You are on page 1of 20

# ASSIGNMENT

by
LEONG KHAI SIANG
(CGS00661701)

## Greenhill Learning Center

Open University Malaysia
No. 55-57, Persiaran Greenhill
30450 Ipoh
Perak Darul Ridzuan

QUESTION 1

a. A corporation has a current ratio of 5.65 when the industry average is 1.42. What could
be the reason for this disparity?

Formula at current rate = Current Asset
Current Liability
The disparity can be due to higher current assets such as cash, debtors etc.
Besides, it is also done to lower current liability such as creditors, payables etc.

b. Determine the sales of a firm with the following financial information:
Current ratio: 2.40
Quick ratio: 1.50
Current liabilities: RM600,000
Inventory turnover: 6 times

Current ratio = CA
CL
2.4 = CA
60, 000
CA = 2.4 x 60,000
= 1,440,000

Q ratio = CA Inventory
CL
1.5 = 1,440,000 Inventory
60, 000
Inventory = 1,440,000 ( 1.5 x 60,000 )

= 540,000

Cost of good sold = Sales (1 gross margin )
= 0.75 sales

Cost = Inventory turnover
Inventory
0.75 sales = 6
540,000
Sales = 6 x 540,000
0.75
= 4,322,000

c. Complete the balance sheet and sales information for Edelle Corporation using the
following financial data:
Debt / equity 50.0%
Quick ratio 1.40
Total asset turnover 1.60
Days outstanding - accounts receivable 30.00
Gross profit margin 25.0%
Inventory turnover 4.00 times

Cash Accounts payable
Accounts receivable Common stock 25,000
Inventory Retained earnings 26,000
Plant and equipment Total liabilities & equity
Total assets
Sales Cost of sales

Debt = 50%
Equity
Debt = 50%
25K + 26K
Account payable = Debt = 50% x 51K
= 25,500

Total liability = Total asset
= 25,500 + 25K + 26K
= 76,500

Q
r
= Cash + Receivable = 1.4
CL
Cash + Receivable = 1.4 x 25,500
= 35,700

Asset turnover = Sales = 1.6
Assets
Sales = 1.6
76,500
Sales = 1.6 x 76,500
= 122,400

Day sales outstanding = Receivable
Sales/365
30 = Receivable
122,400/365
Account Receivable = 30 x 335.342
= 10,060

Cash + Receivable = 35,700
Cash = 35,700 10,060
= 25,640

Cost of good sales = Sales (1 gross margin )
(COGS) = 122,400 (1 25%)
= 91,800

Inventory turnover = COGS = 4
Inventory
Inventory = 91,800
4
= 22,950

Plant & equipment = Total Asset Inventory Cash Account Receivable
= 76,500 - 22,950 -25,640 10,060
= 17,850

QUESTION 2

a. Dynamo Pyro Bhd. (DPB) earned RM6.50 of cash flow per share last year.

(i) If DPB expects its cash flow to grow by 6% per year forever, what is the current value of
a share of DPB stock? Assume that the required rate of return is 14.5%.

Share value = DIV ( 1 + g )
Req rate of return g
= 6.5 (1 + 6% )
14.5% - 6%
= 6.89
8.5%
= RM 81.06

(ii) If the current stock price is RM59.66, what is the markets expected growth rate
underlying the stock price. Assume the same discount rate and expected cash flow.

Share value = DIV (1 + g )
Req - g
59.66 = 6.5 ( 1 + g )
14.5% - g
59.66 (0.145 g ) = 6.5 + 6.5g
8.6507 59.66g = 66.16g
2.507 = 66.16g
g = 3.25%

b. The risk-free rate is 5.45%, and the market risk premium is 5.00%. Under consideration
for investment outlays are Projects Alpha, Beta, and Chi, with estimated betas of 0.6, 1.1,
and 1.8, respectively. What will be the required rates of return on these projects based on
the Security Market Line approach?

