ASSIGNMENT 2 INFORMATION

General Assignment Details

Completion – Individual Basis

This assignment must be completed and submitted on an individual basis. The assignment

answers must be submitted via Learnonline. You need to include your name and student ID

number on the first page of your assignment document. For internal students, the first page of

your assignment document also needs to show your tutorial time as marked assignments will

be returned at tutorial classes. Do not include the assignment questions in your assignment

submission.

Other Assignment Details

Show all working in assignment calculations. In questions involving the use of a financial

calculator, you are required to show all financial calculator steps in your answer. If you

answer a question using a financial calculator, you do not need to detail the equivalent

mathematical formula. Please refer to the Course Outline for other details in relation to this

assignment task.

Question 1 (Total marks for this question = 6 marks)

Suppose you take out a loan of $10,000, repayable by five equal annual instalments. The

interest rate is 10% per year.

(a) How much do you need to repay per year to the nearest cent if payments are due :

(i) at the beginning of each year (ii) at the end of each year? (4 marks)

(b) Which loan in part (a) is preferable, (i) or (ii)? Explain your answer. (2 marks)

Question 2 (Total marks for this question = 8 marks)

Let $1000 be invested at the end of each year in perpetuity. The interest rate is 10% per year.

(a) Calculate the present value (PV) of the investment to the nearest cent after : (i) 1 year

(ii) 10 years (iii) 50 years (iv) 100 years. (4 marks)

(b) Calculate the present value of the perpetuity. Explain why the present values in (a)

approach the present value of the perpetuity as the number of years increases.

(4 marks)

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Question 3 (Total marks for this question = 5 marks)

Consider a share investment which has four possible returns : -5%, 2%, 5%, 10%. The

probability of each of these returns occurring is respectively : 0.4, 0.1, 0.2, 0.3.

(a) What is the expected return for the investment? (2 marks)

(b) What is the risk of the investment to 2 decimal places? (3 marks)

Question 4 (Total marks for this question = 14 marks)

The rate of return for an Australian Commonwealth Government Treasury Bond is given as

4% per annum. The yearly return for the Australian share market is given as 12%. Suppose a

listed company has a beta value of 0.75. The dividend payments for the listed company are

expected to grow at 4% per year. The current dividend is $3 per share.

(a) Calculate the market premium. (2 marks)

(b) Calculate the investors’ required rate of return for the company’s shares.

(4 marks)

(c) Calculate the intrinsic price of the shares. (4 marks)

(d) If the market price is $50 per share, would you buy shares in the company? Explain

your answer. (2 marks)

(e) Explain why Australian Commonwealth Government Treasury Bonds are considered

to be risk-free. (2 marks)

Question 5 (Total marks for this question = 10 marks)

Consider a bond with a par value of $1,000 that will mature in 10 years. You are given that

the investors’ required rate of return is 5% per annum.

(a) Calculate the price of the bond to the nearest cent if the coupon interest rate is 7% per

annum, paid annually. (3 marks)

(b) Calculate the price of the bond to the nearest cent if the coupon interest rate is 7% per

annum, paid half-yearly. (3 marks)

(c) Explain why the answers to parts (a) and (b) must be more than the par value of the

bond. (2 marks)

(d) Explain what are bond ratings, and how they affect investor returns. (2 marks)

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Question 6 (Total marks for this question = 15 marks)

The broadest index on the Australian share market is the All Ordinaries Index.

(a) Define the All Ordinaries Index and explain how the All Ordinaries Index can be used

to estimate the market return of the Australian share market. (4 marks)

(b) Construct a table showing the daily closing value of the All Ordinaries Index from

September 30, 2013, to October 18, 2013, inclusive. (2 marks)

(c) On your table, show the daily percentage change in the All Ordinaries Index in this

time period, to two decimal places. (4 marks)

(d) Did the All Ordinaries Index show any volatility during this time period and what was

the cause of this volatility? (5 marks)

Question 7 (Total marks for this question = 10 marks)

Consider an investment project with a length of n years and an initial outlay IO. Let ACFt be

the net cash flow for the project in year t, where t = 1, 2, …, n. Let k be the project discount

rate per annum, expressed in decimal form.

(a) Write down a formula for the net present value, NPV, for the project. (2 marks)

(b) Write down a formula for the profitability index, PI, for the project. (2 marks)

NPV ? IO

(c) Using your answers to (a) and (b), show that PI ? . (4 marks)

IO

(d) Why is the net present value used more than the profitability index in capital

budgeting? (2 marks)

Question 8 (Total marks for this question = 20 marks)

Consider two mutually exclusive investment projects, project A and project B. You are given

project A has an expected life of 3 years and project B has an expected life of 9 years. Project

A has expected future net cash flows in each of years 1-3 of $12,400. Project B has expected

future net cash flows in each of years 1-9 of $6,500. The initial investment required for each

project is $20,000. Assume a required rate of return of 15% per annum for each project.

(a) Calculate the payback period for project A and for project B. (2 marks)

(b) Calculate the discounted payback period for project A and for project B. (6 marks)

(c) Calculate the net present value (NPV) for project A and for project B. (4 marks)

(d) Calculate the profitability index (PI) for project A and for project B. (4 marks)

(e) Calculate the internal rate of return (IRR) for project A and for project B.

(2 marks)

(f) Is project A an acceptable investment project? Is project B an acceptable investment

project? Explain your answers. (2 marks)

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Question 9 (Total marks for this question = 5 marks)

(a) What is the annual headline rate of inflation in Australia to the end of the June, 2013,

quarter? Give a reference in your references list at the end of your assignment.

(2 marks)

(b) If a 12 month fixed term deposit currently earns 3.5% per annum interest, what is the

real rate of return before tax? Use the annual headline rate of inflation from (a) when

calculating the real rate of return. (3 marks)

Question 10 (Total marks for this question = 7 marks)

(a) State the company tax rate in Australia. (1 mark)

(b) How is the Australian Government proposing to change the company tax rate?

(2 marks)

(c) State whether or not you think the Board of the Reserve Bank of Australia will

decrease the cash rate again in the current interest rate cycle. Give reasons for your

answer. (4 marks)

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