Academic Year 2020-2021 BCO212 BUSINESS FINANCE I FINAL ASSIGNMENT – CASES For this Midterm Assignment, worth 60% of the final mark and to be delivered before 17 January 2021 at 23:59 CET (Week 13), the student must carry out the following individual work: Topic: Cases This assignment aims at putting in the practice the concepts covered in the first part of the course: Interest Rates and Bond Valuation, Equity Valuations. INTRODUCTION The students can base their replies on wider research, even from the internet sources, however, all information should be appropriately referred using Business School’s referencing style. Although student’s quantitative analysis will be same, however, justification, use of theory, paper structure and background for recommendation is to be explained in detail for which you will get higher awards. Using the Turnitin will allow us to detect very easily copied answers. Requirement: Submission is required in MS Word or PDF format via Turnitin submission link in Week 13 Assessments (‘Cases II – Report’). MS Excel file, with all the solutions, is to be uploaded via submission link in Week 13 Assessments (‘Cases II – Excel submission link’) In MS Word/PDF document, Students must have a cover page, with name, Table of Contents, References and Appendix (if necessary) CASES 2 questions are to be answered (please notice the weights in brackets assigned for each problem) Question 1 (Interest Rates and Bonds Valuations) (50%) Assume it is 31 December 2020. An investor has researched two possible bond investments; however, some important information is missing in the details of the description of the investment Page | 1 Academic Year 2020-2021 opportunities. The latest coupon on each bond has just been paid. Each bond has a face, or par, value of €1000. The investor assumes that each bond pays coupons annually. Bond ABC XYZ Coupon rate 6.50% 5.00% Maturity 31 December 2026 31 December 2028 Current price ? €968.33 Yield to maturity 5.50% ? a) Complete the table by calculating the current price of bond ABC (10 points) and yield to maturity of bond XYZ (10 points). b) The investor subsequently realizes the ABC bond makes semi-annual coupon payments. Recalculate the current price of the ABC bond. (10 points). c) Assume for ABC corporation only (with the annual coupon), market interest rate increases, which results in increase YTM to 7.50%. What will be the revised current price of the Bond? (10 points) What will you deduce about the relationship between market interest rate and bond prices? (10 points) Question 2 (Equity Valuations) (50%) You have finally saved $10,000 and are ready to make your first investment. You have the following two alternatives for investing that money: 1. Southeast Carcorp preferred stock paying a dividend of $1.63 and selling for $25.25. 2. Emerson Electric common stock selling for $65. The stock recently paid a $1.80 dividend and the firm’s earnings per share has increased at the rate of 9.15% in the past 5 years. The firm expects to grow at the same rate for the foreseeable future. The required return for preferred stock is 9% and common stock is 12%. d) Calculate the value of preferred stock (10 points) and the common stock (10 points) using the corresponding required rate of return. e) Which investment would you select? Why? (10 points) f) Calculate the expected rate of return for investors in preferred stock (10 points) and in common stock. (10 points) DELIVERIES You will need to upload the elaborated Business Report via Turnitin and the supportive excel file via links you may find in the Week 13 ‘Assessments’ Page | 2 Academic Year 2020-2021 REQUIREMENTS Timing for the assignment • Deadline: 17 January 2021 at 23:59 CET Word count: total: no max word words. Structure of the Report: 1. Cover page: The first page must contain the full name of the student, the logo of the school as well as the name of the course and the name of the professor. 2. The Table of Contents 3. Body of the Report 4. Bibliography: You should use the Harvard Referencing System. 