Corporate Finances - Assignment Example

Assignment on Corporate Finance Question 1 Solution 1 A Annual Rate Of Inflation       Base Year 1626 Current Year 2010 Time (Years) 384 Price in 1626 24 Price in 2010 1100     Inflation Rate (%) 11.675% Solution 1 B The island on Manhattan is a multi billion dollar property. Manhattan is the oldest, smallest and most densely-populated of the five boroughs of New York City. Located primarily on Manhattan Island at the mouth of the Hudson River, the boundaries of the borough are identical to those of New York County, an original county of the state of New York. It has a land area of 23 square miles or 59 square kms and a population of 1,629,054.To estimate the approximate value of the same, we have used the following assumptions: Taking the average floor height to be 5 floors Assuming the rate per square feet of land to be $ 700. This value is a general value put after viewing some property prices on online property websites. Assuming that the super-built area is valued at USD 700 which also includes the roads and other common public areas. Value of the Island of Manhattan   Land Area in Square Miles 23 Area (in square feet) 641203200 Price of land per square feet (in dollars) 700 FAR (building heights)- Assumption 5 Price of Total Area (in Billion dollars) 448.84224 Solution 1 C The value of return is humangus and is over a 100 of million in percentage terms as well. USD 1100 invested for 384 years coining billions of dollar cannot really be calculated as a realistic figure. However, this is a piece of history and the same case is true. Solution 1 D Inflation is a measure of change in the general price level. Property being understood as an asset class with high risk, there is not much relevance in incorporating the inflation factor in the same. As we are dealing with an investment, it is better to take the inflation adjusted value of the investment and make the calculation on such value as it represents the present value of the money. Hence, USD 24 has not been used for assessing the annualized rate of return. Question No. 02 On observing the trends in the gold prices over the past 10-30 years data (www.goldprice.org, website), the following can be stated: The entire world’s currency system (the Money System) is backed by a gold reserve and is a mandatory requirement is majorly all the countries to have a certain percent of their reserve in gold, gold can be taken as good as money The price s of gold has been rising in the last 10 years and is currently trading over USD 43 per gram Since the fall in the markets in 2008, gold has been continuously rising and taking new highs. It can fairly be assumed that gold will not see a fall in price to $30 per gram which would mean a fall of over 40% implying a huge impact in the global economies. Based on the above assumption and also on the fact that gold has not seen a big fall in the prices (in percentage terms) over a reasonable period of time, it can we well assumed that the prices of gold will not fall below USD 30 and the miners will go for work everyday. Hence, on the above observations and assumptions, we can assume that the miners will produce to the maximum of 10 Kilograms (100% capacity) per year for a considerably long period of time (years), the net present value (NPV) would be calculated as the value of perpetuity. Per year total production= 10 Kg = 10000 grams Assuming average price remains USD 30 and the miners are happy selling the gold at USD 30 if the prices go higher, the total income in an year = USD 300000 Hence the present value of a perpetuity earning from the mine = 300000/ .13 = 2.3 Million USD. The following are the limitations to the above mode assumptions and calculation: Different type of mines have different life. Exploration at a level ends and the mine is digged further. Hence estimating the life of the mine is very difficult We have completely ignored the cost factors as the cost of mining is not known The mine can sell high at any price as it is currently tadig at