Table of Contents

Question 1.

Question 2.

Question 3.

Question 4.

Question 5.

References

Finance for Decision-Making - Question 1

  1. Calculation of WACC

The data of ABC Shipping Limited is given as –

10% Debentures ($100 par) = $10000000

Paid up capital – ordinary shares ($1 par) = $45000000

12% Preference share ($10 par) = $5000000

For computing the WACC, firstly the proportion of different types of capital has bene calculated. Proportion of debentures is computed as $10200000 / $240200000 = 4.25%

Proportion of ordinary shares is computed as $225000000/ $240200000 = 93.67%

Proportion of preference shares is computed as $5000000 / $240200000 = 2.08%

Cost of equity is calculated by applying the CAPM formula as Ke = Rf + Equity risk premium * Beta (Frank and Shen 2016)

Ke = 3% + 8% * 1.5 = 15%

Cost of debentures (Kd) = 8%

Cost of preference shares (Kp) = 12%

WACC = Cost of equity * weight of equity + cost of debt * weight of debt (1 – tax rate) + cost of preference shares * weight of preference shares (Garcia 2017)

WACC = 15% * 93.67% + 8% * 4.25% * (1-30%) + 12% * 2.08%

WACC = 14.54%

  1. Evaluation of projects
  2. Cash flows has been set in excel
  3. Payback period of vessel 1 project is computed as 2.14 years and payback period of vessel 2 project is computed as 2 years.
  • Both projects have positive NPV

NPV of vessel 1 project = $15.85 million

NPV of vessel 2 project = $2.30 million

  1. IRR of vessel 1 project = 20% and IRR of vessel 2 project = 5%
  2. Vessel 1 project must be accepted as its NPV and IRR is higher in comparison to that of Vessel 2 project (Ben-Horin and Kroll 2017). Its payback period is higher than that of vessel 2 project but it falls below the maximum acceptable payback period of 5 years.

Finance for Decision-Making - Question 2

Approval for loan

The current ratio of XYZ Engineering ratio has declined from 5 in 2018 to 3.50 in 2019 and became lower than the industry average of 5 (Wen and Zhu 2019). This indicates that the company’s current assets have reduced but are enough to pay its short term liabilities. Similarly, quick ratio of the company has decreased from 2.70 to 2 in 2019 and remained lower than the industry average. Rise in turnover ratio from 30 days to 40 days indicates that the stock of the company remained unsold for large number of days (Sunjoko and Arilyn 2016). The industry average for collection period is 20 days but average collection period for the company ahs reached to 35 days in 2019 from 25 days. This indicates that the debtors are paying it late which is hampering its inflow of cash. It has raised the acquisition of debt funds from 34.69% to 40.50% which shows that the company is already under the obligation to pay interest at regular intervals of time irrespective of the amount of profits earned by the company (Onchong’a et al. 2016). The net profit margin has fallen below the industry average of 12% and return of assets has also lowered down to 5.40% (Sudirman et al. 2020). From all this, it can be claimed that the bank should not approve the loan application of 1 million dollars made by XYZ Engineering Limited as its performance is declining in the current year and has fallen down below the industry average. Decline in profit margin infers that the company is facing difficulty in earning revenue and incurring heavy amount of expenditure on carrying out its business operations. The management is inefficient in using its resources and assets in an optimum manner to derive large amount of profitability. The reduction in current assets might make it difficult for the corporation to even fulfil its short term financial commitments in the near future. It has not adopted any effective marketing strategy to sell off its products and services in the market due to which its inventory turnover is rising. It might become difficult for bank to recover the amount of loan at the time of maturity. Thus, it is suggested to not to offer loan of such a big amount to the company. However, it might offer any short term loan of some small amount.

