 # HI5002 Finance For Business Tutorial Questions Answers Assessment Task – Tutorial Questions

Unit Code: HI5002

Unit Name: Finance for Business

Assignment: Tutorial Questions

Weighting: 50%

Total Assignment Marks: 50 marks

Purpose: This assignment is designed to assess your level of knowledge of the key topics covered in this unit

Unit Learning Outcomes Assessed:

 1. Identify business financial decisions, and critically analyze their impacts on value, and the natureof the broader financial and regulatory environment in which these decisions are made; 2. Critically evaluate the role of finance in business and appraise the way corporate managers usefinancial theory to solve practical problems; 3. Apply underlying finance theories, concepts, assumptions, limitations and arguments to make corporate finance decisions within real-world constraints.

Description: Each week students were provided with three tutorial questions of varying degrees of difficulty. These tutorial questions are available in the Tutorial Material Folder for each week on Blackboard. The Interactive Tutorials are designed to assist students with the process, skills and knowledge to answer the provided tutorial questions. Your task is to answer a selection of tutorial questions for weeks 1 to 11 inclusive and submit these answers in a single document.

The questions to be answered are:

Question 1 (7 marks)

You are the new CFO of Risk Surfing Ltd, which has current assets of \$7,920, net fixed assets of \$17,700, current liabilities of \$4,580 and long-term debts of \$5,890. Required:

a. What are the three important questions of corporate finance you will need to address? Please briefly explain them and indicate how they are related to the areas in the balance sheet of a company. (1 mark)

b. Calculate owners’ equity and build a balance sheet for the company? (3 marks)

c. How much is net working capital of the company? (1 mark)

d. Calculate the return on assets of the company given that Return on Equity is 30%? (1 mark)

e. What is the PE of the company total number of ordinary share outstanding of the companies is 2,000 and market price of each share is \$12? (1 mark)

Question 2 (11 marks)

You are a young personal financial adviser. Molly, one of your clients approached you for consultation about her plan to save aside \$450,000 for her child’s higher education in United States 15 years from now. Molly has a saving of \$120,000 and is considering different alternative options:

Investment 1: Investing that \$120,000 in a saving account for 15 years. There are two banks for her choice. Bank A pays a rate of return of 8.5% annually, compounding semi-annually. Bank B pays a rate of return of 8.45 annually, compounding quarterly.

Investment 2: Putting exactly an equal amount of money into ANZ Investment Fund at the end of each month for 15 years to get 330 000 she still shorts of now. The fund is offering a rate of return 7% per year, compounding monthly.

Required:

a. Identify which Bank should Molly choose in Investment 1 by computing the effective annual interest rate (EAR)? (2 marks)

b. Calculate the amount of money Molly would accumulate in Investment 1 after 15 years if she chooses Bank B? (2 marks)

c. How much is the annual interest rate, assuming compounding annually Molly should aim at if she chooses to invest her \$120 000 in a saving account to get the \$450,000 ready in just 10 years from now? (2 marks)

d. Calculate the monthly payment Molly needs to contribute into ANZ Investment Fund to get \$330,000 after 15 years in Investment 2? (2 marks)

e. In investment 2, if Molly changes to contribute \$1200/month to that super fund at the beginning of each month, how much money she would have in ANZ Investment fund after 15 years? (2 marks)

f. Molly is offered an investment that will pay \$12 000 each year forever. How much should she pay for this investment if the rate of return 12% applies? (1 mark)

Question 3 (7 marks)

You are an active investor in the securities market and you have established an investment portfolio of two stock A and B five years ago.

Required:

a. If your portfolio has provided you with returns of 9.7%, -6.2%, 12.1%, 11.5% and 13.3% over the past five years, respectively. Calculate the geometric average return of the portfolio for this period? (1 mark)?

b. Assume that expected return of the stock A in your portfolio is 14.6%. The risk premium on the stocks of the same industry are 5.8%, the risk-free rate of return is 5.9% and the inflation rate was 2.7. Calculate beta of this stock using Capital Asset Pricing Model (CAPM) (1 mark)?

c. Assume that you bought 200 stock B in your portfolio for total investment of \$1200, now the market price of the stock is \$75, the dividend paid for this stock is \$2 each year. How much is the capital gain of this stock (1 mark)?

d. Assume that the following data available for the portfolio, calculate the expected return, variance and standard deviation of the portfolio given stock A accounts for 45% and stock B accounts for 55% of your portfolio? (4 marks)

 A B Expected return 12.5% 18.5% Standard Deviation of return 15% 20% Correlation of coefficient (p) 0.4

## Question 4 (11 marks)

Blooming Ltd. currently has the following capital structure:

Debt: \$2,500,000 par value of outstanding bond that pays annually 12% coupon rate with an annual before-tax yield to maturity of 10%. The bond issue has face value of \$1,000 and will mature in 25 years.

