Question 1. (This question has three sub-questions: (a), (b) and (c))
a) Sam just won a government lottery. His prize can be taken either in the form of a 20-year ordinary annuity or as a lump sum that is paid immediately. What concept could Sam apply to assist him in choosing between the ordinary annuity or the immediate lump sum? Explain how this analysis will help Sam in making a better decision
b) “If a savings account has an APR (annual percentage rate) of 10%, then its EAR (effective annual rate) must be higher than 10%.” Is this statement correct or incorrect? Explain your answer.
c) (c) Sam is planning to save up for a trip to Italy in 5 years. He estimates that he will need $20,000 for this trip. Currently, Sam has $5,000 in a savings account paying 3.6% annually. He plans to use his current savings plus what he can save over the next 5 years to finance this trip. How much money should Sam save at the beginning of each year over the next 5 years to finance this trip?
Question 2. (This question has two sub-questions: (a) and (b))
(a) Your financial manager is asking you to evaluate the level of market efficiency for the Australian market. After performing some analyses in the Australian market, you believe that you can make abnormally profitable trades by observing that the CEO of a certain company always wears her red suit on days when the company is about to release positive information about itself. Describe which form or forms of market efficiency is/are consistent with your belief.
(b) The table below provides the information about two bonds:
Bond Par value Term to maturity Coupon rate
A $1000 3 years 10% per annum, paid semi-annually
B $1000 15 years 10% per annum, paid semi-annually
(i) Suppose the market interest rate is 6% per annum for both bonds, without performing any calculations, discuss whether these two bonds should sell at identical prices or if one should be worth more than the other.
(ii) Will your answer in Part (i) be different if the market interest rate is 10% per annum for both bonds? Explain.
(iii) Suppose the market interest rate is 8% per annum for both bonds, what prices do you obtain for each of these two bonds?
Question 3. (This question has three sub-questions: (a), (b) and (c))
(a) Sam is evaluating two shares, Share A and Share B. He finds that the standard deviation of returns for both Share A and Share B is exactly the same. He then makes the following two statements:
(i) “It will be indifferent for me to purchase Share A or Share B, as the expected returns for both shares should always be the same.” Do you agree or disagree with this statement?
Explain.
(ii) “If there is another share that has higher expected return than that of Share A and Share B, then its standard deviation of returns must also be higher than that of Share A and Share B as well.” Do you agree or disagree with this statement? Explain. (b) Classify each of the following events as a source of systematic risk or unsystematic risk. Use one to two sentences to briefly justify your classification for each of the events.
(i) In March 2015, Former NAB banker Lukas Kamay was convicted of insider trading and was sentenced to seven years and three months in prison.
(ii) Apple’ share price sunk by more than 5% on the news of the death of Steve Jobs.
(iii) The recent COVID-19 lockdowns in Sydney and Melbourne are causing security prices around the Australia to fall precipitously.
(c) Based on your recent research, there are six pharmaceutical companies working on a new COVID19 vaccine for the Delta-variant. As an investor, you have the option of investing in one of them versus all six of them:
(i) Is your systematic risk likely to be very different? Why?
(ii) If you decide to invest in all six pharmaceutical companies and form an investment portfolio accordingly, would you consider such investment portfolio is well-diversified?
Explain.
Question 4. (This question has two sub-questions: (a) and (b)) (a) The net cash flows for two projects, A and B, are as follows:
Net Cash Flows
Year Project A Project B
0 -$60,000 -$35,000
1 $45,000 $32,000
2 -$15,000 $17,000
3 $60,000 -$5,000
(i) Can you make capital budgeting decisions for the above projects based on the IRR
(internal rate of return) method? Explain. (ii) Given a discount rate of 10% p.a., calculate the NPV of the above projects.
(iii) Assuming you have $60,000 to invest, which one ought to be selected? Explain.
(iv) Will your answer in Part (iii) be different if you have $100,000 to invest and these two projects are not mutually exclusive? Explain.
(b) Sky Tech is a company that producing solar panels. The company is analysing the possibility of introducing a new product, named ‘Solar-2022’, to the market. The ‘Solar-2022’ will adopt a new technology of using silicon solar modules. This new technology could largely increase the power conversion efficiency. The project is estimated to be of 5 years duration. The company’s tax rate is 35%. The following is the additional information about the project:
(i) To produce this new product, Sky Tech needs to introduce a new production line. This production line requires an initial investment of $7,500,000 in fixed asset which is fully depreciated over the five-year life of the project.
(ii) The expected annual sales number of ‘Solar-2022’ is 20,000 units; the price is $680 per unit. Variable costs of production amount to $330 per unit.
(iii) The introduction of the ‘Solar-2022’ will also decrease the company’s sales of regular solar panels by 12,500 units per year; the regular solar panel has a unit price of $350 and unit variable cost of $160.
(iv) To date, Sky Tech had already spent $1,000,000 in research and development on the new silicon solar modules technology.
Assess and justify whether or not each of the items ((i) – (iv) above) should be considered in the estimation of the incremental annual cash flow from operations for the ‘Solar-2022’ project.
Calculate the after-tax incremental annual cash flow from operations.
Question 5. (This question has two sub-questions: (a) and (b))
(a) You are presented with the following information about Tesla Corporation:
• The company has 10 million ordinary shares outstanding, priced at $45 and with a beta of 1.35. The market risk premium is 9.5% p.a. and Treasury bills are yielding 2% p.a.
• There are 1.2 million preference shares outstanding with a par value of $100 and 7.2% dividend. The market price of the preference shares is $60.
• The company has 120,000 of semiannual coupon bonds outstanding with $1,000 par value. The bonds are selling at 120% of par. The yield to maturity is 7.5% p.a. and the corporate tax rate is 35%.
What is the Tesla’s after-tax WACC?
(b) You are the manager of a financially distressed company with $3.1 million in debt outstanding that will mature in three months. Your company currently has $3 million invested in risk-free Australian Government Treasury bills that will pay $3.1 million in three months.
Assume that you are offered with an opportunity that involves selling the $3 million risk-free Treasury bills now and investing the proceed in a high-risk project, with a 30% probability of $6 million pay off in three months, and a 70% probability of $1 million pay off in three months. If you were operating the company in the shareholders’ best interests, will you push for the
acceptance of this high-risk project? Explain your reasoning.
Formulae
1. FV = PV(1 + ??)
2. FV = PV(1 + ??/??) ×
3. PV =
( )