USD 30. The reason for assuming 30 USd for finding the present value is that the prices is difficult to forecast in commodities like gold, silver, oil etc. Question No. 03 The company's effort to stick to its dividend policy is not elegant. Oil spill in the Gulf of Mexico is still reviving from the sub aquatic. Despite the fact that that is so, no one can guess the dimension of the ultimate invoice, still to the bordering $10bn. So sending out a communication, - that the corporation has reviewed the probable costs and accomplished that a $10bn-a-year imbursement to shareholders is affordable. US politicians, reasonably fuming about an environmental disaster, will just suppose that BP is not aching enough. The BP dividend is an imperative basis of profits for UK pension funds – previous year it was 12% of all dividend distributions by UK listed companies. In usual conditions, BP's wish to defend these funds from financial pain would be praiseworthy. But, Circumstances are not normal. The company is in a brawl for its future. In that situation, the irresistible priority for shareholders is protecting the long-term value of the company and its assets, implies a short-term dividend sacrifice. The best response from BP would be along these lines: "We are suspending dividend payments to demonstrate our commitment to plugging the leak, cleaning up the spill and paying compensation to those affected." And it would have been better if that statement had been made several weeks ago. None of which is to deny that some of the US administration's statements are wildly over the top. The notion that BP should have to pay the wages of other companies' workers laid off by the moratorium on deepwater drilling is absurd. There is no point in trying to bankrupt BP. But BP would be in a better position to resist the wacky demands if it accepts that Obama makes a fair point about dividends. Dividend is an event in the corporate world which every investor wants to enjoy. This decision is always taken by the directors of the company. Companies need to be very careful while announcing the Dividend as it directly affects the Capital Structure and Stock market. Distributing dividend increases trust and value of the company in the market among the investors. At the same time if dividend not distributed means not always company not performing well, there might be chances that company might be planning for the new projects and it might be having short of money; so, company might prefer to use the dividend amount for the investment purpose. (Kehl, 1976)Even though company might not distributed the profit to its share holders but in its book the value of the Equity increases. The few factors that generally affect the Dividend decisions are: Liquidity of funds Stability of earnings Financing policy of the firm Dividend policy of competitive firms Past dividend rates Debt obligation Ability to borrow Growth needs of the company Profit rates Legal requirements Policy of control Corporate taxation policy Tax position of shareholders Effect of trade policy Attitude of the investor group Bellow is few situations of announcement of Dividend: Retailer Gap announced that they were raising their dividend by 18%. The stock currently yields 1.6% and has a solid track record of returning cash to their shareholders (having returned $8 billion over the last six years).(Ghaziani,2008) Frontier Oil is suspending their dividend program after posting their 3rd consecutive quarterly loss. The energy stock previously offered a 1.9% dividend yield. Consumer products maker, Kimberley Clark, is increasing their quarterly dividend by 10%. The dividend stocks current yield now stands at 4.3% following the company’s record cash flow in 2009. (Baker,2009) Whether BP should meet up its scheduled dividend commitment to shareholders? On the center of present approximations of fines and clean-up costs, this rich company should have sufficient cash capital to disburse its monies in the Gulf of Mexico and carry on usual dividend payments. But if