1) William Brown owns 12% of Bobcat Ltd. In 2016-17, Bobcat reported profits of $600,000 and expects 2017-18 profits to be 25% higher. It pays dividends at a 70% payout ratio. 2) Jack wants to spend $100,000 in mid-2018. How much can he consume in mid-2017 if he earns 9% interest? 3) This question involves calculating the present value of a perpetual scholarship fund paying inflation-adjusted amounts into the future.

1. QUESTION `1.
[6 + 8 = 1
4
Marks.]
a)
This is a two
period certainty model problem.
Assume that William
B
rown
has a sole income from
Bob
cat Ltd
in which he owns 12
% of the ordinary share capital.
In its
financial year
2016-17
just ended,
Bob
cat Ltd
reported
net profits after tax of $6
0
0
,000, and
announced its
net profits after tax
expectation for the
next financial year, 2017-18,
to be
25

2. % higher
than this year’s figure
. The company operates w
ith a dividend payout ratio of 7
0%,
which it plans to continue,
and will pay the annual
dividend for 2016-17 in mid-August,
2017, and the
dividend for 2017-18 in mid-August
, 2018.
In mid-August, 2018
,
Jack
wishes to
spend $10
0
,000
, which will include the cost of a new car.
.
How much c
an he consume in mid-August, 2017
if the capital mar
ket offers an interest rate of
9
% per year?

3. QUESTION 1 continued.
b)
This qu
estion relates
to the valuation of shares.
Big Ideas Ltd has just paid a dividend of $1.20 a share.
Investors require a 12% per annum return on investments such
as Big Ideas. What would a share in Big Ideas Ltd be expected

4. to sell for today
(August, 2017)
if the dividend is expected to increase by 20% in August, 2018,
15% in August, 2019, 10% in August, 2020 and
thereafter
by 5 per cent a year for
ever, from August, 2021 onwards?

5. QUESTION 2.
[(4 + 6) + (4 + 4 + 4 + 4 + 4) = 3
0
Marks]
a)
This question relates to the time value of money and deferred
perpetuities.
Colin Greenway attended
Bunyip High School in the 1970s. After leaving school, Colin
became a successful entrepreneur and is now very wealthy. He
wishes to establish a perpetual scholarship fund which will
provide $10,000 a year, payable to five high performing
students
at Bunyip High School
each year in Year 12, that is, $50,000 a yea
r, starting in early 2020
. It is now early 2017. The High School Principal believes that
the required fun
ds can be invested at 5 per cent
a year in perpetuity.
i)

6. What is the present value in early 2017
of the whole income stream
, and th
us the amount which Colin must contribute to establish the fund
?
ii)
The High School Principal, while most appreciative of C
olin’s
great
ge
nerosity, mentio
ns that fees at Bunyip High
are rising on average by 3 per cent every year because o
f inflation, and
that in several year
s
,
$10,000 will not be enough to keep a student in year 12 for a
whole year. Colin decides that he will increase the amount to
establish the fund so as to provide for increases in the
scholarship amount by 3 per cent a year
in perpetuity
, the first increase occurring in
early 2021.

7. How mu
ch extra (above the amount calculated in i) above, will Colin
need to contribute
in early 2017
so as to provide for th
ese inflation increases forever?
[
HINT:
Consider a formula similar to the dividend
growth model.]
QUESTION 2 continued
.
b)
This question relates to loan repayments and loan terms.
Ron and Robin Reid
wish to borrow
$54

8. 0,000 to
buy a home
.
The loan
from Bigg
les
Bank requires
equal monthly repayments over 20
years
, and carries
.
an
in
te
re
st rate o
f 7.8
% per annum, compou
nded monthly.
The first repayment is due at the end of the first month.
You are required to calculate:
i)
t
he effective annual interest rate on the above loan.

9. ii)
t
he
amount of the monthly repayment (consisting of interest and
principal repayment components) if the same amount is to be
repaid every
month over
the 20 year period of the loan.
iii)
t
he amount of $X, if -
in

10. stead of the above -
Biggles Bank agrees
that Ron and R
obin will repay
the loan by paying the bank
$3,300 per month for the first 12 months, then $3,750 a month
for the next 12 months
, and after that $X per month for the balance of the 20 year
term.
QUESTION 2
b)
continued.
iiii)
how long (in years and months) it would take to repay the loan
if
, alternatively,
Ron and Robin decide to repay $2,500 per month, with the first
repayment again being at the end of the first month after taking
the loan, and continuing until the loan was repaid.

11. v)
u
nder o
ption iv
) above, the amount of the final
re
payment. [NOTE: Towards the end of the loan repayment
period, after the final full monthly instalment of $2,500 is paid,
a lesser amount is likely to be outstanding. That amount, plus
interest to the end of the following month, is the final
loan repayment amount.]

