅ = 14%

r 2 × Pj = √16 = 4%
σr = √∑( rj - − ̅)

Coefficient of variation = 𝜕 ÷ r̅

= 4% ÷ 14%

= 0,286

Prescribed book reference: chapter 8, pages 309 and 310

Question 3

The correct option is 3.

This question required you to calculate the standard deviation.

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Share J
rK rK̅ ( rK − rK̅ )2
−10,00% 18,9% 835,21
18,50% 18,9% 0,16
38,67% 18,9% 390,85
14,33% 18,9% 20,88
94,5% 33,00% 18,9% 198,81
rK̅ = =18,9%
5 94,5% 1445,91

(rK − rK̅ )2 1445,91

σrK = √∑ =√ = 19,01%
n −1 4

Prescribed book reference: chapter 3, pages 309 and 310

Question 4

The correct option is 2.

This question required you to calculate the expected portfolio.

Myers expected return:

Return Probability Expected return

rj Pj rj × Pj
−5% 0,35 −1,75%
10% 0,30 3%
25% 0,35 8,75%

r̅ = 10%

Ramaphosa expected return:

Return Probability Expected return

rj Pj rj × Pj
2% 0,35 0,7%
18% 0,30 5,4%
40% 0,35 14%

r̅ = 20,1%

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Portfolio return rp = (wM × rM ) + (wR × rR )

= (0,68 × 10%) + (0,32 × 20,1%)

= 13,23

Prescribed book reference: chapter 3, pages 313 and 314

Question 5

The correct option is 2.

This question required you to calculate the required return on a portfolio, using the capital asset
pricing model (CAPM).

Part 1

Calculate the risk-free rate, using the CAPM before the increase.

Risk-free rate (RF ) = (Required return (rJ ) – Beta β × [(Market risk premium (rm − RF )]

= 18,8% − 1,2(9%)

= 8%

Part 2

Calculate the risk-free rate and beta after the increase.

Risk-free rate: Beta:

Risk-free rate = 8% + 1 Beta = 1,2 + 0,50 (1,2)

= 9% = 1,8

Therefore, the required rate of return, using the CAPM:

rJ = RF + β (rm − RF )

= 9% + 1,8 (9%)

= 25,2%

Prescribed book reference: chapter 8, page 324

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Question 6

The correct option is 2.

This question required you to compute the beta coefficient of a portfolio.

Step 1

Calculate the required rate of return.

Shares Invested Weight Return Wi × r

Wi r

A R30 000 0,30 4% 1,2%

B R25 000 0,25 24% 6%

C R45 000 0,45 14% 6,3%

Required rate of return = 13,5%

Step 2

Calculate the market return.

Market return Probability Market return

rj Pj rm × Pj

10% 0,1 1%

12% 0,2 2,4%

13% 0,4 5,2%

16% 0,2 3,2%

Market return = 11,8%

Step 3

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Calculate the beta of coefficient.

Beta β = (Required return (rJ ) – Risk-free rate (RF ) ÷ [(Market risk premium (rm − RF ) ]

= (13,5% − 8%) ÷ (11,8 β − 8 β)

= 5,5 ÷ 3,8

= 1,4

Prescribed book reference: chapter 8, page 324

Question 7

The correct option is 3.

This question tested your knowledge of bond value behaviour.

Compute the value of Bond W.

Financial calculator HP10BII+

Input Function
R15 000 FV
(R15 000 × 12,5%) ÷ 2 PMT
5×2 N
12,35 ÷ 2 I
Output
R15 082,19 PV

Compute the value of Bond X

Financial calculator HP10BII+

Input Function
R15 000 FV
(R15 000 × 12,2%) PMT
6 ×2 N
12,35 I
Output
R14 908,40 PV

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Therefore, Bond W is selling at a premium and Bond X is selling at a discount.

Prescribed book reference: chapter 6, page 236

Question 8

The correct option is 1.

This question tested your understanding of bond valuation.

Step 1

Compute the yield to maturity of the bond.

Financial calculator HP10BII+

Input Function
R1 000 FV
R0 PMT
−R180 PV
25 N
Output
7,1 I

Step 2

Compute the value of the bond five years from now.

Financial calculator HP10BII+

Input Function
−R180 PV
R0 PMT
5 N
7,1 I
Output
R253,64 FV

Prescribed book reference: chapter 6, pages 234 to 241

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Question 9

The correct option is 3.