Req rate of return = R
f
(risk free rate) + (market base premium)

= 5.45 % + 0.6 (5%)
= 8.45%
= 5.45% + 1.1 (5%)
= 10.95%
Chi = 5.45% + 1.8 (5%)
= 14.45%

c. A 12 year corporate bond with RM1,000 maturity value carries a 7.5% coupon rate. It
pays its interest payments semi-annually.

(i) If the bond is currently selling for RM961.88, what is the rate of return on this bond?

Yield of maturity = annual interest income + par value CMP
Years
Par value + CMP
2

= (7.5% x 1,000) + 1000 961.88
12
1000 + 961.88
2

= 7.96%

(ii) If the bond sold for RM1,030.32, what is the rate of return on this bond?

Return of rate = 75 + 1,000 1,030.32
12

1,000 + 1,030.32
2
= 7.14%

QUESTION 3

a. Your sister is celebrating her 28th birthday. She wants to start saving for retirement at age
58. She tells you that ideally she would like to withdraw RM50,000 on an annual basis
for at least 25 years starting the year after she retires. She says that she is comfortable
putting aside some money each year in an annuity and believes that she should be able to
earn an 8% rate of return.

(i) If your sister starts making annuity payments to her savings account at the end of this
year and makes her last deposit at age 58, how much must she deposit each year?

Total money to withdraw = 50,000 x PVIFA
25,8

= 50,000 x 10.675 (from PVIF table)
= 533,750

533,750 = PMT x (1 + i )
n
1
i

533,750 = PMT x (1 + 0.08)
30
1
0.08
= PMT x (9.06 / 0.08)
PMT = 4,711.64

(ii) Your sister mentions that she already has a savings account of RM10,000, if she used that
money to start the account, how much must she deposit each year until she reaches age
58?

## Future value of 10,000 deposit

FV = Principle (1 + i )
n

= 10,000 (1 + 0.08)
30

= 100,626.57

New value = 533,750 100,626.57
= 433,123.43

433,123.43 = PMT x (1 + i )
n
1
i

433,123.43 = PMT x (1 + 0.08)
30
1
0.08
= PMT x ( 9.06/0.08)
Deposit = 3,823.37

(iii) She suddenly remembers that her parents had bought her a life insurance policy that
matures on her 50th birthday for an amount of RM75,000. If she added that to the
retirement fund, along with her RM10,000 (year 0) savings account, how much must she
deposit each year until she reaches age 58.

Insurance value = 75,000 x PVIFA
88.5%

(30 years) = 75,000 x 1.8509
= 138,817

Total money = 533,750 100,626.57 138,817
= 294,305.93

294,305.93 = PMT x (1 + i )
n
1
i

294,305.93 = PMT x (1 + 0.08)
30
1
0.08
= PMT x (9.06 / 0.08)
PMT = 4,711.64

b. Prepare the first three months of a loan amortization schedule for a RM200,000 thirty
year mortgage. The loan has a 6% APR interest rate and is compounded monthly. What
are the monthly payments?

Monthly payment = Total loan i + i
(1 + ii)
n
1
i = 6%
12
= 0.5% (monthly)
n = 30 x 12
= 360

Month payment = 200,000 0.005 + 0.005
(150,005)
360
1

= 200,000 0.005 + 0.005
5.023
= 200,000 (0.005 + 9.9542 )
= 1,199.08
Month
Beginning
Balance
Installment Interest Principle
Year Ending
Balance
1 200,000.00 11,199.10 1,000.00 199.10 199,800.90
2 199,800.90 1,199.10 999.00 200.10 199,600.80
3 199,600.80 1,199.10 998.00 201.10 199,399.70

c. Assume that you are negotiating financing for a new automobile. You have been given
the choice between (1) a RM2,000 rebate and 9% (compounded monthly) financing or (2) no
rebate and 0.0% (compounded monthly) financing. Either loan would require monthly
payments for a two-year period; the cost of the vehicle is RM25,000. The RM2,000
rebate would immediately reduce the price of the vehicle. Calculate your monthly
payment under both alternatives. With which choice are you better off?

