# FIN205 Business Finance: Stock Market Information

### Questions:

James Holloway has just won a television game show. There are two ways in which James can receive his price:

Option 1: a once-off payment of \$100,000 in 18 months.

Option 2: a payment of \$5000 a month for 18 months with the payment increases by 0.5% every month.

Assuming that the monthly discount rate is 2% and that interest rate compounds monthly, which option is financially better for James?

The table below provides stock market information for three different countries.

 Country A Country B Country C Information asymmetry Moderate Low Moderate Transaction Cost Moderate Moderate High Number of market participants Moderate Moderate Low

Using the knowledge you have obtained in this unit, explain which country you believe would have the largest and which country would have the smallest difference between market price and the intrinsic value of shares listed on their respective securities exchange?

Melbourne Ltd is now on a fast-growth phase and expects its dividends to grow at a rate of 15 per cent for the next 4 years. The dividends will then settle to a constant-growth rate of 5 per cent. The current dividend was just paid at \$3. If the required rate of return is 10 per cent, what is the value of the share? finance is considered to be a solution to encourage managers to distribute excess cash to investors rather than investing in sub-optimal projects”. Do you agree with this statement? Explain your answer.

Consider a 3-year bond with 13 percent semi-annual coupon payments and currently priced to yield 12 per cent per annum.

1. Calculate duration of the bond.
2. What is the percentage of price change if interest rate increases to 12.35% per annum?

The table below lists P/E Ratios for some ASX-listed retailers and the average P/E Ratio for the Consumer Discretionary Sector. From this information, what can you say about Super Retail Group, and what does this imply?  What market  research would you need to do before buying Super Retail Group shares on the basis of its P/E Ratio?

COMPANY                                                                          P/E RATIO

JB Hi-Fi (JBH)                                                                          11.8

Super Retail Group (SUL)                                                         8.4

Harvey Norman (HVN)                                                            13.5

Nick Scali (NCK)                                                                      15.2

Consumer Discretionary Sector Average                                 10.2

The following chart shows earnings and dividend growth of Woolworths group from 2016 to 2020. Why do you think dividend growth follows a smoother path than earnings growth? Explain clearly.Explain the likely effects on dividend-payout ratios of each of the followings.

1. Interest rates decrease substantially;
2. Company profitability is negative;
3. Prospectus requirements are tightened, increasing the cost of share issues;
4. Personal income (but not capital gains) tax increases

Consider two firms with identical assets structures and operating characteristics: ABN and RPO. Both companies sell the same product and face the same distribution of expected earnings before interest and tax (EBIT) for the upcoming year. There is a 30% chance that EBIT will be \$2 million, a 40% chance that EBIT will be \$3 million and a 30% chance that EBIT will be \$4 million. Both companies have total assets of \$10 million. ABN is 100% equity financed while RPO has \$4 million of 10% debt on issue.

1. Ignoring corporate taxes, examine the impact of financial leverage on shareholder returns and shareholder risk. Make sure you show details of your calculation steps to get measures of return on equity and risk of equity for ABN and RPO, respectively.
2. How does the financial leverage in (1) affect shareholder returns and risk? What do the Modigliani and Miller Theorems say about whether you would prefer to hold shares in ABN or RPO? Ignore corporate taxes in this question.

As the cost of debt,  is always less than the cost of equity, companies should maximise the use of debt to maximise return. Comment on this statement.In a world of tax, if a firm went from a very low debt level to successively a higher levels of debt, what would happen to share price? Explain your answer.

The total market value of Biz Tech shares is \$60 million, and the total market value of its debt is \$40 million. The treasurer estimates that the beta of the shares is currently 1.5.  The expected risk premium on the market is 8%.  The risk- free rate on the Treasury securities is 5%. Biz Tech’s debt requires a credit spread of 1% above the risk-free rate. The company’s tax rate is 30%s.

1. What is the required rate of return on the Biz tech shares?
2. Estimate the company’s cost of capital.
3. The company has an expansion plan that requires \$10 million initial investment. The net cash flow from the project is estimated at \$2 million per year for 15 years, beginning at year 3. Should the company take the project or not? Assume that the company maintains its current capital structure throughout the expansion. Also, note that the net cash flow is already on the after-tax basis.