Here are the prices of the bond on each remaining coupon payment date and maturity date, assuming the required rate of return remains 3% per annum, compounded semi-annually: Date Price 21/04/2014 $1,009.36 21/10/2014 $1,016.25 21/04/2015 $1,023.13 21/10/2015 $1,030.01 21/04/2016 $1,036.89 21/10/2016 $1,043.77 21/04/2017 $1,050.65 21/10/2017 $1,057.53 21/04/2018 $1,064.41

1. 1
FUNDAMENTALS OF FINANCE (FINC12-
200_153)
DUE: 4TH
DECEMBER 2015
DANEY WEIR (13334404)

2. 2
Table of Contents
Case Study 1.................................................................................................................................3
Question 1:............................................................................................................................... 3
a. .....................................................................................................................................3
b. .....................................................................................................................................3
c. .....................................................................................................................................3
Question 2:............................................................................................................................... 4
a. .....................................................................................................................................4
b. .....................................................................................................................................4
c. .....................................................................................................................................5
Question 3:............................................................................................................................... 7
a. ]....................................................................................................................................7
Case Study 2.................................................................................................................................8
Question 1:............................................................................................................................... 8
a. .....................................................................................................................................8
b. .....................................................................................................................................9
c. .....................................................................................................................................9
d. ................................................................................................................................... 10
e. ................................................................................................................................... 10
Question 2.............................................................................................................................. 11
a. ................................................................................................................................... 11
b. ................................................................................................................................... 12
c. ................................................................................................................................... 12
d. ................................................................................................................................... 13
Question 3:............................................................................................................................. 14
a. ................................................................................................................................... 14
b. ................................................................................................................................... 15
c. ................................................................................................................................... 16
Bibliography........................................................................................................................... 17

3. 3
Case Study 1
Question 1:
You have justcommencedanewjobwitha financial planningfirm.Inadditiontostudyingforyour
RG146 compliance,youhave beenaskedtoreview aportionof a client’sstockportfolioinorderto
assessitsrisk/returnprofile.Yourmanagerhasaskedyouto evaluate the followingfivestocksin
relationtothe clientportfolio:
Price informationis available inthe spreadsheet‘Case Study02DATA.xlsx’oniLearn. The dataseries
providesthe closingprice,adjustedfordividendsandsplits,foreachstockat the endof each month
overthe past five years(1June 2009 to 31 May 2014), retrievedfrom https://au.finance.yahoo.com
on 9 June 2014.
a. Convertthesepricesto monthlyreturnsas the percentagechangein the monthly
prices.Note that to compute a returnforeach month, youneeda beginningand
endingprice,so youwill notbe ableto computethe return forthe firstmonth.
Date AGK ESV MGR TOX WEB
Price %
change
Price %
change
Price %
change
Price %
change
Price %
change
1/06/09 11.13 - 0.46 - 0.87 - 1.71 - 1.07 -
1/07/09 12.32 10.69% 0.46 0.00% 1.03 18.39% 1.93 12.87% 0.97 -9.35%
3/08/09 11.55 -6.25% 0.47 2.17% 1.19 15.53% 1.93 0.00% 1.30 34.02%
1/09/09 11.53 -0.17% 0.57 21.28% 1.37 15.13% 2.26 17.10% 1.31 0.77%
3/03/14 15.18 -1.11% 0.94 -5.05% 1.70 -3.41% 3.36 1.82% 2.75 -7.41%
1/04/14 15.77 3.89% 0.80 -14.89% 1.75 2.94% 3.47 3.27% 2.75 0.00%
1/05/14 15.40 -2.35% 0.90 12.50% 1.81 3.43% 3.60 3.75% 2.47 -10.18%
b. Computethe averagemonthlyreturnand standarddeviationofmonthlyreturns
foreach ofthe stocks. Convertthemonthlystatistics to annual statisticsfor easier
interpretation(multiplytheaveragemonthlyreturnby 12, and multiplythe
monthlystandarddeviationby√12).
Data AGK ESV MGR TOX WEB
Av. Monthlyreturn 0.63% 2.50% 1.40% 1.45% 2.02%
MonthlyS.D. 4.10% 16.51% 5.72% 6.14% 11.19%
Av. Annual return 7.60% 30.05% 16.85% 17.40% 24.23%
Annual S.D. 14.19% 57.21% 19.80% 21.27% 38.76%
c. Computethe correlationbetweenmonthlyreturnsforeachpairofstocks.You
shouldendup witha matrix of10 uniquepairingsincomputingcorrelation.
AGK ESV MGR TOX WEB
AGK 1 - - - -
ESV -0.15 1 - - -
MGR 0.25 0.01 1 - -
TOX 0.19 0.18 0.20 1 -
WEB 0.10 0.03 0.10 0.19 1