Option I 2,000 rebate with 9% compounded monthly
New price = 25,000 2,000
= 23,000

Monthly payment = loan i + i
(1 + i)
n
1
i = 9%
12
= 0.75%

n = 2 x 12
= 24

MP = 23,000 0.0075 + 0.0075
(1 + 0.075)
24
1
= 23K 0.0075 + 0.0075
0.1964
= 23K ( 0.046 )
= 1,050.75

Option 2 0% Interest installment & 0 rebate
Installment = 25,000
24
= 1,041.67

Hence, option 2 is preferably due to its lower installment.

QUESTION 4

a. Nickson bought 100 shares ofPristonBhd stock for RM24 per share on January 1, 2009. He
received a dividend of RM2 per share at the end of 2009 and RM3 per share at the end of 2010.
At the end of 2011, Nickson collected a dividend of RM4 per share and sold his stock for RM18
per share. What was Nicksons realized return during the three year holding period?

Capital gain = 18 24
= 6
Dividend income = 2 + 3 + 4
= 9
Total return = -6 + 9
= 3
Realized return = 3 x (100/24)
= 12.5%
a. Given an expected return for the market of 12 percent, with a standard deviation of 20
percent, and a risk-free rate of 8 percent, consider the following data:

Stock Beta Ri(%)
1 0.8 12
2 1.2 13
3 0.6 11

(i) Calculate the required rate of return for each stock using the SML.

Stock Beta R
i
(%) Req rate of return (Rs)
1 0.8 12 8 + (0.8) (12-8) = 11.2
2 1.2 13 8 + (1.2) (12-8) = 12.8
3 0.6 11 8 + (0.6) (12-8) = 10.4

(ii) Assume that an analyst, using fundamental analysis, develops the estimates labeled Ri for
these stocks. Which stock would be recommended for purchase?

Answer: It would be Stock 1 recommended to purchase. (highest between Rs and Ri)

b. Why is market risk sometimes said to be the relevant risk for a portfolio manager?
What is the measure of market risk?

Market Risk cant diversify and cant be removed or eliminated. For example: market risk = interest
rate, government policy, war.

specific risk

market risk

c. Suppose the Security Market Line (SML) has a risk-free rate of 5 percent and an
expected market return of 15 percent. Now suppose that the SML shifts, changing slope,
so that kRF is still 5 percent but kM is now 16 percent. What does this shift suggest about
investors risk aversion? If the slope were to change downward, what would that suggest?

This shift is suggest to increase in risk premium. For instance, 16% to 5 % = 11% before 15% -
5% = 10% higher risk premium indicates higher risk so investor need to be more risk averse.
Apart from that, downward slope indicate to risk.

QUESTION 5

a. Discuss the different forms of market efficiency under the Efficient Market Hypothesis
(EMH)? Are market anomalies consistent with the concept of EMH?

The efficient Market Hypothesis (EMH) gives rise to forecasting tests that mirror those
adopted when testing the optimality of a forecast in the context of given information set.
However, there are also important differences arising from the fact that market efficiency
tests rely on establishing profitable trading opportunities in real time. Forecasters constantly
search for predictable patterns and affect prices when they attempt to exploit trading
opportunities. Stable forecasting patterns are therefore unlikely to persist for long periods of
time and will self-destruct when discovered by a large number of investors. This gives rise to
non-stationarities in the time series of financial returns and complicates both formal tests of
market efficiency and the search for successful forecasting approaches.

Market efficiency can be defined as a securities market is efficient if security prices fully
reflect the information available. Besides, it is also understandable that the market is efficient
with respect to some specified information system, if and only if security prices act as if
everyone observes the information. The importance of market efficiency includes
encouraging share buying, whereby the investors need to know that they are paying a fair
price and that they will be able to sell at a fair price. Besides, it provides signals to Company
Managers in pursuit of maximizing shareholders wealth, need to get feedback on their
decisions. Furthermore, it can help in allocating resources. For instance: Allocation
Efficiency requires both operating and pricing efficiency.

