GSBS6130 Corporate Finance
Assignment
Trimester 2 2010
留學生dissertation網Instructions: You are required to complete both the case studies. This is an individual assignment. Please ensure that you complete this assignment on your own. All submission must be made via Turn-It-In in the Word Document or PDF format. A hard-copy must also be submitted to the lecturer on the due date. Keep a copy of your assignment for your own reference.
Case Study 1
Part 1: Investors head for the Island
In the last few years in Australia, housing prices have gone up rapidly, not only in capital cities, but also in many other areas. The article ?Investors head for the islands‘ appeared in the September 2003 issue of Personal Investor and provides an example of the validity of the time value of money concept. (The article is available for download in the Assignment folder on Blackboard).
Considering the above information and the article from the Personal Investor, complete the following three questions.
a. Peter has $300,000 and plans to invest this money in the best possible investment. He learns that the property market on the NSW Central Coast is expected to grow at a rate of at least 20% for the next three years. After discussing the issue with friends and investment advisors, Peter decides to invest his money in the property market. He buys a property on the NSW Central Coast for $300,000, with the intention of selling it after three years. As planned, Peter sells his NSW Central Coast property after three years. After receiving such an excellent return from the property market, Peter decides that he should change his investment pattern. He wants to double his money but this time, he is investing in relatively low-risk investments. After attending a couple of investment seminars and talking to investment advisors, Peter decides to invest his money at a 7% rate of return. How long will it take him to double his money and what is his wealth at the end of this period?
b. Are Peter Buitenhuis‘ claims regarding Phillip Island correct? Have property values increased 30% for this period if his property values are correctly quoted?
c. What would you have preferred to own at American River a year ago—a $65,000 prime land block or the cheapest land block?
Part 2: Financial Advisory Services
As a finance student, you are naturally inclined to want to share your skills for the benefit of others. You and a couple of friends have decided to open a free financial counselling service for students from other disciplines. The level of demand for your services has been most pleasing and you have interviewed a number of clients. Your assessments of each person‘s requirement are outlined below.
Client One – University Staff Union (USU)
The USU is currently negotiating with the university employers for the improved condition for staff. As part of the package, the university employers have developed the following proposals to help staff finance further studies:#p#分頁標題#e#
Proposal 1: Reimbursement of eligible education expenses of $2300 each year for 3 years.
Proposal 2: A $19200 loan at 2%, principal and interest to be repaid at the end of 5 years.
The USU members want you to assist them to decide which proposal to accept. They tell you that a typical university staff member‘s opportunity cost is 6% per year. Specifically, the US would like to know:
a. The present value of proposal one to the typical employee
b. How much a typical employee will have to pay at the end of 5 years under proposal 2 and the present value of this amount to an employee
c. If the typical employee would prefer proposal 1 or 2 (to address this issue, assume the present value calculated in the previous question is the amount a typical employee could
normally borrow from a bank. You can then subtract this from the $19200 to determine the present value of the university subsidy).
d. If employees with higher opportunity costs than the typical employee make the same choice. No calculations are required here but be sure to explain your answer.
USU, like many other unions in Australia, is finding it increasingly difficult to attract new members. They are currently looking for ways to increase the success of the next membership drive. One member suggested that they offer discounted domestic travel to members. Domestic airlines offer discounted fares (5% off the regular price) for travel booked 6 months in advance. They require payment for the discounted fare within 2 weeks of booking. If members were to book through USU, they would still have to make the booking 6 months in advance but payment can be made 60 days after booking. USU would book and pay for the member‘s travel on the same day the member booked with USU. USU has an opportunity cost of 10%.
e. Calculate the cost of the scheme and identify any ways the cost could be reduced.
Client Two – Deterrent Dogs (DD) Ltd
DD Ltd is a company that provides security services to residential and commercial properties in all the major cities of Australia. The company has been operating for 20 years and has achieved impressive market penetration and a stable growth rate of 1% per annum. Reported earnings for the financial year just ended were $495000.
DD issued 1000000 shares when the company first floated and has not made any further issues. DD shares are currently selling at $5.00 and the last annual dividend paid was $0.05. In fact, the company has always paid an annual dividend of $0.05. Earnings of $500000 and capital expenditure of $50000 are forecast for next year.
The Board of DD is considering the adoption of a new dividend policy in the coming year. They have asked you to analyse the situation for them.
a. Explain the three main dividend policy alternatives to the Board.
b. Calculate the dividend per share under each of these three policies.
Client Three – Mavis
Mavis has $1 million she wants to leave to hear grandchildren when she dies. She accumulated the money from property and share investments over her lifetime but has sold these assets and has the money in a bank account that generates 2% per annum compounded monthly. Her friend as the retirement village told her that she could invest the money for short periods in the bill market. Mavis doesn‘t expect to live much longer, so she wants her million to be highly liquid for division among her grandchildren when she is gone. She has given you the following information and wants you to tell her if she should purchase any of the bills of if she should simply leave the money in the bank.#p#分頁標題#e#
To give your advice, you have decided to compare the returns on each of the bills to the return of keeping the money in the bank.
Bill X has a purchase price of $98400 and a face value of $100000. It has 180 days to maturity Bill Y has a purchase price of $98900 and a face value of $100000. It has 120 days to maturity. Bill Z has a purchase price of $99560 and a face value of $100000. It has 60 days to maturity.
a. Should Mavis leave her money in the bank or purchase bills if she wants to maximise her wealth?
b. If she should purchase bills, which bill should she purchase?
Assumption: The bills have the same level of risk as the bank account and Mavis has told you that she does not have to place every last dollar of the millions in bills.
Part 3: Investing and Risk Minimisation
Download the Sydney Morning Herald article from the Assignment folder on Blackboard and answer the following questions.
a. Discuss how diversification is used to bring about a positive outcome for retail investors. Why do investment portfolios with different asset classes need to be continually monitored? What are some alternative asset classes that investors can diversify into?
b. Assume that you have the betas of all the companies listed on the ASX. Now you select 20 shares based on their betas and, by investing an equal amount in each share, you create a portfolio with a beta of 1.1. You make sure you select shares with betas ranging in value from 0.4 to 2.4.
i. Is this likely to be an efficient portfolio?
ii. Is the portfolio likely to be well diversified?
iii. Is the portfolio likely to have much non-systematic risk?
c. Now your selection is based upon putting the company names into a hat and withdrawing 20. Revisit question b with relation to this portfolio.
(10 marks)
Case Study 2
Hygienic Solutions and the Enviromist
Hygienic Solution (HG) is an Australian business that has specialised in producing environmentally friendly cleaning products. The business is structured as a partnership and is owned by Bill and Ben Weed. It has been a highly successful operation and is large enough to have several divisions. HS ―Earth Safe‖ range currently includes low phosphate detergents, washing liquids, bathroom and oven cleaning products.
Bill and Ben want you to advise on the feasibility of a proposal to introduce a steam cleaning machine (the Enviromist) for the domestic market. The Enviromist would be very different from the current range of products – HS has not been involved in producing appliances before. Bill and Ben have provided you with the following information:

