Financial Management Corporate Finances Balloon Loans Investments & Cash Flows Worksheet

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All materials will be uploaded. Please feel free to approach if you need further clarifications. Questions involve Balloon loans, comparison of choice for investment between bonds or stocks, CAPM and cash flows.

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Question 1 You have just bought a car. The $50,000 car loan from the finance company involves monthly payments made at the end of the month, over 60 months. However, at the end of the loan, there is a lump sum payment, called a balloon payment of $30,000. Assume the interest rate applicable is 6% p.a. monthly rest throughout the loan tenure. (a) Discuss, using time value concepts of PV or FV of single sums, or multiple sums, etc., how you can compute the first monthly repayment. Show the computations to solve for the monthly repayment amount. (10 marks) (b) Explain and compute the interest amount of the first monthly repayment. (4 marks) (c) Explain and calculate the interest amount of the 13th monthly repayment. (5 marks) (d) Discuss why the finance company offers the balloon scheme instead of the standard loan scheme without a balloon payment. (6 marks) Note: You are to provide explanations of the computations you made. Just providing the answer from the financial calculator is not sufficient. Question 2 Mr. Lim has $10,000 to invest for a period of 5 years. He has a choice of either the bonds or stocks of the Oxley Company. (A) Bond: Oxley's bond: Face value $1,000, 10% coupon paid annually and 8 years' life remaining. The bond can be purchased at $1,100 today. (B) Common Stock: Oxley's common stock just paid a dividend $0.80. Its dividend will grow at 4% per year perpetually. The stock can be purchased at $8 today. (a) Calculate the rate of return per annum over the 5-year period for the investment in bonds if the required return for the bonds is 7% and coupons can be invested to give a 7% return. (10 marks) (b) Compute the rate of return per annum for the investment in stocks over the 5-year period. The required return for the stock is 12%, while dividends received can be invested to give a return of 7%. (10 marks) Question 3 You have $1 million to invest, and you must invest all your money. The following are assets you can invest: Expected Return Beta Risk-free asset Stock X Stock Y 6% 30% 20% Not given 1.8 1.3 (a) Suppose you want to create a portfolio that has an expected return of 12% by investing in the risk-free asset and Stock X. Calculate how much money you will invest in Stock X. (6 marks) (b) Suppose you want to create a portfolio with a systematic risk that is 70% of the risk of the overall market, by investing in the risk-free asset and Stock X. Calculate how much money you will invest in Stock X. (6 marks) (c) Suppose you are told that the beta of Stock X is correct, but there is uncertainty whether the beta of Stock Y is correct. Using the CAPM framework, determine whether the beta of Stock Y is correct. (6 marks) (d) You have learned in this course that if you invest only in X and Y, this 2-asset portfolio will have a higher return than the portfolio return when a risk-free asset (such as Treasury bills) is also included. This being the case, appraise why anyone would want to hold Treasury bills in their portfolio. (7 marks) Question 4 As a result of improvements in product engineering, United Automation is able to sell one of its two milling machines. Both machines perform the same function but differ in age. The newer machine could be sold today for $50,000. Its operating costs are $20,000 a year, but in 5 years the machine will require a $20,000 overhaul. Thereafter operating costs will be $30,000 until the machine is finally sold in year 10 for $5,000. The older machine could be sold today for $25,000. If it is kept, it will need an immediate $20,000 overhaul. Thereafter operating costs will be $30,000 a year until the machine is finally sold in year 5 for $5,000. Both machines have been fully depreciated for tax purposes before this replacement decision. The company pays tax at 35 percent. Cash flows have been forecasted in real terms. The real cost of capital is 12 percent. (Note: the overhaul cost is a capital expenditure and straight line depreciation to zero is used) Analyse which machine United Automation should sell by answering the following. (a) Compute the cash flows and NPV of the newer machine if it is kept, without considering the cash flows associated with the older machine. (9 marks) (b) Compute the cash flows and NPV of the older machine if it is kept, without considering the cash flows associated with the newer machine. (9 marks) (c) Discuss, using the results of parts (a) and (b), which machine should be sold. (7 marks) (d) Discuss why the payback period cannot be used for the decision regarding which machine to keep. (5 marks)
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Explanation & Answer

Attached.

a)
The concepts of PV and FV can show us how we can derive
the monthly payments since we know how many periods
will occur, how much we borrowed, and the interest rate.
We can then calculate the future value of the entire loan
and spread that over the payment periods to give us the
monthly repayment value.

annual interest
principal
periods
monthly interest
Monthly repayment

b)

0.06
$ 50,000.00
60
0.005
$
966.64

The amount of principal paid on the first repayment will be derived from
the total interest generated on the principal subtractracted by the initial
value. Once we know how much of the principal is paid off we can see
how much of the monthly payment was purely interest by subtracting
the portion of the principal from the monthly payment. This can be seen
in the payment table below.

Month
0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
c)

unpaid
$ 50,000.00
$ 49,750.00
$ 49,501.25
$ 49,253.74
$ 49,007.48
$ 48,762.44
$ 48,518.63
$ 48,276.03
$ 48,034.65
$ 47,794.48
$ 47,555.51
$ 47,317.73
$ 47,081.14
$ 46,845.73
$ 46,611.51

principal
$
$
$
$
$
$
$
$
$
$
$
$
$
$

0
250.00
248.75
247.51
246.27
245.04
243.81
242.59
241.38
240.17
238.97
237.78
236.59
235.41
234.23

For the 13th month we can calculate it in the
same manner as the previous value by simply
continuing the pattern down the table.

interest
$
$
$
$
$
$
$
$
$
$
$
$
$
$

...


Anonymous
Awesome! Perfect study aid.

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