the politically satisfactory level of punishment shows to be one that is exorbitant then, by definition, BP cannot have enough money to carry on the rest of its activities with any appearance of regularity. The problem is confused by conflicting views of what a shareholder dividend means? Dividends have a faintly dissimilar place in business civilization of the US. Many big companies hardly disburse them at all, favoring to recompense shareholders more at irregular intervals through one-off share buy-back schemes or permit big cash steadiness to build up for a wet day. BP can begin hoarding cash now, except the indication it would propel to investors was so as to this was a corporation no longer sure of its capability to rise new money in prospect. The already shaking share price would dive, the corporation’s credit rating (and consequently its capacity to borrow) would also almost certainly drop, and BP might with no trouble fall into a cruel twisting of financial turn down.  Question No. 04 ASIC made changes to Section 254T of the Corporations Act 2001 The Act of 254T of the Corporations Act 2001 is the rules and regulations for paying the dividends in the various companies. The Act of section 254T of Corporation Act 2001 is amended by removing the criteria that dividends should get paid out of profits. Under the new scheme of the law as it is applicable to year end on 30th June and subsequent financial years, a company will pay dividend only if : 1. Payment part of dividend should be fair and appropriate for the company’s shareholders. 2. The assets of the company should be exceeding its liabilities after declaration of the dividends and the excess balance should be sufficient for the payment of dividends. 3. The dividend payment should not materially intolerance the ability of the company to pay back to creditors. The key changes made by ASIC to section 254T of the Corporation Act 2001 are given below: Financial statement of Parent Entity There is removal of Corporation Act essential requirement to make the statement for parent entity where the consolidated statements are always compulsory. According to rules & regulations, there should present the notes to annual consolidated statements which are summarized the parent entity financial information for the same.(Boulle,2009) Dividends There is launch of the solvency test for the existing profits of the company so that there should be satisfactory payment of dividends. The dividends would be paid only if value of the assets of the company would exceed the liabilities of the company and can pay the dividends with the sufficient funds. The payment should be fair and there should not be any unfairness for the payment to its creditors. Companies limited by guarantee By considering the revenue and the deductible awards status, there is a introduction of the three-tiered structure for the reporting process. There is change in the full auditing system although in some cases the review is permitted. There is a critical look on the directors’ reports for the new reduced requirements. There is new policy for the prohibition on the payment for the dividends by the organization. (Cassidy,2007) Changing financial years Entities do no permission for making the changes in the financial so that this change would go easily. Now after changing the scenario, no financial year would go beyond 6 o’ clock. As the tax year is not proposed automatically, there are constituently changes.