This question required you to compute the present value of a bond that pays interest more
frequently than annually.

Financial calculator HP10BII+

Input Function
R1 000 FV
(R1 000 × 10%) ÷ 2 PMT
(10 – 2 = 8) ∴ 8 × 2 N
6÷2 I
Output
R1 251,22 PV

Prescribed book reference: chapter 6, pages 234 to 241

Question 10

The correct option is 3.

This question required you to compute the annual coupon rate of a bond.

Financial calculator HP10BII+

Input Function
R1 000 FV
−R924 PV
20 × 4 N
16 ÷ 4 I
Output
R36,82 PMT

R36,82 is a quarterly coupon, so the annual coupon is R147,28, which gives a coupon rate of
R36,82 × 4
( ) = 14,73%
1 000

Prescribed book reference: chapter 6, pages 234 to 241

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Question 11

The correct option is 4.

This question required you to compute the yield to maturity (YTM) of a bond with semi-annual
coupon payments.

Financial calculator HP10BII+

Input Function
R1 000 FV
R40 PMT
−R889 PV
6×2 N
Output
5,27 I

The interest is compounded semi-annually and, therefore, the yield to maturity is (5,27% × 2) =
10,54%.

Prescribed book reference: chapter 6, page 241

Question 12

The correct option is 3.

This question required you to compute the number of years of a bond.

Financial calculator HP10BII+

Input Function
R1 000 FV
(R1 000 × 9%) ÷ 4 PMT
−R1 123 PV
7÷4 I
Output
32,45 N

Quarterly compounding interest involves four compounding periods per year and, therefore, the
number of years will be 32,45 ÷ 4 = 8,11 years
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Prescribed book reference: chapter 6, pages 234 to 241

Question 13

This question required you to compute the present value of a bond, with monthly payments, and
the present value of a zero-coupon bond.

Step 1

Compute the simple and annual interest rate.

Financial calculator HP10BII+

Input Function
R10 000 FV
(R10 000 × 19,2%) ÷ 12 PMT
−R8 290 PV
20 × 12 N
Output
1,93 I

The interest is compounded semi-annually and, therefore, the yield to maturity is (1,93% × 12) =
23,16%.

Step 2

Compute the effective annual interest rate, using the interest rate conversion feature.

Financial calculator HP10BII+

Input Function
23,16 NOM
12 P/YR
Output
25,78 EFF

Step 3

Compute the present value of a zero-coupon bond, using the effective interest rate.

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Financial calculator HP10BII+

Input Function
−R10 000 FV
R0 PMT
20 N
25,78 I
Output
R101,80 PV

Prescribed book reference: chapter 6, pages 234 to 241

Question 14

The correct option is 2.

This question tested your knowledge of the term structure of interest rates.

Prescribed book reference: chapter 6, page 221

Question 15

The correct option is 3.

This question required you to calculate the value of price of a preference share.

P0 = D1 ÷ rs

= R2,75 ÷ 0,10

= R27,50

Prescribed book reference: chapter 7, page 273

Question 16

The correct option is 1.

This question required you to calculate the growth rate.

Step 1

Calculate the required rate of return using the CAPM.

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rJ = RF + β (rm − RF )

= 4% + 2,0(10% − 4%)

= 16%

Step 2

Calculate the growth rate.

P0 = D0 (1 + g) ÷ (ri − g)

R55 = R8(1 + g) ÷ (0,16 – g)

R8,8 – 55 g = R8 + 8 g

R8,8 – R8 = 8 g + 55 g

g = R0,8 ÷ 63

g = 0,0127 ≈1,27%

Prescribed book reference: chapter 7, page 274

Question 17

The correct option is 2.

This question required you to calculate the value of an ordinary share, using the constant growth
model.

Calculate D1 = D0 (1 + g)

= R1,15 × (1 + 0,03)

= R1,185

Then, use the constant growth model to calculate P0 :

P0 = D1 ÷ ( rs – g )

= R1,185 ÷ (0,12 – 0,03)

= R13,16

Prescribed book reference: chapter 7, page 274

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Question 18

The correct option is 2.

This question required you to calculate the value of an ordinary share, using the variable growth
model.

Step 1

Compute the dividend during the high-growth period.

