Discuss the importance of CAPM and SML in determining the trade-off between risk and return.

Discuss the importance of CAPM and SML in determining the trade-off between risk and return.

FINC20018 Managerial Finance T1 2019 Assessment 1 – Written Assignment

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Group Written Assignment Due date: Week 5, Friday 12 April @ 11:55pm Weighting: 20%

Group formation

 For on-campus students, it is a group assignment and the group means 2 students per group.

 For distant learning (FLEX) students, while a group of 1 is likely to be more practical groups of 2 are optional.

The task

 There are 6 questions, each question could be a combination of calculation-based and theory questions assessing work covered in Weeks 1 to 4.

Format and referencing

 Presentation must be 1.5 spacing, 14 pt Bold for Section Headings, 12 pt. for content and Arial.

 Answers to calculation questions should include well-presented tables, accurate calculations, worksheets and related formulae.

 Answers to theory type questions should be around 400 words [excluding in-text referencing, reference list and appendix items] and show supporting examples, diagrams and figures. For six questions the word limit is approx 3000 words in total.

 Proper referencing of all content including figures, tables and narrative using APA Reference system.

 Demonstrations of using your initiative and supporting your answers with interesting references to contemporary issues from newspapers, journals, professional publications, web resources i.e. extracts from podcasts, financial institutional websites etc.

Submission method

 This online submission must be submitted as a word document. PDF submissions will not be accepted.

 For on-campus students this is a group assignment, only one member of the group will submit the assignment online by uploading to the Moodle (DO NOT use turnitin to check similarity for the draft work, and the second person in the group submit the final assignment – this will result in a very high similarity score and penalty will apply)

Issues that will affect your marks include:

 Create your own cover sheet with the names of the students in the group clearly indicated.

 Do not include the marking criteria or rubrics or marking sheet in your assessment. Your grader will include a separate feedback and marking sheet after they have graded your assessment in Moodle.

 The word limit is approx 3000 words in total, 5% leeway above or below is acceptable, if you exceed the word limit significantly marks will be deducted.

 Turnitin will be used to check percentage similarity. Do not copy the questions from the textbook, as this will increase your percentage similarity.

 Where copying from other sources results in high percentage similarity, marks will be deducted. Therefore, proper use of in-text referencing is important. Avoid direct quotes.

 If percentage similarity exceeds 20%, marks will be deducted based on a progressive scale as determined by the course co-ordinator.

 Under extreme circumstances where high % similarity indicates copying from written works of other students in CQU, other universities or any other institutions world-wide, the assignment will be reviewed by the academic misconduct board.

 Penalty for the late submission is 5% per calendar day including Saturday and Sunday.

Assignment Questions Question 1: Understanding Financial Statements (15 Marks)

Business A and business B are both retailers, but seem to take a different approach to this trade according to the information available, which consists of a table of ratios:

Ratio Business A Business B Return on capital employed 20% 17% Return on owners’ equity 30% 18% Average settlement period for accounts receivable 63 days 21 days Average settlement period for accounts payable 50 days 45 days Gross profit percentage 40% 15% Profit percentage 10% 10% Inventory turnover period 52 days 25 days

Required: 1) Discuss what this information indicates about the differences in each business’s approach. 2) If one of them prides itself on personal service and the other on competitive prices, which do you

think is which, and why?

3) Based on the given information, which business tends to require more external financing and what types of external financing you would recommend.

Question 2: Understanding Financial Statements (15 Marks) You are presented with the following financial report extracts for Rocky Ltd:

2015 2014 2013 2012 $ $ $ $ Income statement Sales 370,000 310,000 270,000 Cost of sales 174,000 140,000 116,000 Interest 17,000 9,000 4,000 Taxation 30% Other expenses 60,000 56,000 54,000 Statement of financial position Current assets Inventory 18,000 15,000 17,000 18,000 Accounts receivable 62,000 41,000 31,000 29,000 Total current assets 110,000 72,000 62,000 Non-current assets Property, plant and equipment 140,000 120,000 110,000 Total non-current assets 210,000 190,000 150,000 Total assets 320,000 262,000 212,000 180,000 Current liabilities Accounts payable 30,000 17,000 12,000 11,000 Total current liabilities 70,000 52,000 42,000 Total non-current liabilities 110,000 80,000 30,000 Total liabilities 180,000 132,000 72,000 Total shareholders’ funds 140,000 130,000 140,000

Note: that there are also other current assets, non-current assets, and current liabilities that are not specifically listed in the extracts shown above.