(Kehl,1976) IFRS declaration There is an unreserved statement of compliance with IFSR of companies, schemes which are registered and other disclosing entities as it also include the with reference to director’s declaration. Other changes Aspect The change comes in the expansion for all the listed public companies for director’s reports for all other listed entities. There are some technical changes to cancel the capital, Financial reporting council functions and the also for the composition of companies Auditors and Liquidators Disciplinary Board. Impacts The impacts of ASIC made changes to Section254T of Corporations Act on company’s management, equity holders, and creditors are given below: There is reduction in the clutter in the annual statements means there is two or three columns rather than four to six as it becomes simple to understand. The impacts also come in the best practices globally for the alignment. For entities which are supposed to reporting under the mandate would be considering the mandate before removing the columns for parent entity. There is greater flexibility in payments of dividends where impairment for No Cash and the other similar expenses got recognized. (Boulle,2009)There is introduction of fair and reasonable approaches which are subjective and there are no material tests from now onwards. There would be some uncertainty interpretation of the new requirements. There is need for care to be taken during the transitional phase so that there must be ensures to correct the requirements.(Cassidey,2007) For the smaller entities, as it will not be longer to lodge the financial statements and some of the entities will be able to have the financial review only rather than auditing. There is more focus on the requirement for the reporting in financial statements and director’s report. Prohibition on the payment of dividends will reduce the attractiveness of this structure for commercial activities. There must be more flexibility in changing year ends so that it match the company’s operating cycle and existing requirements on changes in control will be retained also. Most of these changes are not substantive, but will require changes to the financial reports of some entities and other changes are largely considered logical Question 5 Solution 5 A From the data, we derive the following:   NAB ($) BHP ($) FOSTERS ($) LEIGHTON ($) ALL ORDS (Index Price Level) 10 Year Gov Bonds (% Yield) Average return 12.96% 18.50% 12.40% 23.45% 10.33% 8.97% Risk Premium 3.99% 9.53% 3.43% 14.48% 1.36% 0.00% Beta 2.940943 7.029646 2.531917 10.68562 1   Risk premium for an asset is known to be the expected return over the risk free return which in CAPM is termed under the formula: E(ri) = Rf + βi (E(rm) - Rf) In the above formula, βi (E(rm) - Rf) is termed as the risk premium of a stock. For teh above stock category, the risk premium for Leighton is the highest at over 14% as it has a high beta indicating that of the market goes up by 1 %, the stock will move up by 10 % (Beta= 10.68) and vis-versa. From the formula itself, it is implied that the risk premium for government bongs will always be equal to zero. Solution 5 B The Returns for the assets are shown below: Year NAB ($) BHP ($) FOSTERS ($) LEIGHTON ($) ALL ORDS (Index Price Level) 10 Year Gov Bonds (% Yield) 1981 17.11% 47.47% 40.48% 59.32% 42.70% 13.10% 1982 6.74% -34.25% 55.93% 13.83% -16.54% 15.00% 1983 -9.47% -39.58% -15.22% -19.63% -18.49% 13.00% 1984 58.72% 125.86% 74.36% 69.77% 59.72% 13.50% 1985 -7.69% -10.69% 5.88% 13.01% -6.35% 13.10% 1986 27.78% 94.02% 25.00% -48.48% 38.24% 14.10% 1987 26.09% 21.15% 97.22% -10.59% 46.76% 13.80% 1988 -3.94% -0.73% -18.87% -36.84% -10.47% 12.40% 1989 55.13% -1.47% 31.94% 18.75% 12.76% 13.30% 1990 6.12% 43.12% -9.47% 36.84% 10.94% 12.80% 1991 -20.09% 7.53% -30.81% -5.13% -22.43% 11.52% 1992 55.56% 36.71% 26.89% 71.62% 29.03% 10.11% 1993 -4.76% -3.36% -24.83% 3.15% -6.15% 8.60% 1994 62.37% 32.36% 7.05% 71.76% 40.24% 6.36% 1995 -16.21% 11.33% -23.05% -12.89% -12.00% 10.33% 1996 17.02% 6.70% 18.18% 76.53% 15.18% 8.11% 1997 22.31% -5.70% 15.38% 54.34% 10.06% 7.46% 1998 44.80% -20.47% 14.51% -0.75% 7.91% 5.81% 1999 14.79% -15.66% 51.37% 30.57% 7.53% 5.13% 2000 -5.28% 66.54% -1.13% -15.61% 12.05% 7.18% The following is the Arithmetic mean and standard deviation for the returns NAB ($) BHP ($) FOSTERS ($) LEIGHTON ($) ALL ORDS (Index Price Level) 10 Year Gov Bonds (% Yield) Simple Arithematic Mean 17.35% 18.05% 17.04% 18.48% 12.04% 10.74% Standard Deviation 0.26321 0.41893 0.34478162 0.385943947 0.239884325 0.031395683 The Correlation Matrix for each of the pair