Finance for Decision-Making - Question 3

  1. There have been increased risks for Australian companies to export its produce to the Chinese market. The regulatory decision made by China will definitely increase the risk profile that might be faced by businesses when it comes to undertake trade related practices with the Chinese counterparts (Patten and Durkin 2020). These risks are concerned with commercial fraud, infringement and theft of intellectual property, breaches of contract, restrictions on movement, threats to physical safety, bullying, intimidation and several criminal custodies for engaging in operations that may not considered as crimes under the law of Australia (Australian Government 2020). In order to control these risks, Australian companies must spend larger time in investigating the market and must obtain professional advice from experts before setting any kind of business relationship. Australian iron ore company must commit to the highest level of corporate behaviour and must become familiar with both Chinese and Australian law that are in relation with business activities in China. It must identify the growth potentials across other countries like Indonesia and Vietnam, Malaysia, Singapore and other ASEAN countries to undertake trade related investment (Karp 2020).
  2. The duration of the project for which the company requires funds is 1 year. This indicates that the company can successfully borrow from long term sources of finance as it would be able to repay back after 1 year. Long term financing is concerned with borrowing for more than one year. Several long term financing options are as follows –
  3. Equity capital – This is concerned with raising the required amount of funds by public or private financial institutions. The corporate can either acquire money from the market through IPO or it may go for a private investor to undertake a significant amount of ownership in the business organization (Breuer and Pinkwart 2018). The company has to pay the dividend to equity shareholders as a return for investing their money.
  4. Debentures – It can also borrow funds by issuing debentures in the market (Calabrese and Ely 2016). In order to acquire funds in next month, it may approach to major debt investors and borrow from them at comparatively higher interest rates.
  • Term loans – The company can borrow from financial institutions or banks for period of more than one year. They majorly have secured loans where the company has to provide collaterals in the form of machinery, land and any other fixed asset (Nikolova et al. 2016).
  1. Preference shares – It can raise funds by issuing preference shares in the market. Preference shareholders carry preferential rights towards receiving dividends at fixed rate.

Finance for Decision-Making - Question 4

BHP and Qantas

  1. Holding period returns

The formula for holding period return is = (R(t+1) – R(t))/ R(t)

Particulars

BHP (%)

Qantas (%)

Average monthly holding period returns

-2.46

0.34

Standard deviation

4.68

2.57

Average monthly holding period return is computed by taking out the average of monthly holding period returns (Zervoudi and Spyrou 2016). Standard deviation is computed by applying formula.

  1. Given, 60% investment in BHP and 40% in Qantas.

The expected monthly holding period return will be calculated by multiply the weights of investment in particular security with their respective average monthly holding period return (Al-Nator 2018).

Expected return = 60% * (-2.46%) + 40% * (0.34%)

Expected return = -1.34%

Standard deviation of portfolio is calculated by applying the formula as –

SD(P) = SQRT ((w1)^2 * (sd1)^2 + (w2)^2 * (sd2)^2 + 2 * w1 * w2 * corr * sd1 *sd2)

Correlation between the returns is computed as (-0.134) by applying the formula of correlation in excel.

SD(P) = SQRT ((60%)^2 * (4.68)^2 + (40%)^2 * (2.57)^2 + 2 (60%)(40%) (-0.134) (4.68)(2.57))

SD(P) = 2.86

  1. The total risk has been reduced by diversifying the portfolio as standard deviation reduces to 2.86 in comparison to the standard deviation of 4.68 in case of BHP. As the investment has been made across different securities, the overall influence of market volatility reduces. The major benefit of diversification is concerned with minimising of risk of loss (Abrahams 2020). If one investment has performed poorly over a specified period of time, then other investment might perform better over that same period and thereby reducing the probable losses on the investment portfolio that might have resulted from putting all the capital in only one type of investment. The strategy of diversified portfolio will expose the investor to different sectors, stocks and assets that the investor might not be otherwise exposed to such opportunities (Trinks et al. 2018). Period of rotation is often experienced by markets where some sectors achieve an inflow of capital at the cost of other and therefore, resulting in outperformance of one sector over another. A diversified portfolio decreases the time spent in evaluating and monitoring the portfolio and helps in achieving substantial returns from investment.

Finance for Decision-Making - Question 5

  1. The difference between the rates of inflation in two nations and the cost of commodities drive significant changes in the exchange rates between those countries according to RPPP (Relative Purchasing Power Parity). The rate of exchange among two nations is equal to the ratio of price levels in those two nations. It is computed by dividing the price of commodity x in one country by the price of same commodity in other country. Relative purchasing power parity is dynamic form of PPP because it is related to the change in inflation rates in two countries to the change in exchange rate (Lothian 2016). This theory indicates that inflation basically reduces the real purchasing power. Therefore, when the inflation raises in Australia, US will be able to purchase less amount of real goods.
  1. As is evident in the Excel Sheet and the calculations that ensue, opting for the Forward Hedge is a better alternative than hedging through Options, or not hedging at all.
  • Since, ABC Engineering Australia is importing a machinery from Germany three months from now, this three months poses a risk to the possible foreign exchange fluctuations. Also, since ABC Engineering Australia, has to settle the payment in Foreign Currency (Euros), it will have the need to buy such foreign currency.
  • If ABC Engineering Australia uses currency option to hedge its foreign exchange risk, it should become a call option holder, since the option contract is available in foreign currency (Euros).

Since, the prevailing market price does not exceed the Exercise Price; the call option is not exercised and instead, lapses. In the given case, the Euros are purchased at the prevailing Price.

The premium, in any case, will be the cost of the company, and will be payable by the company.