4. 4
Question 2:
a. Constructa data seriesofmonthlyportfolio returnsassuminganequal
investmentin all fivestocks. Computethe average monthlyreturnand standard
deviationofmonthlyreturnsforthis portfolio.Convertthemonthlystatisticsto
annual statisticsas forTask1 part b.
Month Portfolio Return
1/06/2009 -
1/07/2009 6.52%
3/08/2009 9.10%
1/09/2009 10.82%
3/03/2014 -3.03%
1/04/2014 -0.96%
1/05/2014 1.43%
Data Portfolio
Average Monthly Return 1.60%
MonthlyStandard Deviation 4.88%
Average Annual Return 19.23%
Annual Standard Deviation 16.90%
b. Usingthe annual statistics, create an XY scatter plotin Excel with standard
deviationonthe x-axisandaveragereturn onthe y-axis.Ensurethe graphand its
axeshave appropriatelabels.(Tip:Yourscatterplotshouldpresentsixindividual
points– 5 stocksplus1 portfolio.)
AGK
ESV
MGRTOX
WEB
Portfolio
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
30.00%
0.00% 7.50% 15.00% 22.50% 30.00% 37.50% 45.00% 52.50% 60.00%
AverageReturn
Annual Standard Deviation
Risk vs Return of Stocks vs Portfolio
AGK
ESV
MGR
TOX
WEB
Portfolio

5. 5
c. What do youobserveabouttherisk/returnprofileoftheindividual stocksas
comparedto the equally-weightedportfolio?Youmustdiscussdiversificationin
the context ofportfolio theory,andtiethis discussionto yourobservations.
[Maximum500words.]
The risk returnprofile of the individualstocksshowsthatAGKwill generate the lowestreturnbut
alsohas the leastriskassociatedwiththe investment.Onthe contrary,ESV will generatethe highest
returnbut at a much greaterrisk.In orderto minimise the riskassociatedwithanindividualsecurity,
diversificationisreliedupon.Thisisthe act of investinginanumberof individual securitiesthathave
differentrisk-returncharacteristicsinordertohave the greatestchance of generatingapositive
returnon investment(Moyer,R.,McGuigan,J.,& Rao, R. 2005). This strategywill,onaverage,
produce higherreturnsandhave a lowerriskthanindividual securitieswithinthe portfolio
(Investopedia,.(2003)).
The risksthat can affectthe portfoliofall intotwoclassifications:
- Systematicrisk:the riskthatis affectedbythe marketandcannot be controlledbythe firm,
thisisalso call nondiversifiable risk(Moyer,R., McGuigan,J.,& Rao, R. 2005).
- Unsystematicrisk:arisk that can be reducedbydiversification,alsocalled diversifiable risk
(Moyer,R., McGuigan, J.,& Rao, R. 2005).
One cannot discussdiversificationwithoutalsolookingatModernPortfolioTheory(MPT) andthe
relevantportfolioopportunityset.MPTgoeshandinhand withdiversificationasitisknownas not
puttingall youreggsin one basketinorderto benefitfromdiversification-particularlythe reduction
of risk(McClure,B.2006). MPT definesriskasbeingthe standarddeviationfromthe meanexpected
return.In the case of WEB, the meanis 24.24%. The risk value indicatesthat 38.76% deviationfrom
the mean- a relativelyhighvalue whencomparedtothe portfoliostandarddeviationof 16.90%.
Contrastingthisstockwiththe portfoliovaluesperfectlydemonstratesthe portfoliotheory.The risk
of the portfolioislessthanhalf (43.60%) of that of WEB, while the returnremainshighin
comparisonat 19.23% (79.33% of WEB’s return).Thisperfectlyleadstothe portfolioopportunityset
and efficientfrontier.
Spaulding,W. Modern Portfolio Theory:Efficientand OptimalPortfolios.InvestmentFundamentals

