FEEDBACK TUTORIAL LETTER ASSIGNMENT 1 AND 2 MANAGERIAL FINANCE 4B MAF412S

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Percival Gaines
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1 FEEDBACK TUTORIAL LETTER 2 nd SEMESTER 2017 ASSIGNMENT 1 AND 2 MANAGERIAL FINANCE 4B MAF412S 1

2 ASSIGNMENT 1 QUESTION 1 (i) Investment A at end of Year 3: Year Cash flows Present value = x (1 1/( )^4) ( )^4 Present value = x Present value = Present value = N$4 412 (ii) Investment A at Year 0 Year Cash flows Future cash flow Present value = 800 ( ) ( )^ ( )^3 Present value = Present value = N$5 304 (iii) Investment B Year to infinity Cash flows to infinity Present value at Year 4 = 400/0.1 = N$4 000 Cash flow at Year 4 =

3 = Present value at Year 0 =7 000/ =N$4 781 (iv) Investment C Year Cash flows % growth to infinite Value of investment growth as at Year 3 = Present value = ( )^ ( )^ ( )^3 = = N$4 958 Question 2 (a) Determine whether Marine should acquire shark Marine Fisheries expected return State Return Expected mean 0.25 X 0.16 = X 0.10 = X 0.02 = 0.01 Mean Standard deviation Marine Resources Return Expected mean Deviation Squared Deviations Prob Sq. Dv x Prob

4 Variance SD 0.05.(5%) Shark Bait expected return State Return Expected mean 0.25 X 0.19 = X 0.12 = X - = - Mean Shark Bait S.D. Standard deviation Return Expected mean Deviation Squared Deviations Prob. Sq. Dev x Prob Variance SD % Covariance: Marine Fisheries & Shark Bait State Exp. Return (Marine) Exp. Ret. Shark Bait Marine Fisheries Dev. Marine Shark Bait Dev. Shark Covariance Covariance Expected return of a portfolio of Marine & Shark Bait (40% x 9.4) + (60% x 9.4) = 9.4%

5 Risk of the portfolio: = (0.6 2 x ) + (0.4 2 x ) + (2 x 0.6 x 0.4 x ) = Variance = or 0.58% Standard deviation = or 7.62% The CV of Marine Fisheries = 0.05/0.094 = 0.53 The CV of the new company = /0.094 = 0.81 They should acquire Shark Bait. The returns of the company do increase while the risk increases after acquisition. (b) The required return for a portfolio with the same characteristics as Marine Fisheries: P (R m -R f )/ m Rf + (5.4/3.2) (R m R f) = 5 + (5.4/3.2) (9.2 5) = % = Market returns = (0.30 x 14%) + (0.40 x 8%)+ ( %) = 9.2% (c) Calculate, in line with portfolio theory, how an investor can move along the capital market to a point that gives him a standard deviation equal to 6.4%. (Ignore Marine and Shark Ltd) Rf +( i / m) (R m R f ) = 5 + (6.4/3.2) (9.2 5) = 13.4% As the required risk is twice the market risk, an investor would have to borrow an amount equal to his/her investment in the market portfolio at the risk-free rate and invest the whole amount in the market. Borrow 1 Own capital 1 Invest in the market 2 Market return 9.2 x Cost 5

6 Return 13.40% (d) Determine whether Marine Fisheries and Shark Bait are a good investment in the context of the capital asset pricing model. The required return for both companies is determined by: ke = R f + β(r m R f) Βeta for Marine Fisheries = / = 2.34% Marine expected return: Required return = (9.2 5) = % Expected return = 9.4% Βeta for Shark Bait = / = 2.25 Shark Bait: Required return = (9.2 5) = 14.45% Expected return = 10.8% Both companies offer a return well below their required return. This means that both returns are below the SML and are overpriced.

7 FEEDBACK TUTORIAL LETTER 2 nd SEMESTER 2017 ASSIGNMENT 2 MANAGERIAL FINANCE 4B MAF412S 1

8 ASSIGNMENT 2: MEMO Question 1 [16 Marks] (a) Value of equity YEAR Earnings after tax Dividends (70%) Cost of equity: k e = R f + β(e (rm) R f) k e = 7% (12.8 7%) =14.83% P 4 = D 5/(ke g) P 4 = /(14.83% 4%) 411 Discounting the future dividend and P 4 34/( ) + (36.82/ ) + (39.66/ ) + (42.83/ ) + [( )/ ] = P o = cents Total market value = N$3.36 x = N$ (b) Preference shares P p = N$10/0.09 V= N$ Total value = N$ x =N$ (c) Zero coupon Bonds Bo = N$100/(1.085) 10 = N$ x N$44.23 = N$ % Bonds : Bo = ( x 5) + (100/ )

9 Bo = Bo =N$88.53 Total value N$88.53 x = N$ (d) Calculating the weights Market Value Weight Cost Weighted cost Equity % Preference shares % Zero coupon bonds % % Bonds % Total value % WACC 10.74% Question ER(A) = Rf + β(erm Rf) 9% = Rf+ 0.4(11% - Rf) 9% = Rf Rf 9% - 4.4% = Rf - 0.4Rf 4.6 = 0.6Rf Rf= 7.67% 2.2 (a) βa= CovAM = 18.6 ƠM 9.3 ΒNictus= 2 ER = 6% + 2 (13% - 6%) = 20% (a) The return on the asset is incorrect. This asset is offering low returns (8%) given its risk. The asset therefore plots below the SML. Given the EMH (efficient market hypothesis) the asset s price will fall and its return will rise until it plots at the SML with a return of 20%. (b) The beta value measures systematic risk. The total risk of an asset comprises systematic and unsystematic risk. Unsystematic risk is diversifiable by holding different assets with negative correlation. However systematic risk cannot be diversified away. It is therefore the true risk of the firm hence the use of the beta coefficient in the CAPM and not the variance or Std deviation.

10 Question 3 Calculation of NPV. 3.1 Determining the NPV. Fixed Op. costs per year Residual value Operating cash flows Taxation (81 250) (81 250) (81 250) (81 250) ( ) Cash flows Disc Present values Cost Net present value ( ) The project is acceptable because it has a positive NPV. Workings: 1. Taxation Operating cash flows Fixed costs Net income Recoupment Depreciation deduction ( ) ( ) ( ) ( ) ( ) Taxation Operating cash flows Revenue Variable costs Operating cash flows 2.2 Ratios (a) From the Du-Pont system: Return on equity = Net Income/Sales x Sales/assets x Assets/equity = NP percentage x asset turnover x financial leverage multiplier

11 = ROA x FLM ROA = Net Income/Sales x Sales/assets = NP percentage x asset turnover = 3% x 1.7 = 5.1 (b) Return on Equiy = ROA x FLM FLM = 1 + D/E ratio. = 1+40% = 1.40 = 1.40 x 5.1 ROE= 7.14% (c) ROE = NP% x Asset turnover x equity multiplier = 10% x 2.5 x 1.67% = 41.67%

FIN 6160 Investment Theory. Lecture 7-10

FIN 6160 Investment Theory. Lecture 7-10 FIN 6160 Investment Theory Lecture 7-10 Optimal Asset Allocation Minimum Variance Portfolio is the portfolio with lowest possible variance. To find the optimal asset allocation for the efficient frontier