Option 2

Call option

 
     

Option Contract :

   
     

Expected Price
A$/Euro

Action at Exercise
Price of A$/Euro 0.61

Expected Outflow

     

0.58

Lapse

 $ 3,44,828

     

Add:

   

Premium ( Upfront)

 

 $ 2,000

     

Total Outflow 3 months

 

 $ 3,46,828

from now

   
     

Additional Outflow

 

 $ 13,494

     
  • In case the company opts for neither forward hedge, nor options hedge the outflow would be $ 3,44,828..

Option 3

 

no risk hedging

     

Taking neither Forward
nor Option

200000/0.58

344827.5862

Therefore,

 If all three options are analysed, in following table of comparison, then it could be said that the cash outflow is least in 90 days forward contract and so the importer should take up the 90days forward currency derivative to mitigate the risk of currency depreciation.

Table of Comparision

PARTICULARS

 

90 days forward

Call option

no risk hedging

         

Expected Outflow

 

 $ 3,33,333

 $ 3,46,828

 $ 3,44,828

         
         

References for Competitive Advantage in Investing

Abrahams, S., 2020. Competitive Advantage in Investing: Building Winning Professional Portfolios. John Wiley & Sons.

Al-Nator, M.S., 2018. Portfolio analysis with general commission. Journal of Mathematical Sciences, 234(6), pp.793-801.

Australian Government. 2020. Australian Trade and investment commission. [Online]. Available at: https://www.austrade.gov.au/Australian/Export/Export-markets/Countries/China/Doing-business/Business-risks [Accessed on: 21st October 2020].

Ben-Horin, M. and Kroll, Y., 2017. A simple intuitive NPV-IRR consistent ranking. The Quarterly Review of Economics and Finance, 66, pp.108-114.

Breuer, W. and Pinkwart, A., 2018. Venture capital and private equity finance as key determinants of economic development.

Calabrese, T.D. and Ely, T.L., 2016. Borrowing for the public good: The growing importance of tax-exempt bonds for public charities. Nonprofit and Voluntary Sector Quarterly, 45(3), pp.458-477.

Frank, M.Z. and Shen, T., 2016. Investment and the weighted average cost of capital. Journal of Financial Economics, 119(2), pp.300-315.

García, F.J.P. 2017. The WACC. In Financial risk management (pp. 345-351). Palgrave Macmillan, Cham.

Karp, P. 2020. Australian trade minister says ‘risk’ of trade with China may drive businesses to other markets. [Online]. Available at: https://www.theguardian.com/australia-news/2020/may/17/australian-trade-minister-says-risk-of-trade-with-china-may-drive-businesses-to-other-markets [Accessed on: 21st October 2020].

Lothian, J.R., 2016. Purchasing power parity and the behavior of prices and nominal exchange rates across exchange-rate regimes. Journal of International Money and Finance, 69, pp.5-21.

Nikolova, L.V., Rodionov, D.G. and Mottaeva, A.B., 2016. Securitization of bank assets as a source of financing the innovation activity. International Journal of Economics and Financial Issues, 6(2S).

Onchong’a, E.A., Muturi, W. and Atambo, W., 2016. Effects of debt financing on businesses firms financial performance. International Journal of Social Sciences and Information Technology, 2(5), pp.723-737.

Patten, S. and Durkin, P. 2020. Risks of exporting to China have increased for Australian companies. [Online]. Available at: https://www.afr.com/policy/economy/risks-of-exporting-to-china-have-increased-for-australian-companies-20200823-p55odn [Accessed on: 21st October 2020].

Sudirman, S., Kamaruddin, K. and Possumah, B.T., 2020. The Influence of Net Profit Margin, Debt to Equity Ratio, Return on Equity, and Earning per Share on the Share Prices of Consumer Goods Industry Companies in Indonesia. International Journal of Advanced Science and Technology, 29(7), pp.13428-13440.

Sunjoko, M.I. and Arilyn, E.J., 2016. Effects of inventory turnover, total asset turnover, fixed asset turnover, current ratio and average collection period on profitability. Jurnal Bisnis dan Akuntansi, 18(1), pp.79-83.

Trinks, A., Scholtens, B., Mulder, M. and Dam, L., 2018. Fossil fuel divestment and portfolio performance. Ecological economics, 146, pp.740-748.

Wen, H. and Zhu, T., 2019. Interpretation of Financial Statements.

Zervoudi, E. and Spyrou, S., 2016. The equity premium puzzle: new evidence on the optimal holding period and optimal asset allocation. Review of Behavioral Finance.

Remember, at the center of any academic work, lies clarity and evidence. Should you need further assistance, do look up to our Accounting and Finance Assignment Help

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