6. 6
Thisdiagramdisplaysall possiblecombinationsof individualstocksinthe greenshadedareawiththe
mostefficientonesonthe darkgreenline labelledthe efficientfrontier.Itisimportanttonote that
that while the calculatedportfolioof evenweightsisbeneficialandmayappearalongthe efficient
frontierline,the mostefficientcombinationmayinvolveagreater or lesserweightsonthe individual
stock inorderto create more negative correlations.Negativelycorrelatedportfolioscounteracteach
other- if there isa lossinone itis generallymade upforbya gainin the otherand vice versa.
Whilstitcan be pointedoutthatinvestinginTOXorMRG will bringaboutsimilarrisksandreturnsas
the portfolio,itisimportanttonote that doing sowill be puttingall eggsinone basket.If one were
to investinTOXwhose price thencrashed,the investmentwouldbe lost;however,if one investsin
the portfolioandTOXpricescrash, thislosscan be made up for inthe potential gainof anyof the
otherfourstocks.
An alternative toinvestinginthe portfoliowouldbe investinginsolelyAGK.One shouldn’tchoose to
investinthe otherindividual securitiesoverthe portfolioastheyeitherhave fartoo greata risk or
generate alesserreturnforthe same level of risk.

7. 7
Question 3:
a. Whichof the followingrisksofastockare likelyto befirm-specific,diversifiable
risks,and whicharelikelyto besystematic risks?Whichriskswill affectthe risk
premiumthat investorswill demand?[Maximum200words.]
The risk that the founderandCEO retires
i. Firmspecific,diversifiablerisk
The risk that oil pricesrise,increasingproductioncosts
ii. Systematicrisk
The risk that a productdesignisfaultyandthe product mustbe recalled
iii. Firmspecific, diversifiablerisk
The risk that the economyslows,reducing demandforthe firm’sproducts
iv. Systematicrisk
The risk that the founderandCEO retire andthe riskthat a productdesignisfaultyandthe product
mustbe recalledare bothdiversifiablerisks. Thisisbecause firmsmayputpoliciesinplace inorder
to avoidor combat suchinstancesfromoccurring.The riskthat oil pricesrise increasingproduction
costs andthe riskthat the economyslowsreducingdemandforthe firm’sproductsare both
systematicrisks.Thisisbecause bothof these are at the handsof the marketwhichisout of the
control of the firms.
It isthe systematicriskthatwill affectthe riskpremiumsthatinvestorswill demand.Thisisdue to
the uncontrollable nature of the nondiversifiablerisk.Investorswill notdemandsuchahighrisk
premiumforunsystematicriskastheyare aware that throughdiversifyingthe portfolio,firmsare
able to minimiserisktoan almostnon-existentpoint. The effortsputtowardsminimisingthe risksof
unsystematicrisksare highlybeneficial as theyaccountfor more than 50% of the total riskof most
individualsecurities(Moyer,R.,McGuigan,J.,& Rao, R. 2005).
Because systematicrisksare atlibertytochanginginterestratesandchangesinpurchasingpower
amongstotherthingsthat are all outof the firm’scontrol,investorsdemandtobe compensatedfor
riskingtheirmoneybyincreasingtheirrequiredrate of return.