4. Effective Annual Rate = 1 + - 1
( )
5. FV of an ordinary annuity = ???? ×
( )
6. FV of an annuity due = ???? × × (1 + ??)
7. PV of an ordinary annuity = × 1 -
( )

8. PV of an annuity due = × 1 - × (1 + ??)
( )

9. PV of a perpetuity =
10. PV of a growing perpetuity =
11. CF of an ordinary annuity =
( )

12. Single period realized return on a dividend paying stock =
13. Expected return of n observations = E(RAsset) =E(R) = (R1 + R2 + R3 + … + Rn)/n
14. ???????????????? (?? - ??(??)) )
15. ???????????????? ??????????????????(??) = ?? = ????????????????(??)
16. Capital Asset Pricing Model: ??(?? ) = ?? + ?? ??(?? ) - ??
17. Portfolio expected return: ?? ?? = ?? ??(??
) + ?? ??(?? ) + … + ?? ??(?? )
18. Portfolio beta: ?? = ?? ?? + ?? ?? + … + ??

19. Constant dividend growth model: P = ??
20. Annual coupon bond price = 1 - +
( ) (

)
/
21. Semi - annual coupon bond price = 1 -
/ (

+
/ ) (

/ )
22. NPV = ??????
23. Payback period=Years to recover cost + Remaining cost to recover
Cash flow during the year
24. Cost of equity based on growing dividend: ??
= D1 + ??
25. Cost of equity (CAPM): ?? = ?? + ?? ??(??
) - ??
26. WACC without preference shares: ???????? =
?? (1 - ?? ) + ??
27. WACC with preference shares:
?? + ??
???????? = ?? (1 - ?? ) +
28. Required return on levered equity: ?? = ?? + (?? - ?? )