JNB518 Finance for Decision-Making: How Shareholders Manage Cash?

Questions:

Q 1.

Below table contains the share prices of QUBE Holdings Limited (Ports and Logistics sector) and Australia and New Zealand Banking Group Limited for the 13 months from 1 September 2020 to 1 September 2021 (Price data were downloaded from Yahoo Finance).

Date

QUBE

ANZ

Price ($)

Price ($)

 

1/09/2020

2.51

17.22

1/10/2020

2.65

18.81

1/11/2020

2.86

22.64

1/12/2020

2.94

22.70

1/01/2021

2.85

23.71

1/02/2021

3.07

26.17

1/03/2021

2.99

28.18

1/04/2021

3.01

28.74

1/05/2021

3.01

28.71

1/06/2021

3.17

28.15

1/07/2021

2.92

27.71

1/08/2021

3.16

27.85

1/09/2021

3.31

27.59

 

  1. Calculate the monthly holding-period returns for QUBE and ANZ (there will be 12 monthly returns for each share).
  2. Calculate the average monthly holding-period returns and the standard deviations of these returns for QUBE and ANZ.
  3. Assume you have decided to invest 60% of your money in QUBE and 40% in ANZ. Calculate the expected monthly holding-period return and the standard deviation of the return for the two-share portfolio.
  4. Discuss whether you have gained benefits through the creation of the portfolio of 60% in AUBE and 40% in ANZ.

Q 2.

  1. Explain why shareholders would care if a firm accumulated a very large amount of cash and discuss options available for a firm to manage cash if it believes there is too much cash.
  2. Explain the impact of the following actions related to working capital management on a business’s operating cycle.
  1. Payments to suppliers are speeded up.
  2. Account receivables turnover goes from 6 times to 8 times.
  3. Inventory turnover goes from 8 times to 6 times.
  4. Credit sales discontinued.

Q 3.

A large and well-known listed company wants to raise $1 million next month for its 12-month period project. Identify and explain four different financing options available to it.

Q 4.

  1. ‘When the inflation rate in Australia is relatively higher than the inflation rate in the USA, the value of the Australian dollar will increase relative to the US dollar.’ Comment on the above statement using the theory that explains the adjustment of foreign exchange rates.
  2. Discuss the types of exchange rate risks a multinational shipping company may face and explain how the company would manage these risks. Use examples to support your discussion.
  3. An Australian airline company has just entered a contract to purchase a new fleet of airplanes for 2 billion US dollars (USD) and the current exchange rate is AUD/USD0.74. The company must pay for the fleet in six months’ time. The airline company considers hedging its exposure to foreign exchange risk by using an The company has the following information on the two types of option.

Currently a call option on USD that expires in 6 months has an exercise price of AUD/USD0.70 and a premium of AUD0.01.

Currently a put option on USD that expires in 6 months has an exercise price of AUD/USD.72 and a premium of AUD0.01.

  1. Which type of option should the company use? Why?
  2. If the actual exchange rate in six months’ time is AUD/USD0.67, explain how the hedge has protected the company from its exposure to exchange rate fluctuation.
  3. If the actual exchange rate in six months’ time is AUD/USD0.76, explain how the hedge has protected the company from its exposure to exchange rate fluctuation.

Q 5.

ABC Shipping is considering replacing an existing ship with a newer and more efficient one for a 5-year contract of affreightment. The existing ship is five years old; it cost $36 million and is being depreciated under the prime cost method at a rate of 10%. The existing vessel has a remaining useable life of five years. The new ship costs $45 million to purchase and $ 5 million to outfit for service. It will be depreciated under the prime cost method at a rate of 10%.

The existing ship can currently be sold for $10 million and will not incur any removal or clean-up costs. At the end of five years, the existing ship can be sold for net $1 million before taxes. The new ship can be sold for net $20 million before tax at the end of the five -year period. The company is subject to a 30% tax rate on both ordinary income and capital gains.

The projected profits before depreciation and taxes for the new ship and the existing ship are given in the following table.

Year

New Ship

Existing ship

1

$30,000,000

$23,000,000

2

30,000,000

23,000,000

3

30,000,000

23,000,000

4

30,000,000

23,000,000

5

30,000,000

23,000,000

The required rate of return used for evaluating the two options is the company’s Weighted Average Cost of Capital (WACC), which can be calculated according to the following information on the company’s capital structure.

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Debentures ($100 par, 10% coupon-annual)

$2,000,000

Ordinary shares ($1 par)

$5,000,000

Bank loans

$300,000

Additional information:

The ordinary shares are currently traded at $3.00 per share. The beta coefficient of ABC Shipping is 1.2.

The risk-free rate (a 10-year government bond) in the market is 3%. The average historical market return for the past 10 years is 9%.

The debentures are priced at $102.00.

The current return (i.e. market yield) on the company’s debentures is 8%. The interest rate of bank loans is 6%.

The company tax rate is 30%.

The existing capital structure is unlikely to change.

  1. Using a table in Word or an Excel spreadsheet, set up the cash flows for each option, i.e. purchase the new ship and continue using the existing ship.

Calculate the company’s WACC.

  1. Calculate the Net Present Value (NPV) of each option.

What option would ABC Shipping choose? Justify your answer. [8

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