8. 8
Case Study 2
Question 1:
The Commonwealthof AustraliacurrentlyhasTreasuryBondsonissue thatare due to
mature on 21 October2018. The term sheetattachingtothisseriesof TreasuryBonds
providesthe followingdetails:
 ISSUER- Commonwealthof Australia
 INSTRUMENT- TreasuryBonds
 CURRENCY- Australiandollars
 MATURITY DATE- 21 October2018
 COUPON- 3.25% per annum,paidsemi-annuallyinarrears,onthe Face Value of the bonds
 REDEMPTION- Par
 COUPONPAYMENT DATES- 21 April and21 Octoberin eachyear commencingon21 April
2014, to andincludingthe MaturityDate
 DENOMINATION- $1,000 Face Value
a. Basedoncurrent market pricesforthisbond,it ispossibleto inferthat investors
requireareturn of3% perannum, compoundingsemi-annually,oninvestments
ofthis risk. Assumingthisrequiredrateofreturnremainsconstant throughto the
bond’smaturitydate, howmuch do youexpect this bondto tradeforon 21
October2014, immediatelyafterthe couponinteresthas been paidto the holder
ofthe bond?
𝑃0 = 𝐼 (
1 −
1
(1 + 𝑘 𝑑) 𝑛
𝑘 𝑑
)+
𝑀
(1 + 𝑘 𝑑) 𝑛
𝑘 𝑑 = 3% ÷ 2 = 1.5%
𝐼 = 1000 × 0.0325 = 32.50 ÷ 2 = 16.25
𝑛 = 5 × 2 = 10 ( 𝑓𝑖𝑟𝑠𝑡 𝑡𝑤𝑜 𝑝𝑎𝑦𝑚𝑒𝑛𝑡𝑠 𝑎𝑟𝑒 𝑚𝑎𝑑𝑒,10 − 2 = 8)
𝑀 = 1000
𝑃0 = $1009.36

9. 9
b. Is this bondtradingat par, at a premiumorat a discount?Whatconditiongives
riseto this pricingrelationship?Basedonthispricingrelationship,whatcan you
inferaboutthe riskof an investmentin these bondssincetheywerefirst issued?
[Maximum200words.]
Thisbond’sface value of $1000 andpresentvalue of $1009.36 meansit currentlytradesat a
premiumof $9.36. The relationshipbetweenprice andface value isdetermined bythe relationship
betweencouponrate and yieldtomaturity.Whenthe requiredrate of returnislessthanthe coupon
rate,the bond tradesat a premiumwhich isreflectedinthisbond(requiredrate- 3% comparedto
couponrate- 3.25%). If the couponis greaterthan the requiredrate,the bond tradesat a discount
and whenthe twoare equal the bondtradesat par.
The predominantfactorgivingrise tothis relationshipisinterestrates. Parvaluesare highly
correlatedtointerestratesthuschanginginterestrateswillcause changingparvalues(if interest
ratesdecrease,the price of the bond increasesandvice versa) (Staff,I.2004). Note that par values
are alsoaffectedbychangesincreditmarketconditions,inflationand increased firmrisk(Moyer,R.,
McGuigan, J.,& Rao, R. 2005).
One can inferthisinvestmenthasnotbeenriskysince the bondswere first issued.Thisis because
the bondtradingat a premium alignswiththe value of time valueof moneytheory(moneyisworth
more today thanit isin the future) andbecause the bondprice graduallyreachesparvalue as all
otherfactors remainequal.
c. Assuminginvestors’ requiredrateofreturnfrompart a doesn’tchangethroughto
the maturity date ofthe bond;recalculatethe priceofthe bondon eachcoupon
payment date remaining,immediatelyafterthe couponinteresthasbeenpaid to
the holderofthe bond.Includethe maturity date in thispriceseries,where value
is calculatedimmediatelyafterthecouponinteresthas beenpaidbut priorto the
return ofpar valueto investors.
𝑃0 = 𝐼 (
1 −
1
(1 + 𝑘 𝑑) 𝑛
𝑘 𝑑
)+
𝑀
(1 + 𝑘 𝑑) 𝑛
Year Date Price
2014 21 April 1010.45
21 October 1009.36
2015 21 April 1008.25
21 October 1007.12
2016 21 April 1005.98
21 October 1004.82
2017 21 April 1003.64
21 October 1002.44
2018 21 April 1001.23
21 October 1000