Memo One
From: New Project Divisions To: Bill and Ben
Our engineers have estimated the following costs of equipment needed to produce 15000 units of the Enviromist a year: The installed cost of the main machine is $500000. The machine would have a useful life of 10 years. The machine could be sold at the end of 5 years for an estimated $100000, or at the end of 10 years for an estimated $20000. The Australian Tax Office (ATO) allows prime cost depreciation at the rate of 20%. $36000 of specialised small tools are also required. The ATO allows prime cost depreciation at 33.33%. The tools will have a useful life of 15 years, after which time they would be scrapped. You can assume that any benefits from tax deductions are received in the year in which the deduction is incurred.#p#分頁標題#e#

Memo Two
From: Production Manager To: Bill and Ben
Our department has estimated the following costs for production of the Enviromist: Staff training would need to be conducted at the start of the project. The estimated cost of training is $7500. Training costs are tax deductible. Each unit of Enviromist would require 3 hours of labour. HS currently has an enterprise bargaining agreement with our workers. Wages are fixed at $15 per hour for the next 5 years. After 5 years, wages are expected to be increased to $20 per hour and remain at the rate for at least the following 5 years. Material cost per unit would be $85 for the first 3 years of the project. The Enviromist is made from recycled materials. As advances in recycling technology are forecast, the material cost is expected to tall to $60 per unit after year 3. Working capital in the form of Raw materials and parts inventories costing $10000 would be needed to facilitate production of the Enviromist. Electricity, machine maintenance and other variable expenses are $3 per unit of production. Insurance and other tax-deductible fixed overhead expenses associated with the project will be $8000 per annum.

Memo Three
From: Marketing Manager To: Bill and Ben
Only one other competitor (KStar) currently sells a steam cleaner in the market. From what we can gather, KStar has been increasing sales at a rate of 5% for each of the 3 years their product has been on the market. KStar sold 70000 units in the year just ended. We think KStar‘s growth in sales is more closely linked to the environmental benefits of steam cleaning than to the quality of their product.
KStar product is manufactured overseas. We believe we can capitalise on our use of recycled products and use of domestic labour to gain market share. If our estimates of the market size and the effectiveness of our marketing strategy are correct, we expect to see 6000 units in the first year. We estimate that sales growth will be at 10% per annum for the following 6 years. After that time, we expect a stable level of sales. We also expect to maintain a constant $175 per unit price.
An advertising campaign costing $30000 per annum would be needed to gain market share and meet our growth forecasts. The advertising expensive is tax deductible. A one-off increase of $15000 in 留學生dissertation網accounts receivable would be necessary to support the expected level of sales (not tax deductible).
A small downside of introducing the Enviromist is that the current customers purchasing the appliance will be able to substitute it for our Earth Safe range. This will result in a before-tax annual loss of $75000 net cash flows.

Memo four
From: Finance Manager To: Bill and Ben
The following information has been collated by the Finance department. The before-tax cost of capital is 15% Bill and Ben‘s marginal tax rate is 47% The after-tax cost of capital is 11% The rate of return on Treasury Bills is 3% New projects with similar risks as existing projects are to be evaluated at the cost of capital. Any new products that have different characteristics to our current product line are evaluated at the cost of capital plus 3% The current financing structure of HS is 30% debt and 70% equity All working capital will be recovered at the end of the project.#p#分頁標題#e#

The owners of HS have asked you to help them with their investment decision. Specifically, they want you to produce a report that develops a recommendation on the acceptance or rejection of the project. You have decided to use the NPV approach.
Required:
a. Analyse the project and make a recommendation about the project.
b. Bill and Ben have had a quick look at the memos and have noticed the large fall in salvage value on the machine after year 5. They think they might be better off if they produce the Enviromist for only 5 http://www.400190.com/Thesis_Writing/years rather than 10. Should Bill and Ben terminate the project at the end of year 5? The partnership will not change to a company
(10 marks)