Question FIN303 Financial Management

08 Jun Question FIN303 Financial Management

Question
FIN303

Financial Management

Assignment 1 – Individual Assignment / TMA01

July 2015 Presentation

FIN303 Assignment 1

In this assignment, you are expected to:

 Compute and interpret financial ratios

 Evaluate investment proposals

 Apply knowledge to decide appropriate financing plan and dividend policy

___________________________________________________________________________

In June 2015, you joined a private banking firm as a relationship manager. As your first

assignment, your boss asked you to join her for a client meeting with Mr. Chou. During your

discussion with client, you understand that Mr. Chou retired at the age of 65 years this year

and has recently sold his software business for $2 million. He intends to retire and hopes to

invest the proceeds in income generating financial assets.

Since he will be retiring, he would need an investment that pays periodic payments. He is

considering investment in stocks, bonds or annuity. You have identified the following

possible investments: Equity stock of Commodity Investment Company which invests in

commodities.

At your request, your firm’s equity research department furnished you with their 5-year

dividend forecast for this counter:

Year

Dividend Per

Share (Cents)

2019

13

2018

12

2017

11

2016

11

2015

10

The dividends are anticipated to grow at 3% per annum from 2020 onwards. They also told

you that the market risk premium is 4% and the risk-free rate is 2%. The beta and standard

deviation of this company are 1.1 and 30% respectively. The shares are trading at $3.25 on

June 30, 2015. The dividends will be paid on 31 December every year.

Your suggestion for him to consider bonds issued by OSIM international and the salient

terms are detailed as follows:

 Issue date = July 1, 2011

 Amount issued = $850 million

 Maturity date = June 30, 2021

 Coupon = 8%

 Payment = Semi-annual

FIN303 Assignment 1

SIM UNIVERSITY Assignment 1 – Page 3 of 4

 Par value = $100.00

OSIM received an Aa2 credit rating by Moody’s and the credit spread for corporate bonds

with similar rating is 4%. The standard deviation of this bond is 12% and the correlation

coefficient between stock and bonds is -0.3.

The third option is to purchase a life annuity offered by insurance company. This annuity

scheme will make a payout of $2,500 at the end of each month for as long as policyholder

lives. Mr. Chua expects his life expectancy to be that of an average Singaporean, which is 85

years.

You will be having a follow up meeting with Mr. Chou next week and your boss needs you to

address the issues raised at the last meeting as well as evaluate the risk and return of a

portfolio comprising stock and bond in the following combinations:

stock

bond

100%

0%

80%

20%

60%

40%

40%

60%

20%

80%

0%

100%

Question 1

Calculate the cost of equity by applying the Capital Asset Pricing Model (CAPM).

(10 marks)

Question 2

Calculate the net present value of dividends paid by the company and advise Mr.Chou

whether he should consider investing in this stock. Note that the price is being calculated as

of June 30 while dividends are paid on December 31 every year.

(20 marks)

Question 3

Apply principle of time value of money to calculate the fair market value of the bond.

(15 marks)

Question 4

Calculate the value of the life annuity offered by the insurance company. Assume the interest

rate for annuities to be 3%.

(15 marks)

FIN303 Assignment 1

Question 5

Calculate the expected return and standard deviation of the two-asset portfolio and plot a

graph to illustrate the data points. Assume the expected return on stock and bond are 10% and

6% respectively.

Recommend a portfolio mix to Mr.Chou on the presumption that he is a risk adverse investor.

(40 marks)

—- END OF ASSIGNMENT —-