Ordinary shares: 65,000 outstanding ordinary shares. The firm plans to pay a \$7.50 dividend per share in the next financial year. The firm is maintaining 3% annual growth rate in dividend, which is expected to continue indefinitely.

Preferred shares: 40 000 outstanding preferred shares with face value of \$100, paying fixed dividend rate of 14%.

Company tax rate is 30%.

Required: Complete the following tasks:

a. Calculate the current price of the corporate bond? (2 marks)

b. Calculate the current price of the ordinary share if the average return of the shares in the same industry is 9%? (2 marks)

c. Calculate the current value of the preferred share if the average return of the shares in the same industry is 12% (2 marks)

d. Calculate the current market value (rounded off to the nearest whole number) and capital structure of the firm (rounded off to two decimal places). Identify the total weights of equity funding (2 marks)

e. Compute the weighted average cost of capital (WACC) under the traditional tax system for the firm, using dividend constant growth model for calculation the cost of ordinary equity (3 marks)

Question 5 (7 marks)

Bunnings Ltd is considering to invest in one of the two following projects to buy a new equipment. Each equipment will last 5 years and have no salvage value at the end. The company’s required rate of return for all investment projects is 8%. The cash flows of the projects are provided below.

 Equipment 1 Equipment 2 Cost \$186,000 \$195,000 Future Cash Flows Year 1 86 000 97 000 Year 2 93 000 84 000 Year 3 83 000 86 000 Year 4 75 000 75 000 Year 5 55 000 63 000

## Required:

a. Identify which option of equipment should the company accept based on Profitability Index? (4 marks)

b. Identify which option of equipment should the company accept based on discounted pay back method if the payback criterion is maximum 2 years? (3 marks)

Question 6 (7 marks)

Net profit of Lily Fashion House Ltd in the current year is \$2,575, 000. The company is planning to launch a project that will requires an investment of \$745 000 next year. Today the company’s stock has market value of \$22/share. Lily Fashion House has the current capital structure of 60% in equity and 40% in debt. Required:

a. The company is paying a cash dividend of \$4.50/share plus an extra-cash dividend of \$1.5/share. Tomorrow the stock will go ex-dividend. Explain why there is ex-dividend date and ex-dividend price? Calculate the ex-dividend price tomorrow morning. Assuming the tax on dividend is 25%?  (2 marks)

b. How much dividend Lily Fashion House can pay its shareholders this year and what is dividend payout ratio of the company. Assume the Residual Dividend Payout Policy applies? (2 marks)

c. Floral Textile Ltd. is a daughter company of the Lily Fashion House Group and currently under a liquidation plan due to severe business contraction caused by the COVID 19 pandemic. The company plans to pay total dividend of \$3.5 million now and \$ 8.5 million one year from now as a liquidating dividend. The required rate of return for shareholders is 13.5%. Calculate the current value of the firm’s equity in total and per share if the firm has 2.5 million shares outstanding? (3 marks)

Information given in question is mentioned hereunder:

 Elements Cost Assets in use (Current) AUD 7920 Net Assets (Fixed) AUD 17700 Liabilities in use (Current) AUD 4580 Debt AUD 5890

## A. Essential Factors in finance of corporate

The Corporate Finance can be defined as a financial branch which controls the requirements of finance, base of capital and essential decisions which are in relation to corporation investment (Cloyne and Surico, 2018). The corporate finance plays an important role in profit maximization by formulating plans and implementing those plans. Some of the essential areas that are to be determined as company’s CFO are:

• Budgeting of Capital- Budgeting of capital is a process in which the company or organization determines its long term investments which are worthy of cash funding via the company’s structure of capitalization.
• Structure of Capital- The Structure of Capital is a combination of equity and debts for funding their operations & growth.
• Working Capital Management- The working capital management can be defined as a process through which the organization or company can ensure the efficiency of the company by keeping an eye on the current assets and liabilities and using them at its best

B. Equity of Owner

Equity of Owner shows the investment of owner in the business minus the withdrawals of the owner plus net income from the beginning of business (Ponomareva and Zheleznova, 2018).