10. 10
d. Createa linechart that plotsthe bondpriceovertime (i.e. date on the x-axis,price
onthe y-axis).Ensurethe graphandits axes haveappropriatelabels.
e. What do youobserveregardingthepriceofthe bondovertime, holdingall other
variablesconstant?Explainthefactorsthat aredrivingthisobservation.
[Maximum200words.]
While all othervariables remainconstant,itisclearto see thatthe bondprice decreasesata steady
rate until iteventuallyreachesface valueatthe time of maturity. Thisobservationispredominantly
drivenbythe linearline createdonthe graphthat isbasedon the table of annual bondprices.
The bond price decreasesovertime due tothe time value of moneyprinciple- moneyisworthmore
todaythan it isinthe future.We value moneymore todaybecause we are able toreinvestitand
make itsvalue continue toincrease overthe periodof time thatwe wouldhave hadto waitif we
didn’treceive the moneyuntil intothe future.
The formulaexplainsbothwhythe there isadecrease inprice andwhythe relationshipislinear.The
firstpart of the equation(the presentvalue of interestpayments)decreasesas n decreases- the
fewerpaymentperiodsthatare left,the lessinterestthatneedstobe paid.The secondpart of the
equationcomputesthe presentvalue of future principle payments.The graphislinearbecause the
formulausedtocalculate the paymentsisbasedonannuities (equal paymentsoverregularperiods
for a finite periodof time).Whilstthe table showsthe paymentsare notexactlyequal,the graph
showsthe differencesbetweenthe paymentsare tooinsignificanttoaffectthe lineageof the
relationship.
994
996
998
1000
1002
1004
1006
1008
1010
1012
Price($)
Date
Bond Price over Time
Payment

11. 11
Question 2
The bondsin Task 1 can be consideredasrelativelyshortterm, withonlyfouryearstomaturity.The
Commonwealthof Australiaalsohasbondsonissue thatare due to mature on 21 April 2029 that
pay the same couponrate of interest.The termsheetattachingtothislong-termseriesof Treasury
Bondsprovidesthe followingdetails:
 ISSUER- Commonwealthof Australia
 INSTRUMENT- TreasuryBonds
 CURRENCY- Australiandollars
 MATURITY DATE- 21 April 2029
 COUPON- 3.25% per annum,paidsemi-annuallyinarrears,onthe Face Value of the bonds
 REDEMPTION- Par
 COUPONPAYMENT DATES- 21 April and21 Octoberin eachyear commencingon21 April
2013, to andincludingthe MaturityDate
 DENOMINATION- $1,000 Face Value
a. Calculatethepriceof boththe shortterm (21October 2018)bondsandlongterm
(21 April 2029)bondson21October2014,immediatelyafter the couponinterest
has beenpaidto the holderofthe bonds,assumingayieldto maturity onboth
bondsof3% per annum, compoundingsemi-annually.
𝑃0 = 𝐼 (
1 −
1
(1 + 𝑘 𝑑) 𝑛
𝑘 𝑑
)+
𝑀
(1 + 𝑘 𝑑) 𝑛
Short Term Bonds 21 October 2018
𝑘 𝑑 = 3% ÷ 2 = 1.5%
𝐼 = 1000 × 0.0325 = 32.50 ÷ 2 = 16.25
𝑛 = 5 × 2 = 10 ( 𝑓𝑖𝑟𝑠𝑡 𝑡𝑤𝑜 𝑝𝑎𝑦𝑚𝑒𝑛𝑡𝑠 𝑎𝑟𝑒 𝑚𝑎𝑑𝑒,10 − 2 = 8)
𝑀 = 1000
𝑃0 = $1009.36
Long Term Bonds 21 April 2029
𝑘 𝑑 = 3% ÷ 2 = 1.5%
𝐼 = 1000 × 0.0325 = 32.50 ÷ 2 = 16.25
𝑛 = 16 × 2 + 1 = 33 ( 𝑓𝑖𝑟𝑠𝑡 𝑝𝑎𝑦𝑚𝑒𝑛𝑡𝑠 𝑎𝑟𝑒 𝑚𝑎𝑑𝑒,33 − 4 = 29)
𝑀 = 1000
𝑃0 = $1029.22

