QUESTION

a) This is a two period certainty model problem.

Assume that Bradley Lane has a sole income from Fisher Ltd in which he owns 12% of the ordinary share capital. Currently, Bradley has no savings.

In August, 2018, Fisher Ltd reported net profits after tax of $800,000 for the last financial year, 2017-18 (1 July, 2017 to 30 June, 2018), and announced it expects net profits after tax for the current financial year, 2018-19, to be 20% higher than last financial year's figure. The company has a dividend payout ratio of 70%, which it plans to continue, and will pay the annual dividend for 2017-18 in late-September, 2018, and the dividend for 2018-19 in late-September, 2019.

In late-September, 2019, Bradley wishes to spend $95,000, which will include the cost of a new car. How much can he consume in late-September, 2018 if the capital market offers an interest rate of 10% per year?

b) This is an annual equivalent costs (AEC) problem.

Speedy Delivery Ltd, which operates a courier service, requires a new van. It has received two quotes. Van A will cost $70,000 now, has a three year life and will cost $7,000 a year to operate. Van B will cost $90,000 now, has a four year life and will cost $9,000 a year to operate. The relevant discount rate is 6 per cent per annum. Ignoring depreciation and taxes, calculate the AEC for each. Which van do you recommend that Speedy Delivery Ltd buy, and state why?

c) This question relates to the valuation of interest-bearing securities.

Because of the drought, Farmers Bank Ltd has experienced large losses on its rural loan portfolio and is unable to meet its next two annual interest payments on its recent issue of unsecured notes. The notes are of $1,000 face value each, mature in September, 2023 and bear a yearly interest coupon payment of 13%.

The Bank paid the interest due this month (September, 2018), and following a meeting of creditors, arranged to defer payment of the next two interest coupons due in September, 2019 and September, 2020 respectively. Under the arrangement with creditors, the Bank will pay the remaining interest coupons (due in September, 2021, September, 2022 and September, 2023) on their due dates, and pay the two deferred coupons (without interest) along with the normal final interest payment and face value of the notes on the maturity date. Farmers Bank Ltd's notes are now seen as risky, and require a 19% per annum return.

REQUIRED: Calculate the current value of each Farmers Bank unsecured note.