is as under: Correlation matrix NAB ($) BHP ($) FOSTERS ($) LEIGHTON ($) ALL ORDS (Index Price Level) 10 Year Gov Bonds (% Yield) NAB ($) 1 0.369476 0.56498663 0.540170123 0.745967314 -0.125146905 BHP ($) 0.369476 1 0.26899614 0.174345537 0.746917298 0.184646588 FOSTERS ($) 0.564987 0.268996 1 0.306797575 0.667784873 0.228162376 LEIGHTON ($) 0.54017 0.174346 0.30679757 1 0.451591504 -0.264814874 ALL ORDS (Index Price Level) 0.745967 0.746917 0.66778487 0.451591504 1 0.040434335 10 Year Gov Bonds (% Yield) -0.12515 0.184647 0.22816238 -0.26481487 0.040434335 1 Solution 5- C & D Portfolio 1 Portfolio 1 Weight (wn) Annual volatility (σn) Expected returns wnσn NAB ($) 25% 26.32% 17.35% 0.065802 BHP ($) 25% 41.89% 18.05% 0.1047332 FOSTERS ($) 25% 34.48% 17.04% 0.0861954 LEIGHTON ($) 25% 38.59% 18.48% 0.096486 ALL ORDS (Index Price Level) 0% 23.99% 12.04% 0 10 Year Gov Bonds (% Yield) 0% 3.14% 10.74% 0 Total 100%                 Expected returns =   17.73%               Annual variance =   0.06     Therefore volatility =   0.25     Risk free rate =   10.74%     Sharpe Ratio =   0.28     Portfolio 2 Portfolio 2 Weight (wn) Annual volatility (σn) Expected returns wnσn NAB ($) 40% 26.32% 17.35% 0.1052832 BHP ($) 0% 41.89% 18.05% 0 FOSTERS ($) 0% 34.48% 17.04% 0 LEIGHTON ($) 30% 38.59% 18.48% 0.1157832 ALL ORDS (Index Price Level) 20% 23.99% 12.04% 0.0479769 10 Year Gov Bonds (% Yield) 10% 3.14% 10.74% 0.0031396 Total 100%                 Expected returns =   15.97%                         Annual variance =   0.05     Therefore volatility =   0.23     Risk free rate =   10.74%     Sharpe Ratio =   0.23     Portfolio 3 Portfolio 3 Weight (wn) Annual volatility (σn) Expected returns wnσn NAB ($) 0% 26.32% 17.35% 0 BHP ($) 0% 41.89% 18.05% 0 FOSTERS ($) 0% 34.48% 17.04% 0 LEIGHTON ($) 0% 38.59% 18.48% 0 ALL ORDS (Index Price Level) 80% 23.99% 12.04% 0.1919075 10 Year Gov Bonds (% Yield) 20% 3.14% 10.74% 0.0062791 Total 100%                 Expected returns =   11.78%                         Annual variance =   0.04     Therefore volatility =   0.19     Risk free rate =   10.74%     Sharpe Ratio =   0.05     Solution 5 D Looking at the above portfolios, portfolio 1 has the highest sharpe ratio (0.28) indicating that it has the best risk adjusted retrn amongst the three. Solution 5 E The Returns for the assets for the time period 2001- 2007 are shown below: Year NAB ($) BHP ($) FOSTERS ($) LEIGHTON ($) ALL ORDS (Index Price Level) 10 Year Gov Bonds (% Yield) 2001 23.65% -4.19% 8.01% 6.85% 0.07% 5.41% 2002 10.59% 14.29% 2.97% 64.10% 6.50% 5.86% 2003 -0.35% 2.32% -7.41% -1.76% -11.44% 5.28% 2004 -5.67% 20.10% 0.00% 16.10% 11.11% 5.70% 2005 -3.77% 25.84% 28.67% 4.37% 22.60% 5.35% 2006 12.42% 48.31% -3.63% 45.04% 16.18% 5.20% 2007 24.69% 11.21% 24.01% 13.12% 19.87% 5.88% 2008 -6.46% 58.66% -5.35% 202.65% 13.76% 6.08% 2009 -44.77% -24.17% -16.03% -54.32% -43.01% 4.09% 2010 31.29% 41.66% 0.00% 37.83% 33.43% 5.56% The following is the Arithmetic mean and standard deviation for the returns NAB ($) BHP ($) FOSTERS ($) LEIGHTON ($) ALL ORDS (Index Price Level) 10 Year Gov Bonds (% Yield) Simple Arithematic Mean 4.16% 19.40% 3.12% 33.40% 6.91% 5.44% Standard Deviation 0.219443991 0.25284 0.13853917 0.674391932 0.214570764 0.005554068 The Correlation Matrix for each of the pair is as under: Correlation NAB ($) BHP ($) FOSTERS ($) LEIGHTON ($) ALL ORDS (Index Price Level) 10 Year Gov Bonds (% Yield) NAB ($) 1 0.38362 0.46977045 0.190220753 0.758234138 0.643285119 BHP ($) 0.383620282 1 0.09323775 0.777889187 0.773483902 0.608939698 FOSTERS ($) 0.469770451 0.09324 1 -0.085781468 0.587184613 0.422166404 LEIGHTON ($) 0.190220753 0.77789 -0.08578147 1 0.444382024 0.691152735 ALL ORDS (Index Price Level) 0.758234138 0.77348 0.58718461 0.444382024 1 0.756010169 10 Year Gov Bonds (% Yield) 0.643285119 0.60894 0.4221664 0.691152735 0.756010169 1 Solution 5- F & G For Portfolio 1 Portfolio 1 Weight (wn) Annual volatility (σn) Expected returns wnσn NAB ($) 25% 21.94% 4.16% 0.054861 BHP ($) 25% 25.28% 19.40% 0.06321 FOSTERS ($) 25% 13.85% 3.12% 0.034635 LEIGHTON ($) 25% 67.44% 33.40% 0.168598 ALL ORDS (Index Price Level) 0% 21.46% 6.91% 0 10 Year Gov Bonds (% Yield) 0% 0.56% 5.44% 0 Total 100%                 Expected returns =   15.02%                         Annual variance =   0.06     Therefore volatility =   0.25     Risk free rate =   5.44%     Sharpe Ratio =   0.39     Portfolio 2 Portfolio 2 Weight (wn) Annual volatility (σn) Expected returns wnσn NAB ($) 40% 21.94% 4.16% 0.087778 BHP ($) 0% 25.28% 19.40% 0 FOSTERS ($) 0% 13.85% 3.12% 0 LEIGHTON ($) 30% 67.44% 33.40% 0.202318 ALL ORDS (Index Price Level) 20% 21.46% 6.91% 0.042914 10 Year Gov Bonds (% Yield) 10% 0.56% 5.44% 0.000555 Total 100%                 Expected returns =   13.61%                         Annual variance =   0.07     Therefore volatility =   0.27     Risk free rate =   5.44%     Sharpe Ratio =   0.31     Portfolio 3 Portfolio 3 Weight (wn) Annual volatility (σn) Expected returns wnσn NAB ($) 0% 21.94% 4.16% 0 BHP ($) 0% 25.28% 19.40% 0 FOSTERS ($) 0% 13.85% 3.12% 0 LEIGHTON ($) 0% 67.44% 33.40% 0 ALL ORDS (Index Price Level) 80% 21.46% 6.91% 0.171657 10 Year Gov Bonds (% Yield) 20% 0.56% 5.44% 0.001111 Total 100%                 Expected returns =   6.61%                         Annual variance =   0.03     Therefore volatility =   0.17     Risk free rate =   5.44%     Sharpe Ratio =   0.07     Solution 5- G Hence from the above, it is evident that the Portfolio 1 has performed better than the other 2 portfolio considering the risk adjusted returns. Solution 5 H There have been quiet a changes between the two time period. One of the most interesting things to observe is the change in the risk free return. The arithmetic mean on the returns in the government bond has reduced from 10.7% to 5.44% between the time periods. Also, the standard deviation has reduced quite a bit more specifically on the government bonds. The arithmetic mean and standard deviations are always important tools to study the historic behaviour of prices. Looking at the total change can never give the right picture. The arithmetic mean and standard deviation of one time period cannot be taken for another time period for calculation purpose for the basis reason that the world is dynamic and so is the investment bucket. With time, new asset classes come in and the characteristic of asset class (risk associated etc) also changes. However, again, if we sit back and thing about the portfolio managers of the year 2000, probably they did use the data of 1980-2000 to forecast the market for 2000-2010. Again, forcasting is a situation where assumptions have to be made (logically). However, if the data is available, it should be used to the most appropriate. Since the risk free return has moved quiet low, while constructing a portfolio, the attraction of the same is reducing as well. It does mean risk free return but the number (return) does matter as well. It also depends on the risk profile of the investors, but again a decline by almost 50% does effect its weightage in a portfolio construction. Bibliography Website: Section 254T of Corporation Act, 2001. www.companydirectors.com.au Accessed on 19/11/10 Website: Explanation for Dividends (http://finance.mapsofworld.com/corporate-finance/investment-decision/dividend.html) Accessed on 19/11/10 Boulle L., 2009, The law of globalization: an introduction, Kluwer Law International Australia, CCH Corporate Law editors, CCH Australia Limited, 2009, Australian Corporations & Securities Legislation 2009: Corporations Act 2001, ASIC Act 2001, related regulations Cassidy J., 2007, Concise Income Tax, Edition 4, revised, Federation Press, 2007 Baker K.H.,2009,Dividends and Dividend Policy, Wiley Finance, Edition illustrated, John Wiley and Sons Kehl D.,1976,Corporate dividends, The History of accounting, Edition reprint, illustrated, Ayer Publishing Ghaziani A.,2008, The dividends of dissent: how conflict and culture work in lesbian and gay marches on Washington, Edition illustrated, University of Chicago Press Read More