FINANCE 251: Financial Management

| June 12, 2016

Question
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The University of Auckland Business School

FINANCE 251: Financial Management

2015 S1 (First Semester)

Group Assignment Due Date: by 4:00pm on Wednesday 20th May 2015

The Assignment is marked out of 100 and counts towards 15% of the overall mark for this course.

Question One (25 marks)

You plan to retire in 35 years and need to accumulate sufficient savings / investments to provide you with an annual income of $60,000. Based on information you’ve read you anticipate that your retirement will last 20 years (when you expect to pass away peacefully in your sleep leaving nothing but your false teeth to be passed on in your will).

Savings interest rates are around 5% p.a. and you think it’s reasonable to assume they’ll remain around this level, on average, for the foreseeable future.

Assume you plan to put money into a savings account at the end of each year until you retire. You then plan to draw a full year’s spending money out at the beginning of each year during your retirement. Interest will be compounded annually in this savings account.

a) How much will you need to deposit each year to achieve your goal?

b) If the rate of inflation is currently 2% p.a. and you expect it to maintain this level, on average, for the foreseeable future, demonstrate how this will change your answer in a) above.

You should complete this section using either excel or a calculator. In either case you should clearly show all your workings/calculations.

Question Two (25 marks)

This part of the assignment requires you to produce a graph similar to Figure 8.8 on page 331 of the course text-book and explain its significance.

Go to:http://nz.finance.yahoo.com/

Access data, for the same period as AIA and FRE (in Participation Homework 2), for the NZX50 Index.

You can access to this data set is through the NZX 50 Index link which appears immediately under the “Look Up” button.

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Using the same process as you did for AIA and FRE in Participation Homework 2, calculate the returns for the NZX 50.

When you’ve calculated the returns for the NZX 50, copy and paste the returns column first from the AIA spreadsheet and then from the FRE spreadsheet into the column immediately to the right of the NZX 50 returns.

Highlight the three “returns” columns on your spreadsheet, click the “Insert” Tab in the top toolbar and select the “Scatterchart” icon then select “Scatter with only Markers”.

Click on one of the markers, then right click and choose “Add Trendline”. The options default to “Linear” at the bottom of that dialog box.

Choose “Display Equation on chart” and click close.

a) Attach a copy of your graph (you do not need to attach your excel data tables/calculations).

b) Identify the numbers from the lines’ equations that are most relevant to the topic material from Chapter 8 and explain their meaning.

c) Briefly explain what your graph means and how it can be used.

Question Three (50 marks)

Glasstec Yachts manufactures luxury fibreglass yachts, for both the domestic New Zealand market and for export, and is considering a proposal to purchase a new automated plant for its production process which will radically reduce the time for manufacturing these craft. The plant will cost $25 million plus a further $150,000 investment in inventory at the start of the project, and is expected to last for seven years before it needs replacing.

The new plant is expected to generate an additional $15 million per year in revenues in its first year and achieve a growth rate in revenues of 10% for the next two years, flattening out at 5% for the remainder of the plant’s life.

Variable costs are projected to be 40% of sales in the first year, growing at a constant rate of 4% thereafter and fixed costs (excluding depreciation) of $2.5 million are anticipated. The new plant would be depreciated on a straight line basis over the seven years to a residual value of $5 million.

This new investment proposal that may change the way luxury yachts are built, is very promising but carries a great deal more risk than current technology used by the company. Expected returns for similar projects adopted by Glasstec’s competitors in the boating industry are around 15% p.a.

The company’s latest balance sheet shows a long-term debt of $40 million and shareholders’ funds of $80 million. Glasstec issued 10-year bonds exactly 4 years ago, each with a face value of $1,000 and an annual coupon rate of 8%. The bonds are currently trading at a yield of 7.0% p.a. Glasstec has 30 million shares on issue and the current share price is $3.00. The company’s share beta is 1.20, the risk-free rate is estimated to be 5% p.a., the market risk premium is estimated at 7.5% p.a., and the company tax rate is 28%.

The company’s production manager has asked your finance team to complete a financial analysis for the investment. He will make a recommendation to the board of directors based on your analysis and report.

a) Determine Glasstec’s weighted average cost of capital (WACC).

b) State whether Glasstec should use this WACC as the opportunity cost of capital for the proposed investment. Explain your reasons.

c) Prepare an analysis of the proposal on Excel. Print a copy of this analysis on a single A4 sheet and attach it to your assignment.

d) Should Glasstec accept the proposed investment? Explain why or why not.

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