12. 12
b. Recalculatethepriceof bothbondseriesonthe same valuationdateof21 October
2014,changingonlythe yieldto maturity demandedby investors.Usea rangeof
valuesstartingat 1% perannum, compoundingsemi-annually,andincreasingin2
percentagepointintervalsto 9% perannum, compoundingsemi-annually.
𝑃0 = 𝐼 (
1 −
1
(1 + 𝑘 𝑑) 𝑛
𝑘 𝑑
)+
𝑀
(1 + 𝑘 𝑑) 𝑛
Short Term- 21 October 2018 Long Term- 21 April 2029
Yieldto Maturity (%)
(annually)
Price ($) Yieldto Maturity (%)
(annually)
Price ($)
1 1088.01 1 1303.00
3 1009.36 3 1029.22
5 937.26 5 821.03
7 871.11 7 661.83
9 810.37 9 539.37
c. Createa linechart that plotsbondpricerelativeto yieldto maturity (i.e. yieldper
annum onthe x-axis,priceon the y-axis).You shouldendupwith two bondprice
seriesplottedon the same axes – short term versuslong term. Ensure the graph and its
axes have appropriate labels.
400
500
600
700
800
900
1000
1100
1200
1300
1400
1 3 5 7 9
Price($)
Yield per Annum (%)
Price vs Yield per Annum
Short Term
Long Term

13. 13
d. At what pointdo thesepriceseriesintersect?What is significantaboutthispoint?
What do youobserveregardingpricesensitivityofeachbondseriesto changesin
yieldto maturity?If youexpect interestrates, andresultantyields,to increasein
the near future,whichbondserieswouldyoupreferto holdas an investment?
[Maximum400words.]
These price seriesintersectat $1000 and 3.25% whichisalsothe face value andthe couponrate.
Thismeansthat the pointof intersectionisthe parpointforboth the short andlongterm bonds.
Anythingabove thisistradingata premiumandanythingbelow istradingata discount. The pointat
whichthe linesintersectrepresentsthatwhenthe yieldrate is3.25%, it doesn’tmake adifference to
investorswhethertheyinvestinshortorlongterm as bothwill have a price of $1000.
There are advantagesanddisadvantagestobothbonds.Forthe short termbonds,if the interestrate
increasesafterthe periodof time one mayrenegotiatethe interestrate whichmayendupin their
favourbut thisworksthe otherway also- if the interestrate hasincreasedfromthe initial,theywill
oftenhave nochoice but to acceptthis.Long termbondsare advantageousastheycan provide
protectionfromincreasinginterestrates; however,if the interestratesdecrease duringthistime,
the investorlosesastheymustcontinue topaythe higher,initial interestrate.
The price and yieldhave aninverse relationship-whenone increasesthe otherdecreasesandvice
versa.A numberof factorscan cause investorstoincrease theirrequiredrate of return(thereby
decreasingbondprice) includinghigherinflation, tightercreditmarketconditionsandincreasedfirm
risk(Moyer,R., McGuigan,J., & Rao, R. 2005).
It iseasyto observe fromthisgraphthat the longerabond isheldfor,the more sensitiveitbecomes
to changesinyieldtomaturity whichisdemonstratedwithalargergradientonthe longtermline
comparedto the short time line.Itisclearto see thatalthoughan investor willbenefitgreatlyfroma
lowyield,theywill sufferagreatlossfroma highone wheninvestinginlongtermbondsthusitcan
be consideredmore stable andlessriskytoinvestinshorttermbonds. Whenthe yieldislessthan
3.25%, investorswill wanttoinvestinlongtermandwhenthe interestrate isgreater,investors
shouldchoose shorttermbonds. If we were expectinginterestandyieldratestoincrease inthe
future,itiswiserto holdontothe short termbondas althoughthistoois trading at a discount,its
value isstill higherthanthat of the longtermbonds.

