Student Name:________________

GSBS6130 Assignment Marking Sheet

Question 1 Student’s mark

 Correct annual deposit /4

 Correct lump sum deposit /2
 Correct annual deposit /3

Question 2
 Correct NPV (1 mark per option) /3
 Correct IRR (1 mark per option) /3
 Correct PP (1 mark per option) /3
 Correct recommendation and explanation /2
 Discussion of limitations with reference to /3
the specific option recommended

Question 3
 Correct expected rate of return /2
 Correct expected share price /3

Question 4
 Correct average returns and standard /3
deviation (1 mark per company)
 Correct correlation (1 mark per company) /3
 Correct identification of highest correlation
 Compare to average standard deviations /1
 Correct standard deviation of portfolio /1
 Compare to average standard deviations /1
 Correctly identify pair of companies for /1
greatest diversification and explain why /2

Total mark /40

Final mark: /20

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 GSBS6130 Corporate Finance
Individual Assignment
Trimester 1, 2011

Instructions:
1. You are required to complete this assignment individually. The work
you submit must be your own work.
2. You are required to SHOW ALL WORKINGS for all questions.
3. Your assignment must be typed, and any workings in Microsoft Excel
need to be printed and submitted with your answers.

Question 1 9 marks

You are 35 years old and want to start saving in anticipation for your retirement at
age 65. You work out that you will need $90,000 from your retirement account on
each birthday for 15 years following retirement; the first withdrawal being on your
66th birthday.

You decide to invest your money at the local bank, which offers 8% per annum
compounding yearly. You want to make equal annual payments on each birthday
into the account established at the bank for your retirement fund.

Required:
1. If you start making these deposits on your 36th birthday and continue to
make deposits until you reach the age of 65 (the last deposit being on
your 65th birthday), what amount must you deposit annually to be able to
make the desired withdrawals at retirement? (4 marks)
2. Suppose you have just inherited a large sum of money. Rather than
making equal annual payments, you have decided to make one lump sum
payment on your 35th birthday to cover your retirement needs. What
amount do you have to deposit? (2 marks)
3. Suppose your employer will contribute $1500 to the retirement account at
the end of every year as part of your employer’s bonus plan. In addition
you will receive inheritance of $25,000 which you place into your
retirement account on your 55th birthday. What amount must you deposit
annually now to be able to make the desired withdrawals at retirement?
(3 marks)

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Question 2 14 marks

Your client has recently inherited a lump sum of $500,000 and is looking for a
suitable investment opportunity. You have perused a number of opportunities and in
identifying these investment opportunities you have decided that your client’s
minimum required rate of return that the investment will need to generate is 12%
per annum.

Option 1: involves placing $500,000 into a fund that is guaranteed to return $50,000
at the end of each year for 10 years (starting at the end of the first year) after which
time you get your $500,000 back.

Option 2: involves investing a total of $500,000 to buy 2 apartments. Each

apartment will then be rented out for $30,000 a year with the rent received at the
end of the year commencing at the end of year 1. The rent is guaranteed as the
apartments are rented out to the Department of Defence and they have signed a
contract for ten years. After the ten years the Department of Defence has agreed via
a signed contract to buy both apartments for a total of $750,000 in cash.

Option 3: involves investing in a brand new scheme whereby you are required to
invest $500,000 into an orchard of apples. The apple trees will not generate any
apples for the first two years. At the end of the third year they are expected to
generate $60,000 of apples and will increase their production by $30,000 per year.
Ten years after the apple trees are planted they cease yielding a commercial
quantity of apples and the orchard is sold to a neighbouring farmer for $80,000 in
cash.

Required:
1. For the 3 options calculate
a. The Net Present Value (NPV) (3 marks)
b. The Internal Rate of Return (IRR) (3 marks)
c. The Payback Period (PP) (3 marks)
2. Which option would you recommend to your client and why? (2 marks)
3. Explain 2 limitations of the project evaluation method you used to make your
recommendation in part 2, with specific reference to the investment option
selected. You must not provide discussion of the limitations generally; it
needs to be related to the option recommended. (3 marks)

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Question 3 5 marks

New Start Winery Ltd is a winery located in the Hunter Valley of New South Wales.
The winery was a small family owned business to begin with, but has grown and
eventually became a publicly listed company. They supply wines nation-wide in
Australia and also export wines to Asian countries.

For the next year New Start Winery Ltd is expected to pay a dividend of $4 per
share, based on reinvesting 40% of its earnings each year.

Required:
1. Assume the constant growth rate of 4% continues indefinitely, what is the
expected rate of return that you would earn if you purchase shares in New
Start Winery Ltd at a price of $100 per share? (2 marks)
2. The CEO of New Start Winery has announced a plan to start exporting to
Europe. This will require expansion to the existing vineyards and production
facilities in the Hunter Valley. New Start Winery will now have to reinvest
80% of its earnings for the next 5 years (instead of the previously assumed
40%) to undertake this expansion plan. During the next 5 years the earnings
and dividends will grow at a rate of 8% per annum. The company will be able
to lower the amount of earnings reinvested each year to 40% from year 6
onwards. The growth rate in earnings and dividends will fall to 4% per annum
from year 6 indefinitely.
What is the value of a share in New Start Winery on the basis of this
expansion plan, using a required rate of return of 10% per annum?
(3 marks)

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Question 4 12 marks

You have been provided with a Microsoft Excel spreadsheet containing 5 years of
monthly rates of return (expressed as a decimal) on ABC Ltd, LMN Ltd, and XYZ Ltd.
The spreadsheet is titled “Data for Assignment Question 4”.

Required:
1. Calculate the average return and the standard deviation of returns for each
company for the 5 year period. (3 marks)
2. What was the correlation of returns between each pair of companies (ABC
and LMN, ABC and XYZ, LMN and XYZ)? Which pair of companies exhibits the
highest correlation of returns? [Hint: you can use Microsoft Excel’s CORREL
function to solve this part] (3 marks)
3. Suppose that you hold an equally weighted portfolio of ABC Ltd and XYZ Ltd
(you have a portfolio with equal dollar investments in both companies).
Calculate the portfolio’s rate of return for each month, and calculate the
standard deviation of the portfolio’s monthly rate of return. How does the
portfolio standard deviation compare to the average of the standard
deviations of each company included in the portfolio? (2 marks)
4. Suppose that you hold an equally weighted portfolio of ABC Ltd and LMN Ltd
(you have a portfolio with equal dollar investments in both companies).
Calculate the portfolio’s rate of return for each month, and calculate the
standard deviation of the portfolio’s monthly rate of return. How does the
portfolio standard deviation compare to the average of the standard
deviations of each company included in the portfolio? (2 marks)
5. Which pair of companies provides the greatest benefits from diversification?
To explain your answer you should discuss the correlation of returns that you
calculated for requirement 2. (2 marks)

END OF ASSIGNMENT

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