Finance Assignment

Question 1 - Capital Budgeting

Smart Enterprises is branching out into another line of business. Smart Enterprises currently produces several models of high-end laptops, as well as two versions of the Smartphone. Due to existing intellectual property and resources, CEO Steve Smith believes the company could vastly profit from producing Tablets.

To expand into Tablets, the company must purchase additional machinery specific for Tablet production. The cost of this initial investment is expected to be $65m. The useful life of the machinery is 10 years, which will be depreciated to zero on a straight-line basis over its useful life. The residual value of the machinery is expected to be $5m. The machinery can be housed in the existing warehouses owned by the company.

In the first year, all research and development will be conducted. This is expected to cost the Company approximately $3m in the first year only. Therefore, there will be no sales until the second year. During that second year, the Company expects sales to be $14m. They have projected for sales to grow by 8% pa for the next 4 years and then 4% over the remaining 4 years of the project. Working capital is $3m and is fully recoverable at the completion of the project. Expenses for the life of the project (excluding research development costs in year 1) are expected to be 25% of total revenue.

You can assume all cash flows occur at the end of the period and that the company tax rate is 30%. The cost of capital is 8%.

a) Calculate the free cash flows on a yearly basis and the NPV of the project.

b) What is the Internal Rate of Return (IRR) for the project?

c) Based on your analysis in parts a) and b) above, should the company proceed with the project?

d) Have you come to the same conclusion under both capital budgeting techniques? Is it possible to come to different conclusions from each technique? If so, under what conditions.

e) Apart from the NPV and IRR methods used above, what other capital budgeting techniques could be used? (Explain each method briefly) Discuss which method (consider all) you would recommend management to use. (Give reasons for your recommendation)

f) Management is concerned with the accuracy of some of the models inputs and would like you to calculate the NPV of the project under the following scenarios. In each case, illustrate whether management should proceed with the project.

a. The equipment is depreciated over the first five years on a straight-line basis to zero. (Residual value at the end of the project is still $5m).

b. Research and development (first year only) increases to $10,000.

c. Growth in revenue (from years 2 to 6) is lower than expected at 6.5%.

Question 2 - Share Valuations

a) Retrieve the data of dividends paid by Commonwealth Bank since the beginning of the 2010/11 financial year (up to now). Comment on the trend of dividends of Commonwealth Bank over this period?

b) Ryan Booth purchased Commonwealth Bank shares on March 30, 2011. How much would he have paid for each share? Ryan Booth sold the shares on November 14, 2016. What was Ryan Booth's holding period return?

c) You want to estimate the expected return of Commonwealth Bank's shares. To do so, you need to estimate the expected market return. You have decided to use the ASX200 to represent the market and using the time frame of the past 12 months. What is the actual return of the ASX200 over the last 12 months? (i.e. calculate the holding period return from November 15, 2015 to November 14, 2016, ignoring dividends)

d) Applying the Capital Asset Pricing Model CAPM, calculate what would have been the expected return on Commonwealth Banks shares over the period. Over the period from March 2010 to November 2016 assume that the yield on government bonds was 2.5% and Commonwealth Banks beta was 1.7.

e) Assume Commonwealth Bank is considering two different dividend policies to be implemented as of the 1 of July 2017 (you will need to use the annual dividend just paid, i.e. FY16/17 dividend to represent the dividend just paid).

a. Option 1 - The growth rate of dividends over the next five years is expected to be 4.85% pa. After that, the dividends will only grow by 2% pa in perpetuity.

b. Option 2 - The growth rate of dividends over the next three years is expected to decline to 1.5% pa as the firm retains cash to invest. This will lead to a period (after three years), where the dividends will grow by 12% pa. From thereon, dividends are expected to grow by 2% pa in perpetuity.

Calculate the expected price of the shares (as of 1 July, 2017) for options 1 and 2. Imagine you are on the board of directors, decide whether option 1 or 2 is better for the shareholders of the company and justify your reasons for your decision.

f) In your own words, describe the difference between ordinary and preference shares.

Question 3 - Wesfarmers

In answering the following questions, refer to the following documents.

Debt/bond details:

Wesfarmers half-year (2017) results:

Wesfarmers 2016 Financial Reports:

Part A -

1. Discuss the framework for management compensation for Wesfarmers. Discuss the difference in remuneration between the Group Managing Directors and the other Senior Executives (see 2016 Annual Report)

2. Wesfarmers decided to invest in the UK and Ireland in 2017. Suppose they didn't have sufficient cash reserves to fund the expansion and therefore had to decide on raising funds through long-term bonds or equity. Discuss the advantages and disadvantages of each option.

Part B -

1. Refer to the 2017 Half-year results 'debt management' slide. What is the trend in debt financing costs over the past 5 years? Explain the reasons for the trend you have identified.

2. The debt maturing in the capital markets is a domestic bond issued in March 2012 and maturing in March 2019. Referring to the bond information sheet, calculate the value of the bond if today's date is 29 September, 2016. The relevant discount rate/yield to maturity is 7.50%.

3. Refer to the 2016 financial reports for Wesfarmers.

a. What is the value for the current liabilities, non-current liabilities and equity for 2016?

b. Suppose that the cost of equity is 9%, the cost of short-term debt is 4.5% and the cost of long-term debt is 5%. Estimate WACC for the company (in 2016) given that its effective tax rate is 30%.

Just need to complete Q1 in Excel.

Attachment:- Assignment.rar