12. QUESTION 3.
[(2 + 3 + 3 + 4 + 3 + 3) + (6 + 2 + 4) = 30
marks]
a)
This question relates to
alternative investment choice techniques
Stanley Livingstone
is considering the following cash flows for two mutually
exclusive projects.
Year
Ca
sh Flows,
Investment X
($) Cash Flows,
I
nvestment Y
($)
0
-40,000 -40,000
1 12,000
18,000
2 18,000
18,000
3 27,000
18,000
You are required to
answer
the following questions

13. :
i)
If the cash flows after year 0 occur evenly over each year, what
is the payback period for each project, and on this basis, which
project would you prefer?
IN THE REMAINING PARTS, ASSUME THAT ALL CASH
FLOWS OCCUR AT THE END OF EACH YEAR.
ii)
Would the payback periods
then
be any different to your answer in i)?
If so, what would the payback periods be?

14. QUESTION 3
a)
continued.
iii)
Sketch
freehand
the net present value (NPV) profiles for each investment on the
same graph.
Label
both axes and the NPV profile for each investment.

15. iiii)
Calculate the internal rate of return (IRR) for each project and
indicate them on the graph.
[NOTE: It is satisfactory if t
he approximate
IRR is
calculated for
Investment X by trial and error, and stated as a percentage
correct to the nearer whole number. The IRR for Investment Y
should be calculated as a percentage exactly, correct to 1
decimal place.]
QUESTION 3 a) continued.
v)

16. Calculate the exact crossover point and indicate it on the
above
graph.
vi)
State which of the investments you would prefer, depending on
the required rate of return (i.e., depending on the discount rate).
b)
This question relates to the valuation of bonds.

17. Bradley White
, a retired school teacher, has two
6
per cent per annum
$100,000 Australian Governme
nt bonds that mature on 15 August, 2020 and 15 August, 2023
respectively.
At the date of the last half-yearly
interest payment, viz., 15 February, 2017
, both bonds were selling at par.
Since then, interest yields on bonds have risen by 2% per
annum, compounded half-yearly.
Bradley
now intends to sell the bonds and put a deposit on a
suburban townhouse
.
i)
Calculate the price
he will receive from eac
h bond if he sells on 15 August
, 2017
at the new yield, immediately after receiving the interest
payments due that day.
QUESTION 3 b) continued.

18. ii)
Explain the relative price movements in the two bonds, as
evidenced in your answer to i) above.
iii)
Suppose that Bradley defers buying the bonds for 84
days,
that is until 7 November, 2017. How much will he pay for each
bond on that day
?
[
NOTE: Between the bond interest due dates from mid-August to
mid-February is 184 days, during which time interest accrues on
a compound basis.]

19. QUESTION 4.
[24 + 2 = 26
marks].
This question relates to capital budgeting.
Perth Projects
Ltd
is considering the purchase
of
new technology
cos
ting $6
0
0,000
, which it will fully finance
with a fixed interest loan of 10
% per annum, with the
principal repaid at the end of 4
years
.

20. The new technology
will permit the company to reduce its to reduce its labour costs
by $
20
0,000 a year for 4
years, and the
technology
may be
depreciated for tax purposes by the straigh
t-line method to zero over the 4
years.
T
he company think
s that it can sell the technology
at the end of 4
years
for $
3
0
,000.
The technology
will need to be stored in a building, current
ly
being rented
out
for $4
0
,000 a year
under a leas
e agreement
with 4
yearly
rental payments
to run

21. , the next one being due at the end of one year. Under the lease
agreement,
Perth Projects
Ltd can cancel the lease by
paying the tenant (now) compensation
equal to one year’s rental payment
plus 10%
, but this amount is not deductible for income tax purposes.
This is not the first time that the company has considered this
purchase. Twelve months
ago, the company engaged Marvel
Consultants, at a fee of
$30
,000 paid
in ad
vance, to conduct a feasibility study
on savings stra
tegies and
Marvel
made the above recommendations. At
the time,
Perth P:rojects
did
not procee
d with the recommended strategy, but
is now reconsidering the propo
sal.
Perth Projects
further
estimates that
it wil
l have
to spend $20
,000 in 2 years’ time overhauling the technology

22. .
It will
also
require
additions to current assets of $
30
,000 at the beginning of the project, which will be fully r
ecoverable at the end of the four
th year.
Perth Projects
Ltd’s
cost of
capital is 10
%.
The tax rate is 30%.
Tax
is paid
in
the year in wh
ich earnings are received.
REQUIRED
:
(a)
Calculate the net pres
ent value
(NPV)
, that is, the net be
nefit or net loss in present va
lue
terms of the proposed purchase
costs
and the resultant incremental cash flows.
[

23. HINT:
As shown in the text-book, it is recommended that for each
year you calculate the tax effect first, then identify the cash
flows, then calculate the overall net present value.]
QUESTION 4 a) continued.

24. (b)
Should the company
purchase the technology
? State clearly why
or why not
.