From the given  x , the equity of owner can be calculated as-

Total business assets= Assets in use + Net Assets

= AUD 7920 + AUD 17700

= AUD 25620

Total business liabilities= Liabilities in use + Debts

= AUD 4580 + AUD 5890

= AUD 10470

Equity of owner = AUD 25620 – AUD 10470

= AUD 15150

Balance Sheet- the Risk Surfing is given below:

Balance Sheet of Risk Surfing

 Assets Cost Assets in use (Current) AUD 7920 Net Assets AUD 17700 Total AUD 25620 Liabilities Liabilities in use (Current) AUD 4580 Debts AUD 5890 Total AUD 10470 Equity of Owner AUD 15150 Equity of owner and Total of Liabilities AUD 25620

C. (WC) Working Capital

The working capital of an organization or company shows the operating liquidity available in business or organization (Panda and Nanda, 2018). The working capital of an organization can be calculated using the formula given below:

Working Capital (WC) = Assets in use (Current) – Liabilities in use (Current)

Therefore, from the given information working capital is calculated as:

Working capital= AUD 7920 – AUD 4580

= AUD 3340

D. Return (ROA) on Asset

The Asset return can be defined as an indicator which represents profit of an organization with respect to total assets in an organization (Sujud and Hashem, 2017).

Given in the question: Equity Return= 30%

Return on (ROA) Asset = Business Income/ Total Asset

Equity Return = Business Income/ Equity

30%= Business Income/ AUD 15150

Business Income = 30% x AUD 15150

= AUD 4545

Asset Return = AUD 4545/ AUD 25620

= 17.75%

E. Price to (PE) Earnings

Earning of Price is defined as a represents the ratio between share price and earnings per share of the company (Pitaloka, 2017). The earning price can be calculated as:

Earning price = Market Price per share / Earnings per share

Firstly, earnings per share will be calculated using the formula given below:

Earnings per share = Available Net Income for owners / Number of O/S Shares

= AUD 4545 / 2000

= AUD 2.2725

Earning Price = AUD 12 / AUD 2.2725

= 5.28

Savings of Molly as cash in hand is AUD 120000 and kept aside money for the education of here child is AUD 450000. There are two investments before her:

Investment A: Savings money to be invested in bank

 Suggested Bank B Bank A Rate of return 8.45% 8.50% Compound Quarter Half-Yearly

Investment B: Allocating same amount of investments in ANZ bank in the month end therefore she will be able to get AUD 330000 at 15th year beginning now.

 Suggested ANZ Investment Fund Rate of return 7.00% Compound Every Month

## A. Effective Interest Rate (Annual)

The Effective Interest Rate can be defined as an interest rate Restated from nominal rate of interest and represented as equivalent rate of interest in case if the compound interest is annually payable.

Effective Interest Rate can be calculated using the formula given below:

Effective Interest Rate = {1 + (Nominal Rate of Interest / Number of period)} ^ Number of period – 1

Bank A

Number of Period = 2 (Half-Yearly) x 15 yrs.

= 30

Effective Interest rate = {1 + (.085/30)} ^ 30 – 1

= 8.862%

Bank B

Number of Period = 4 (Quarter) x  15 years

= 60

Effective Interest Rate = {1 + (0.0845/60)} ^ 60 – 1

= 8.81%

From the above values calculated for Effective Interest Rate, it can be concluded that Molly should invest her savings amount in Bank X because it provides higher Effective Interest Rate than Bank Y

B. Future value of Money

If Molly decides to invest her savings amount in Bank Y, given below will be the amount she would receive after 15 years:

Predicted Values = Current Value x (1+Rateof Interest/Number of compound) ^ Number of periods

= AUD 120000 x (1+0.0212) ^ 60

= AUD 420645

C. Annual Rate of Interest

Rate of Interest = (Predicted Values/Current Values) ^ (1/ Number of Periods) -1 (ZVINGELIS, 2019)

Number of Periods = 10

Annual Rate of Interest = (AUD 450000/ AUD 120000) ^ 0.1 -1

= 14.12%

D. Per Month Payment

Current value = Predicted Value/(1+Rate of Interest/Number of compound) ^ Number of Periods

Number of Compound = 12

Number of Periods = 15 x 12 = 180

Current Value = AUD 330000 / (1+0.07/12) ^ 180

= AUD 115839

Per Month Payment = AUD 115839/180

= AUD 643.50

E. Expected Future Value

Predicted Value = (Current Value  x  (1+Rate of Interest) ^ n – 1) / (Rate of Interest)  x  (1+Rate of Interest)

= AUD 1200 x (1 + (0.07/12)) ^ 180 – 1 / (0.07/12) x  (1 + (7%/12))

= AUD 1200 x 316.9513 x 1.005833

= AUD 382560

F. Investment Payment

Value of Investment = AUD 12000/0.12

= AUD 100000

An investment portfolio was established which involves the stock of X and Y.