Required: 1) Prepare a ratio analysis from the available information to cover profitability, liquidity, efficiency and

capital structure.

2) Based on the above ratio analysis, prepare a report indicating potential strengths and weakness in the management of this business.

3) Identify additional information you would require to improve your analysis of this company over the period specified.

Question 3: Understanding Cash Flow Statement (15 Marks) The cash flow statements for retailing giant Discount Bonanza Ltd spanning the period 2012-2015 are as follows:

12 Months Ending

31/12/2015 ($ millions)

31/12/2014 ($ millions)

31/12/2013 ($ millions)

31/12/2012 ($ millions)

Net profit 13,000 12,000 11,000 10,000 Depreciation expense 6,500 6,300 5,000 4,000 Changes in working capital 1,200 2,300 2,400 1,000

Cash from operating activities 20,700 20,600 18,400 15,000 Capital expenditure (16,000) (14,500) (14,000) (12,300)

Cash from investing activities (16,000) (14,500) (14,000) (12,300) Interest and financing costs (350) (250) (350) 100 Total cash dividend paid (3,600) (2,800) (2,500) (2,200) Issuance (retirement) of shares (8,000) (1,500) (3,600) (4,500) Issuance (retirement) of debt 1,500 (100) 4,000 4,100

Cash from financing activities (10,450) (4,650) (2,450) (2,500) Net change in cash (5,750) 1,450 1,950 200

Required: 1) Describe Discount Bonanza’s sources of financing in the financial markets over the last four years. 2) Prepare a brief narrative that describes the major activities of Discount Bonanza’s management team

over the last four years.

3) Explain the three perspectives from which financial statements can be viewed.

Question 4: Time Value of Money (15 Marks)

A couple will retire in 50 years; they plan to spend about $30,000 a year in retirement, which should last about 25 years. They believe that they can earn 8% interest on retirement savings.

Required:

1) If they make annual payments into a savings plan, how much will they need to save each year? Assume the first payment comes in 1 year.

2) Would the answer to part 1) change if the couple also realize that in 20 years, they will need to spend $60,000 on their child’s college education?

3) Explain what the time value of money is and why it is so important in the field of finance.

Question 5: Time Value of Money (20 Marks)

Babu is planning to save for his son’s university education. His son is currently 11 years old and will begin university in 7 years. Babu has an index fund investment of $17,500 earning 9.5 per cent annually. Total expenses currently at the University of Sydney where his son says he plans to go, currently costs $25,000 per year but are expected to grow at roughly 4 per cent every year. Babu plans to invest a certain amount in an investment fund that will earn 11 per cent annually to make up the difference between the education expenses and his current savings. In total, Babu will make seven equal investments with the first starting today and with the last being made a year before his son begins university. Assume the discount rate is 6 per cent. Required:

1) What will be the present value of the 4 years of education expenses at the time that Babu’s son starts university?

2) What will be the value of the index fund when his son just starts university? 3) What is the amount that Babu will have to have saved when his son turns 18 if Babu plans to cover

all of his son’s university expenses?

4) How much will Babu have to invest every year in order for him to have enough funds to cover all his son’s expenses?

Question 6: Risk and return (20 Marks)

Assume you have invested in two shares Woolworth (WOW) and Village Roadshow (VRL). Woolworth is a leading retail company in Australia and Village Roadshow is an Australian film producer and distributer. Consider the following information associated with the two shares:

Probability of return WOW

Rate of return VRL

Rate of return 0.30 0.02 – 0.20 0.40 0.32 0.12 0.30 0.18 0.40

The market risk premium is 12%, and the risk-free rate is 4%. Required:

1) Calculate and explain which share has the most systematic risk? 2) Calculate and explain which share has the most total risk? 3) Discuss which share is actually the ‘riskier’ share based on the concept of diversification. 4)

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