Corporate Finance

1. Explain the differences between an ordinary share and a preference share? Give examples of the different characteristics of a preference share.

Solution

Ordinary shares also referred to as ‘common stock’ are the equity shares of a company. The shareholders having the ordinary shares indicate that they possess the ownership within a company on the basis of the proportion of shares owned by them. The shareholders also receive voting rights to appoint or remove the directors or auditors of a company. On the other hand, the preference shares have both equity and debt characteristics and does not providing any voting rights to the investors. The preference shares possess a priority claim over the assets and earnings of a company.

The major characteristics of a preference share are as follows:

  • Preference shares are commonly known as hybrid security as they have both equity and debt characteristics
  • The preference shares provides a fixed dividend before paying up any ordinary dividends

2. Lovotel Ltd, a telecommunication company, did not pay a dividend in the last financial year. However, the company has indicated that it expects to earn $4 per share in this financial year and to pay out 20% of these earnings in dividends. Financial analysts expect that Lovotel’s earnings per share and dividend per share will grow at a rate of 7% a year. The rate of return required by investors has been estimated at 12% per annum. Estimate the present value of the share.

Solution 2:

Using the dividend growth model:

P0 = D1/r-g

D1= $4*20% = $0.80

r = 12%

g = 7%

Present value of share = $0.80/(0.12-0.07)

= $16.00

3. How can lenders of funds protect themselves from borrowers defaulting on the loan? List and provide examples of the different strategies/methods used.

Solution

The lender of funds protects themselves from borrowers for defaulting on a loan with the use of secured loans. Secured loans means agreeing to provide the lender with some form of collateral which means an item having monetary value that is equl to or larger than the amount of borrowing. It tends to act a security for the lender and protecting for the loss that can occur in case of failure to repay the loan.

4. Explain why a bond might trade at a price greater than its face value. Provide an example

Solution

A premium bond is regarded as a type f bond that can trade above its face value. The major reason for a bond to trade at a premium is because the interest rate tend to become higher than the market rate of interest. In addition to this, the credit rating of a company and the bond can also result in increasing the price of bond.

5. On the 1st October 2009 Nisha Limited issued bonds with a maturity date of 1st October 2019. One Nisha bond has a face value of $100,000 and the coupon rate is 8.50% p.a. with interest payable half-yearly. Assuming the market yield is 3.5% p.a. calculate the present value of the bond.

Solution 5:

Given:

· Bond duration = 10 years

· Coupon rate = 8.5% p.a or 4.25% per half year or $4250

· Face value = $100,000

· Yield rate or rate of discount = 3.5% p.a

Price of bond = $141882.20

6. What is the value of an ordinary share which paid a dividend this year of $20.00 and has an expected growth of 5% a year indefinitely? The required rate of return is 12%

Solution 6:

Using the dividend growth model:

P0 = D1/r-g

· D0 = $20.00

· D1 = $20.00 * (1+0.05) = $21.00

· r = 12%

· g = 5%

Present value of share = $21.00/(12%-5%)

= $300.00

7. A woman deposits $10,000 every year into a savings account that pays interest at 4% p.a. If she made her first deposit in 1974, how much will she have in her account just after she makes her deposit in 2015?

Solution 7:

Number of year = 32 years

Interest rate = 4 % pa

Amount every year = $10000

$627,014.69

8. With an 8% p.a. rate, how much would you pay for a business that produces $8,500 per year forever, with the first cash flow occurring in one year’s time?

Solution 8:

Cash flow per year = $8500 per year

Discount rate = 8% p.a.

$106250

9. Health Co. wants to raise approximately $150,000 for a short-term project and only require funds for 60 days. The 60 bank-bill rate is 4.2% p.a. To raise the funds, Health Co. approaches Dud Bank who has agreed to accept the bill for a fee of 300 basis points.

a. How much will Health Co receive?

b. How much does the investor pay?

c. How much does Dud Bank receive?

Solution 9:

Valuation is made using the simple interest approach: P = S (1 + r t)-1

Health Co receives:

P = $150,000 (1+ (0.042+0.03)x60/365)-1

= $148245.42

The Investor will pay:

P = $150,000(1+0.042x60/365)-1

= $148971.48

Dud Bank receives:

$148971.48– $148245.42= $726.06

10. What is the price of a bond that was issued three years ago and has seven years before its maturity date?

Interest is paid half yearly. The last interest payment was made today. The coupon rate is 5% and the current market yield is7%

Assume a $100,000 face value

Solution 10:

  • Bond duration = 7 years
  • Coupon rate = 5% p.a or 2.50% per half year or $2500
  • Face value = $100,000
  • Yield rate or rate of discount = 7% p.a

Price of bond = $89,079.48

Q11. You are offered an investment that requires you to invest $15,000 today in exchange for $105,000 ten years from now with interest compounded quarterly (4 times per year). What is the nominal rate of return?

Q12.You have a home loan of $200,000 (PV). How much (FV) will be required on 14 December 2021 to repay the loan if it was made on 14 December 2015 (6 years) at 3% p.a compounding semi annually?

Q13.You will receive an inheritance of $80,000 in 10 year’s time. Your goal is to invest this money in a bank account until it has grown to $275,000. If the bank account pays interest at 5.5% pa, how long will it be before you achieve your goal?

Q14 - You have $45,000 that you want to invest in an online account for the next 20 years. You are offered an investment plan that will pay you 3% for the first 10years and then 5% for the remaining 10 years. What will be the balance in your online account at the end of the 20 years? Assume that the interest rate is compounded monthly.

Q15 - On your 40th birthday you receive $100,000 as a result of a deposit that your grandparents made on the day you were born. How large was that deposit if it earned interest at 4% p.a.?

Q16 - You have just won the NSW state lottery. You are given the choice of receiving a total of $4.5 million now or you can elect to be paid $500,000 every year for the next 10 years. If you can earn 6% p.a. compounded quarterly on your investments, which option should you choose?

Q17 - You have just received an inheritance and are ready to buy an apartment for $420,000. You have a $80,000 deposit and legal fees.

• The interest rate on the loan is 3.2 % per year with monthly compounding for a 30 -year fixed rate mortgage

• Legal fees are estimated to be 1% of the property value. You have an annual salary of $98,000 and the bank is willing to allow your monthly mortgage repayment to be equal to 21% of your monthly income.

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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