Basically, there are three forms of market efficiency as below:

(i) Weak Form Efficient Market
- Market prices reflect all historical information.
- RandomWalk.

(ii) Semi-strong Form Efficient Market
- Market Prices reflect publicly available information.

(iii)Strong Form Efficient Market
- Market prices reflect all information, both public and private.

b. Conventional wisdom has long held that diversification of a stock portfolio should be
across industries. Does the correlation coefficient indirectly recommend the same thing?

No, because different industry and minral correlation coefficient. As example

a. What are the assumptions in the CAPM? Can these be relaxed without destroying the
conclusions of the model?

The Capital Asset Pricing Model (CAPM) is a theory based upon the above theory of portfolio
selection. The basic premise is that in capital markets people are rewarded for bearing risk. Any
asset is priced in equilibrium so that if the asset is risky people receive a higher rate of return
than they would receive if they held a risk free asset. This higher rate of return is called a risk
premium. But the market does not reward people for bearing unnecessary risk, risk that can be
avoided by diversification. The risk premium on an asset is thus not related to its standalone risk,
but rather to its contribution to an efficiently diversified portfolio. Any efficiently diversified
portfolio can be constructed by mixing a risk free asset and a tangency portfolio of risky assets.

The CAPM model is based upon two assumptions:
Assumption 1: Investors agree on their forecasts of the expected rates of return, risks and
correlations for every asset. They therefore hold risky assets in the same proportions. (Note:
different investors may have differing levels of risk aversion so they may mix the optimal
portfolio of risky assets with the risk free asset in differing proportions.)

Assumptions 2: Investors generally behave rationally. In equilibrium, the prices of all assets have
adjusted so that the market clears. It follows that in equilibrium because all investors hold risky
assets in their portfolios in the same optimal proportions that for the market to clear the market
values of those assets must adjust so that the total market value of each asset is the same
CP O&G

proportion of the total value of all the risky assets as its proportion in the optimal portfolio. A
portfolio which holds assets in the same proportions as they are held in the market is called a
market portfolio. The implication of the CAPM model is that the Market portfolio is the optimal
portfolio.

QUESTION 6
Write a short essay (minimum 250 words) to discuss the importance of good corporate
governance and its effects on firms value. The essay has to be original (evidence of plagiarism,
i.e. cut-and-paste, etc., will result in zero mark). Your arguments must be supported by factual
evidence and, if necessary,sources of reference must be listed down.

The essence of good corporate governance is to ensure trustworthy relations between the
corporation and its stakeholders. Therefore, good governance involves a lot more than
compliance. Nevertheless, good corporate governance is a culture and a climate of
accountability, consistency, effectiveness, fairness, responsibility and transparency that is
deployed throughout the organization.

In an organization, good corporate governance could support in effective decision making. This
effective decision making in a well-governed organization is based on a well balanced
accountability framework that is clear communication and understanding across the organization
and understanding across the organization of roles and responsibilities. Apart of that, it also
robust performance, financial, risk and information management systems as well as the high
standards of conduct.

Organizations with good corporate governance have the capacity to maintain high-quality
services and to deliver improvement. Poor governance arrangements set the framework within
which the organizational systems and processes fail to detect or anticipate serious service and
financial failures. Good governance in organizations, based on openness, clarity and honest
accountability enhances public trust and civic engagement.

As conclusion, good corporate governance is a must for complex and dynamic business
environment to ensure long-term sustainability nowadays. So, it should be cultivated and
practiced regularly within the current structure of the business. Undoubtedly, corporations that
genuinely recognize and embrace the principles of good governance will derive enormous
benefits, the availability and lower cost of capital, the ability to attract talent clients and business
partners, improved competitiveness and financial performance, and truly sustainable long-term
growth. With that, good corporate governance is also very important for sustainable
development, not only for the individual company, but also for the economy as a whole.
Therefore, the quality of governance should be continuously improved and good governance
should be promoted.