5. Appendix It assesses the following learning outcomes: • Outcome 1: Categorize the value of bonds as per risk, maturity, rate of return; assess bonds yields within the current financial markets’ conditions; • Outcome 2: Analyze the different types of stocks (preferred and common), asses their value and rate of return. Page | 3 Academic Year 2020-2021 4 questions are to be answered (please notice the weights in brackets assigned for each problem) Question 1 (Introduction to Financial Management) (10%) Evaluate the following statement: In recent years, large financial institutions such as mutual funds and pension funds have become the dominant owners of stock in the United States, and these institutions are becoming more active in corporate affairs. What are the implications of this trend for agency problems and corporate control? Prepare a short (1-page essay). Question 2 (Time Value of Money) (20%) In 2013 Bill Gates was worth about $28 billion after he reduced his stake in Microsoft from 21% to around 14% by moving billions into his charitable foundation. Let’s see what Bill Gates can do with his money in the following problems. a. I’ll take Manhattan? Manhattan’s native tribe sold Manhattan Island to Peter Minuit for $24 in 1626. Now, 387 years later in 2013, Bill Gates wants to buy the island from the “current natives.” How much would Bill have to pay for Manhattan if the “current natives” want a 6% annual return on the original $24 purchase price? Could he afford it? (5 points) PV 24 Years 387 rate 6% FV 149.135.522.178,18 If Gates wants to purchase the Manhattan from the tribe he needs to pay arounf 149 billion but he has only 28 billion so he cannot afford it b. How much would Bill have to pay for Manhattan if the “current natives” want a 6% return compounded monthly on the original $24purchase price? (5 points) PV Years rate FV 24 4644 1% 275.043.913.580,74 If Gates wants to purchase the Manhattan from the tribe he needs to pay arounf 275 billion but he has only 28 billion so he cannot afford it Page | 1 Academic Year 2020-2021 c. Microsoft Seattle? Bill Gates decides to pass on Manhattan and instead plans to buy the city of Seattle, Washington, for $60 billion in 10 years. How much would Mr. Gates have to invest today at 10 percent compounded annually in order to purchase Seattle in 10 years? (5 points) FV 60.000.000.000,00 Years 10 Rate 10% Solution 23.132.597.365,77 If Gates wants to purchase the Seattle he needs to pay around 23 billion and he has only 28 billion so he can afford it d. Now assume Bill Gates wants to invest only about half his net worth today, $14 billion, in order to buy Seattle for $60 billion in 10 years. What annual rate of return would he have to earn in order to complete his purchase in 10 years? (5 points) PV FV Years 14.000.000.000,00 60.000.000.000,00 10 Rate 15,67% Question 3 (Time Value of Money) (20%) Pacific Marine Transport Corporation is considering the purchase of a new bulk carrier for $10 million. The forecasted revenues are $5.5 million a year and operating costs are $4 million. A major refit costing $2 million will be required after both the fifth and tenth years. After 15 years, the ship is expected to be sold for scrap at $1.5 million. a. What is the NPV if the opportunity cost of capital is 8%? (10 points) b. Should the company accept the purchase of the carrier? (10 points) Group 2 Initial Investment RevenueS Operating Costs Refitting Selling price Cash flows PV NPV 0 -10.000.000 1 2 3 4 5 5.500.000 5.500.000 5.500.000 5.500.000 5.500.000 -4.000.000 -4.000.000 -4.000.000 -4.000.000 -4.000.000 -2.000.000 6 7 5.500.000 5.500.000 -4.000.000 -4.000.000 8 9 5.500.000 5.500.000 -4.000.000 -4.000.000 10 11 12 5.500.000 5.500.000 -4.000.000 -4.000.000 -2.000.000 5.500.000 -4.000.000 13 14 15 5.500.000 5.500.000 -4.000.000 -4.000.000 5.500.000 -4.000.000 1.500.000 -10.000.000 1.500.000 1.500.000 1.500.000 1.500.000 -500.000 1.500.000 1.500.000 1.500.000 1.500.000 -500.000 1.500.000 1.500.000 1.500.000 1.500.000 3.000.000 11.024.527,22 € 1.024.527,22 € As the NPV is positive, the company should invest in the project. Page | 2 Academic Year 2020-2021 Question 4 (Risk and Return) (50%) The data below presents monthly closing prices of Standard & Poor’s 500 Index, Wal-Mart, and Target to calculate the holding-period returns for the 24 months from May 2013 through May 2015 Month 2013 2014 2015 S&P500 Walmart Target May 1.631 74,84 69,50 June 1.606 74,49 68,86 July 1.684 77,94 71,25 August 1.633 72,98 63,31 September 1.682 73,96 63,98 October 1.757 76,75 64,79 November 1.806 81,01 63,93 December 1.848 78,69 63,27 January 1.783 74,68 56,64 February 1.859 74,70 62,54 March 1.872 76,43 60,51 April 1.884 79,71 61,75 May 1.924 76,77 56,76 June 1.960 75,07 57,95 July 1.931 73,58 59,59 August 2.003 75,50 60,07 September 1.972 