A. Geometric Average (GAR) Return

The Geometric Average Return is a way which is used to calculate average return rate over investment which is compounded on various periods. Gar can be calculated using the formula given below:

Geometric Average Return = {(1+ 1st Rate)  x  (1+ 2nd Rate)  x  (1+ 3rd Rate)  x  ….(1+ nth Rate)}^(1/n) – 1

The Return Rates given in the  x  are mentioned below:

 Annum Revenue in percentage 1st Year 9.70 2nd Year -6.20 3rd Year 12.10 4th Year 11.50 5th Year 13.30

Geometric Average Return = {(1+ 9.7%) x (1-6.2%) x (1+12.10%) x (1+11.50%) x (1+ 13.30%)} ^ (1/5) – 1

= 7.82%

B. β Beta

According to the pricing model of Capital Asset,

Expected Return = (Beta x Premium Risk) + Risk Free Return

Expected Return = 14.6%

Risk Free Return = 5.9%

Premium Risk = 5.8%

Placing the values in the above formula, we get:

Beta (β) = 1.5

C. Capital (CG) Gain

Total Invested Amount = AUD 1200

Stock Purchased = 200

Cost of each stock = AUD 1200/200 = AUD 6

Capital Profit on Investment = Dividend + Present Price of share - Purchase Cost of Share (Maleki and Ranjbar, 2017)

= AUD 75 + AUD 2 – AUD 6

= AUD 71 per share

Total Capital Profit = AUD 71  x  200 = AUD 14200

D. Portfolio

Details given in the  x  are mentioned below:

 Particulars A B Expected Return (%) 12.50 18.50 Standard Deviations (%) 15 20 Correlation of Coefficients 0.4 Weights 45% 55%

Expected Return of the Portfolio = Weight X  x  Expected Return X + Weight Y  x  Expected return Y

= 12.5 x 45% + 18.5 x 55%

= 15.8%

Variance of Portfolio = (Weight X)^2  x  (Standard Deviation X)^2 + (Weight Y)^2  x  (Standard Deviation Y)^2 + 2  x  Weight X  x  Weight Y  x  Covariance (X, Y)

Covariance (X, Y) = Correlation of Coefficient x Standard Deviation A x Standard Deviation BY

= 0.4 x 15% x 20%

= 0.012

Variance of Portfolio = (0.45) ^ 2 x (15%) ^ 2 + (0.55) ^ 2 x (20%) ^ 2 + 2 x 0.45 x 0.55 x 0.012

= 0.02259625

Standard Deviation of Portfolio = Standard Deviation of Portfolio = (Variance of Portfolio) ^ (1/2)

= (0.022596) ^ (1/2)

= 15%

# A. Current Bond Price

Rate of Coupon = 12%

Amount of Coupon = AUD 1000 x  12% = AUD 120

Maturity Time = 25 Years

YTM = 10  x  (1-30%) = 7%

Face Value = AUD 1000

Bond Value = Coupon Cost  x  (1-(1+Rate of Interest) ^ -Number of Period)/ Rate of Interest + Face Value (1+ I ) ^ -n

Bond Value = AUD 120 x  (1-(1+0.07)^-25)/7% + \$1000(1+0.07)^-25

= AUD 1582.68

1. ## Equity Share Value

According to method dividend growth,

B. Equity share value = Dividend Expected/ (Rate of Return – Growth Rate)

= AUD 7.50/ (0.09-0.03)

= AUD 125

## C. Preference Share Value

Dividend = 14% in essence, AUD 100 x 14% = AUD 14

Cost = Dividend/Rp

= AUD 116.67 each share

D. Value of Company and Structure of Capital

Value of Firm

 Particulars Number of Bonds/Shares Rates Cost Weight Equity Shares 65000 125 8125000 0.43 Preference Shares 40000 166.67 6666800 0.36 Debt 2500 1582.68 3956700 0.21 Total 18748500 1.00

Structure of Capital

 Particulars Number of Bonds/Shares Rates Cost Weight Equity Shares 65000 125 8125000 0.56 Preference Shares 40000 100 4000000 0.27 Debt 2500 1000 2500000 0.17 Total 14625000 1.00

Information given in the  x  is mentioned below:

