Question 1
Leon has in his investment a portfolio that paid him the rate of returns of 14 %, -13%, 15.6%, 17% and 19.5% over the past five years. Required:
a) Calculate the arithmetic average return (AAR) and geometric average return (GAR) of the portfolio? If someone asks you what is the actual compounding rate of return of Leon's portfolio over the past five year, which one (AAR or GAR) will be a better answer? (2 marks)
b) Following is forecast for economic situation and Leon's portfolioreturns next year, calculate the expected return, variance and standard deviation of the portfolio. (4 marks)
State of economy Probability Rate of returns
Mild Recession 0.25 -2.5%
Normal 0.45 13.5%
Growth 0.30 20%
c) Assume that expected return of the stock A in Leon's portfolio is 13.2%. Beta of this stock is 1.2, risk free rate is 3.5%. Calculate market portfolio rate of return, which is used to compute the expected return of this stock by Capital Asset Pricing Model (CAPM)?
Question 2
Question 2A :Black Gold Ltd. currently has the following capital structure:
Debt funding: A callable bond that pays annually 10.5% coupon rate with an annual before-tax yield to maturity of 9.7%. The bond issue has face value of $1,000 and will mature in 16 years.
Ordinary equity funding: An ordinary share that just paid a $6.50 dividend per share in the current financial year. The firm is maintaining 4.5% annual growth rate in dividend, which is expected to continue indefinitely.
Hybrid - funding: A preferred share with face value of $100, paying fixed dividend rate of 15%.
Required:
a) Calculate the current price of the corporate bond?
b) Calculate the current price of the ordinary share if the average return of the shares in the same industry is 11.5%?
c) Calculate the current value of the preferred share if the average return of the preferred shares in the same industry is 12.5%?
Question 2B :Magnum Ltd has the following capital structure:
Ordinary Equity: 68 000 ordinary shares outstanding at a market price of $35 per share. The shares have just paid a $1.85 annual dividend and have a dividend growth rate of 2.5%.
Preference Equity: There are 15 000 preference shares with an 8% dividend rate, outstanding at a market price of $75 a share. The preference shares have a par value of $100.
Debts: The outstanding bonds mature in 20 years, have a total face value of $850 000, a face value per bond of $1000 and a market price of $1196.4 each. The bonds have before tax YTM 8%.
The marginal tax rate of the firm is 35%. Required:
a) Calculate the current market value (rounded off to the nearest whole number).
b) Calculate the capital structure of the company. Identify the total weights of equity funding(rounded off to two decimal places)
c) Compute the weighted average cost of capital (WACC) under the traditional tax system for the company, using dividend constant growth model for calculation the cost of ordinary equity.
Question 3
Your company is considering to choose one of the two projects: Project Gold and Project Diamond. Each project will last 5 years and have no salvage value at the end. The company's required rate of return for all investment projects is 9%. The cash flows of two projects are provided below.
Gold Diamond
Cost $485 000 $520 000
Future Cash Flows
Year 1 105 850 117 050
Year 2 153 250 162 400
Year 3 225 650 275 500
Year 4 245 000 255 000
Year 5 250 350 260 000
Required:
a. Identify which project should your company accept based on Net Present Value method?
b. Identify which project should your company accept based on Discounted Payback Period method if the payback criterion is maximum 2.5 years?
Question 4 :
Net profit of Harper Holding Ltd in the current year is $3,546,000. The company is planning to launch a project that will requires an investment of $1,045,000 next year. Today the company's stock has market value of $72/share.Harper Holding Ltd has the current capital structure of 65% in equity and 35% in debt. Required:
a. How much dividend can Harper Holding Ltd pay its shareholders this year and what is dividend payout ratio of the company. Assume the Residual Dividend Payout Policy applies.
- The company is paying a cash dividend of $5.50/share plus an extra-cash dividend of $2.5/share. Tomorrow the stock will go ex-dividend. Calculate the ex-dividend price tomorrow morning. Assuming the tax on dividend is 15%?
- M&T Ltd. is a daughter company of the Harper Holding and currently under a liquidation plan due to severe business contraction. The company plans to pay total dividend of $8.5 million now and $ 12.5 million one year from now as a liquidating dividend. The required rate of return for shareholders is 12%. Calculate the current value of the firm's equity in total and per share if the firm has 1.5 million shares outstanding?
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