76,47 62,68 October 2.018 76,27 61,82 November 2.068 87,54 74,00 December 2.059 85,88 75,91 January 1.995 84,98 73,61 February 2.105 83,93 76,83 March 2.068 82,25 82,07 April 2.086 78,05 78,83 May 2.182 75,86 79,29 a. Use the price data from the table (use the excel available in week 7) for the Standard & Poor’s 500 Index, Wal-Mart, and Target to calculate the holding-period returns for the 24 months from May 2013 through May 2015. Calculate the average monthly holding-period returns and the standard deviation of these returns for the S&P Index, Wal-Mart, and Target. Please compare the results obtained for these three series. (15 points) Month Average St.Deviation S&P500 Walmart 1,26% 2,75% Target 0,15% 4,47% 0,74% 6,42% Page | 3 Academic Year 2020-2021 The average monthly Return on the stock market index are bigger than of Wal-Mart or Target with the lower level of risk at the same time b. Plot (1) the holding-period returns for Wal-Mart against the Standard & Poor’s 500 Index, and (2) the Target holding-period returns against the Standard & Poor’s 500 Index. From your graphs, describe the nature of the relationship between stock returns for Wal-Mart and the returns for the S&P 500 Index. Make the same comparison for Target. (5 points) Walmart 20,00% 15,00% 10,00% 5,00% -4,00% -2,00% 0,00% 0,00% 2,00% 4,00% 6,00% 2,00% 4,00% 6,00% -5,00% -10,00% Target 25,00% 20,00% 15,00% 10,00% 5,00% -4,00% -2,00% 0,00% 0,00% -5,00% -10,00% -15,00% The returns for Wal-Mart and Target are positively related to the market returns, but with a lot of noise, which represents unsystematic or diversifiable risk Page | 4 Academic Year 2020-2021 c. Assume that you have decided to invest one-half of your money in Wal-Mart and the remainder in Target. Calculate the monthly holding-period returns for your two-stock portfolio. (The monthly return for the portfolio is the average of the two stocks’ monthly returns.) Plot the returns of your two-stock portfolio against the Standard & Poor’s 500 Index as you did for the individual stocks in part b. How does this graph compare to the graphs for the individual stocks? Explain the difference. (10 points) Portfolio 20,00% 15,00% 10,00% 5,00% -4,00% -2,00% 0,00% 0,00% -5,00% 2,00% 4,00% 6,00% -10,00% -15,00% When we plot the two-stock portfolio of Wal-Mart and Target together against the S&P500, the spread of the returns is a slightly tighter, with the exception of one really high monthly return. In other words, more in the variation of the two-stock portfolio can be explained by the returns of the market portfolio (S&P500) than was the case with the individual stock returns. That is, systematic risk has been reduced somewhat. d. Make a comparison of the average returns and the standard deviations for all the individual assets and the portfolio that was created. What conclusions can be reached by your comparison in the context of the risk and return? (5 points) Month S&P500 Average St.Deviation Walmart 1,26% 2,75% Target 0,15% 4,47% PF 0,74% 6,42% 0,45% 5,03% With exception of the S&P500, we observe that as risk, measured by the standard deviation of returns, increases, the average return increases. e. According to Standard & Poor’s, the betas for Wal-Mart and Target are 0.48 and 0.85, respectively. Compare the meaning of these betas relative to the standard deviations calculated above. Answer the question in the context of the systematic and unsystematic risk. (5 points) Page | 5 Academic Year 2020-2021 If our data is representative for the rates of returns an investor would receive and the variation of these returns, an investor would have a higher expected rate of return for Target, the stock that exhibits greater total risk (a larger standard deviation) and greater systematic risk (higher beta). f. The Treasury bill rate at the end of May 2015 was 4%. Given the betas for Wal-Mart and Target and using the above data for the S&P Index as a measure for the market portfolio expected return, estimate an appropriate required rate of return, using the CAPM model and given the level of systematic risk for each stock. You need to convert the monthly average S&P500 return into annual terms simply by multiplying by 12. What do you conclude? (10 points) Walmart Risk free rate Market return Beta Required Return 4% 15,07% 0,48 9,32% Target Risk free rate Market return Beta Required Return 4% 15,07% 0,85 13,41% Page | 6
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