 Particulars Equipment A Equipment B Price AUD 186000 AUD 195000 Flow of Cash 1st Year AUD 86000 AUD 97000 2nd Year AUD 93000 AUD 84000 3rd Year AUD 83000 AUD 86000 4th Year AUD 75000 AUD 75000 5th Year AUD 55000 AUD 63000 Rate Required 8%

## A. Index of Profitability

Index of Profitability = Current value of predicted cash flow/Project’s Initial Cost

Calculating Current Value of cash flows from Equipment A:

 Annum Flow of Cash Current Value at 8% Current Value 1 AUD 86000 0.9259 AUD 79629 2 AUD 93000 0.8573 AUD 79732 3 AUD 83000 0.7938 AUD 65888 4 AUD 75000 0.7350 AUD 55127 5 AUD 55000 0.6805 AUD37432 Total AUD 317809

Index of Profitability of Equipment A = AUD 317809.53 / AUD 186000 = 1.708

Calculating Current Value of cash flows from Equipment B:

 Annum Flow of Cash Current Value at 8% Current Value 1 AUD 97000 0.9259 AUD 89814 2 AUD 84000 0.8573 AUD 72016 3 AUD 86000 0.7938 AUD 68269 4 AUD 75000 0.7350 AUD 55127 5 AUD 63000 0.6805 AUD 42876 Total AUD 328104

Index of Profitability of Equipment B = AUD 328104.83 / AUD 195000 = 1.68

From the above calculations, we can conclude that the organization should accept the Equipment B proposal because it gives higher index of profitability as compared to Equipment A.

B. Discounted Method of Payback

Calculating discounted period for the Equipment A:

 Annum Flow of Cash Discount at 8% Discounted Flow of Cash Primary Investment to recover Time period in annum 0 AUD 195000 0 1 AUD 86,000 0.9259 AUD 79,629.63 AUD 1,15,370 1 2 AUD 93,000 0.8573 AUD 79,732.51 AUD 35,637 2 3 AUD 83,000 0.7938 AUD 65,888.08 AUD -30,250 3 4 AUD 75,000 0.7350 AUD 55,127.24 AUD   -85,377 4 5 AUD 55,000 0.6805 AUD 37,432.08 AUD- 1,22,809

There is presence of negative balance in the column of Primary Investment to recover which says that Primary investment can be recovered in 2nd year.

Calculating specific period:

Discounted Period = 2 years + (AUD 35637.86 / AUD 65888.08)

= 2.54 years

Calculating Discounted period for Equipment B:

 Annum Flow of Cash Discount at 8% Discounted Flow of Cash Primary Investment to recover Time Period in Annum 0 AUD 195000 0 1 AUD 97,000 0.9259 AUD    89,814 AUD 1,05,185 1 2 AUD 84,000 0.8573 AUD    72,016 AUD      33,168 2 3 AUD 86,000 0.7938 AUD    68,269 AUD    -35,100 3 4 AUD 75,000 0.7350 AUD    55,127 AUD    -90,228 4 5 AUD 63,000 0.6805 AUD    42,876 AUD -1,33,104

There is presence of negative balance in the column of Primary Investment to recover which says that Primary investment can be recovered in 2nd year.

Calculating specific period:

Discounted Period = 2 yrs. + (AUD 35637.86 / AUD 68269.57)

= 2.49 yrs.

In case selected criteria of discounted periods is 2 annum, both the above proposals of investment are not fit.

A. Price of Ex-Dividend

The price of ex-dividend is defined as a rate which is set up by an entity for the sale of shares in market a day before the date of record (Dupuis, 2019).

The Price of ex-dividend is calculated as:

Price of Ex-Dividend = Current share price – Dividend * (1- rate of tax)

= AUD 22- AUD 4.5

= AUD 17.5

B. Pay-out of Dividend

The pay-out of dividend can be defined a s proportions of paid out earnings in form of dividends to the shareholders.

Net Gain = AUD 2575000

Succeeding year fund requirement = AUD 745000

Paid out dividend of company for present year = AUD 2575000 – AUD 745000

= AUD 1830000

Pay-Out of dividend = AUD 1830000/ AUD 2575000 = 71%

C. Equity Value

Total Dividend = Present year dividend + Current dividend value for succeeding year

= AUD 3500000 + AUD 8500000  x  (1/1.14)

= AUD 3500000 + AUD 7488987

= AUD 10988986.8

Company Value = Total Dividend /Rate Required

= AUD 10988986 / 13.5%

= AUD 81399902.1

Cost of per share = AUD 81399902/2500000

= AUD 32.55