D0 = R2

Year 1: D1 = R2 × (1 + 0,20) = R2,40

Year 2: D2 = R2,40 × (1 + 0,20) = R2,88

Year 3: D3 = R2,88 × (1 + 0,08) = R3,11

Year 4: D4 = R3,11 × (1 + 0,08) = R3,36

Step 2

Compute the value of the cash of all constant dividends that would occur during the high-growth
period.

Financial calculator HP10BII+

Input Function
0 CF0
R2,40 CF1
R2,88 CF2
R3,11 CF3
R3,36 CF4
15 I
Output
R8,23 NPV

Step 3

Compute the value of all constant dividends that would occur after the high-growth period.

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In this case, the high-growth period ends after four years and constant growth starts in year three.
Therefore, we need to calculate P4 :

D4 (1 + g) = D5 R3,36 (1+0,04) = R3,49

P4 =
ri − g
; P4 =
0,15 - 0,04
= R31,73

Compute the present value of the constant dividends after the high-growth period.

Financial calculator HP10BII+

Input Function
R31,73 FV
15 I
4 N
Output
R18,14 PV

Step 4

Compute the sum of all the present values.

P0 = R8,23 + R18,14

= R26,37

Prescribed book reference: chapter 7, page 275

Question 19

The correct option is 2.

This question required you to use the basic dividend valuation model; you can find the value of
the share today.

Step 1

Calculate the required rate of return using the CAPM.

rJ = RF + β (rm − RF )

= 2% + 1,4(6%)

= 10,4%

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Step 2

Calculate the growth rate using the constant growth model.

P0 = D1 ÷ (ri − g)

R30 = R2(1 + g) ÷ (0,104 – g)

R3,12 – 30g = R2

R3,12 – R2 = 30g

g = R1,12 ÷ 30

g = 0,0373 ≈3,73%

Step 3

Calculate the value of the share at the end of four years, using the constant growth model.

P4 = D5 ÷ (ri − g)

= R2,32 ÷ (0,104 – 0,0373)

= R35

The value of the share will be 35.

Prescribed book reference: chapter 7, page 274

Question 20

The correct option is 2.

This question required you to use the basic share valuation model to value the share.

Use the constant growth model to find the value of the share at the end of year 5, and discount
that value to the present:

P5 = D6 ÷ (ri − g)

= R6,65 ÷ (0,20 – 0,10)

= R66,50
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 Financial calculator HP10BII+
Input Function
R66,50 FV
20 I
5 N
Output
R26,72 PV

Prescribed book reference, chapter 7, pages 272 to 276

4 IMPORTANT INFORMATION
4.1 Answer books
Please note that we will not provide answer books during the May/June examination. You must
write your answers in the designated spaces in the booklet containing the examination questions.
The booklet will contain adequate ruled space for this purpose as well as enough space for rough
work. Please note that you must hand in the examination booklets.

4.2 Examination format

The examination paper is two hours long and consists of two sections. Section A comprises 40
multiple-choice questions, which are worth one mark each, taken from all the prescribed chapters:
1, 2, 3, 5, 6, 7 and 8. Section B contains two long questions, taken from any of the prescribed
chapters, which are worth a total of 30 marks. Your total mark will be out of 70 and contribute
80% to your final examination mark. Your assignment mark will contribute the remaining 20% to
your final mark.

4.3 Assignments
Please note that both Assignment 01 and Assignment 02 for this semester form an integral part
of your final assessment in the sense that they contribute 20% (10% each) to your year mark and
the final mark you will obtain. We encourage you to submit both these assignments on or before
their due dates in order to capitalise on your year mark and increase your chances of passing this
module. However, bear in mind that you need to obtain at least 40% in the final examination for
your year mark (assignment marks) to be considered.

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5 CONCLUDING REMARKS
Lastly, do not hesitate to contact any of your module lecturers if you have any queries or are
experiencing any problems relating to this module. Please note that lecturers will only be able to
assist you with problems of an academic nature in relation to this module. We have included the
contact details of all the lecturers, who are responsible for this module, on page 3 of this tutorial
letter.

The lecturers in Financial Management (FIN2601) would like to take this opportunity to wish you
every success with your final preparation for the examination.

Best wishes!

Your lecturers

DEPARTMENT OF FINANCE, RISK MANAGEMENT AND BANKING

UNISA 2019

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