14. 14
Question 3:
Wombat+Wombatisa well-establishedcreativedesignagencylocatedonthe Gold
Coast.It has experiencedverystable growthinbothearningsanddividendsoverthe past10 years,
averaging7% perannum.Dividendsare typicallypaidatthe endof each year,the most recent
dividendof $3.00 per share havingjustbeenpaidtoshareholders.
a. If this growthindividendsisexpectedto continueinto the foreseeablefuture, how
much wouldaninvestorbewillingto payper shareof Wombat+Wombatcommon
stockif they requireareturn of18% per annumon investmentsofthis risk?
𝑃0 =
𝐷1
𝑘 𝑒 − 𝑔
𝐷1 = 3.00 × 1.07
𝑘 𝑒 = 18%
𝑔 = 7%
𝑃0 = $29.18

15. 15
b. Wombat+Wombatisconsideringtheacquisitionofacompetingdesignagencyas
part ofits growthstrategy. Thefirm wouldneedto issuenew sharesofcommon
stockin orderto financethisacquisition.However,theacquisitionitselfwill
resultin changesto the dividends thefirmis expectedto payto common
stockholders.Specifically,thefirmwill needto suspenddividendpaymentsfora
periodoftime infavourofreinvestingearningsbackinto growthprojects
associatedwiththe acquisition.Dividendsareexpectedto resumein three years’
time, at whichpointthe firm will paya dividendof$5.00per share.Thisdividend
is subsequentlyexpectedto growat20% per annum fortwo years, at 15% per
annum forthe followingtwo years,andthen at 8% per annumthereafter. This
growthstrategywill causeinvestorsto revisetheir requiredreturnsupwardsto
20% perannum. What pricewouldinvestorsbewillingto payfornewsharesof
commonstockissuedbyWombat+Wombatto financethe acquisition?
Year Dividend($) Growth
(1+g)
Future Value
ofDividends
($)
(Dx(1+g))
Discount
Value
PV of
Expected
Returns($)
1 0 -
2 0 -
3 5 - 5
(
1
1.2
)
3
2.89
4 5 1.20 6
(
1
1.2
)
4
2.89
5 5 1.20 7.2
(
1
1.2
)
5 2.89
6 5 1.15 8.28
(
1
1.2
)
6
2.77
7 5 1.15 9.52
(
1
1.2
)
7
2.66
$14.10
𝑃9 =
𝐷8
𝑘 𝑒 − 𝑔
𝐷8 = 10.28
𝑘 𝑒 = 20%
𝑔 = 8%
𝑃7 = $85.68
85.68 × (
1
1.20
)
7
= 23.91
23.91 + 14.10 = $38.01
Investorsare willingtopay$38.01 per share afterthe acquisition.

16. 16
c. Basedonyouranswersto parts a andb, do yourecommendWombat+Wombat
proceedwiththe acquisitionofthecompetingdesignagency?Whyorwhy not?
[Maximum200words]
From a purelyfinancial perspective,IwouldrecommendWombat+Wombatproceedwiththe
acquisitionof the competingdesignagencyasinvestorsare willingtopaya higherprice forshares
afterthe merger($38.01 as opposedto$29.18). Whenconsideringwhetherornotto proceedwith
the acquisition,Wombat+Wombatshouldalsothinkabouthow theirshareholderswillreacttothe
negative consequencesof thisdecision.If investorsare unhappyabout dividendpaymentbeing
postponedforthree yearsorthe dilutionof ownershipthatwill occurfromsellingmore shares,
Wombat+Wombatshouldrevaluate theirdecision.Onthe contraryto the negative consequences
for shareholders,theyshouldweighupthese withthe increasedgrowthrate afterthe acquisition
(8% aftercomparedto 7% beforehand).

17. 17
Bibliography
Investopedia,.(2003). Diversification Definition | Investopedia.Retrieved30November2015, from
http://www.investopedia.com/terms/d/diversification.asp
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