ACC515 Accounting And Finance For The Present Value Of The Whole Investment : Solution Essays

Questions:

For the following numerical problems, detailed answers must be shown. This involves providing a brief description of the problems, formulae used, progressive and final answers to the questions. For assignments you are expected to show your workings using the appropriate formula.
a.Sandy expects to receive the following stream of cash flows from an investment over the next 5 years:
End of year Cash flow (\$)
1 400
2 800
3 500
4 400
5 300

If the relevant rate of interest is 9% per annum on this investment, how much should she pay for this investment opportunity? (4 marks)
b.Lee has taken out a loan of \$100,000 with an interest rate of 10% per annum. The loan is to be paid off by 20 equal quarterly payments; the first payment is due today. How much will Lee’s quarterly payment be? (4 marks)
c.Dianne won a lottery prize of \$200,000. She invested the entire amount and expects a yearly return of 10% per annum compounded monthly on her investment. Dianne will receive 150 equal monthly payments with the first payment due to be paid to her in exactly 2 years. Find the size of the monthly payments that Dianne will receive. (7 marks)
Question 2 (15 marks)
This question relates to material covered in the Topics 1 to 3. This question addresses the 5th and 6th subject learning outcomes.
Following is an example of a cash flow timeline developed using the Table Function within MS Word. Please use this example as a means to develop a similar timeline in your answer to the following question

1. Using the Table function within MS Word, draw a time line showing the above cash flows and interest rates .
2. What will be the value of all these cash flows at each of the following times:
-Time 1
-Time 5
-Time 10

Requirement a:

Sandy would receive a stream of cash flows within the next 4 years. Therefore, it is necessary to determine the discounted values of the expected cash flow stream for computing the present value of the whole investment. The formula of discounted cash flow is shown below:

Where, CFn = Cash flow of n period

r= Interest Rate

n = Period

By using the stated formula, the present value of the investment is calculated below:

ΣDCF =  +  + + +

=   +  + + +

=   +  + + +

=

= 1904.76

As per the above calculations, it can be stated that Sandy has to pay \$1,904.76 for the investment option to earn the given cash flow streams.

Requirement b:

Lee has to repay the loan of \$100,000 by 20 equal installments. Such equal installments for a specified period are referred as annuity. The formula of annuity is given below:

P =

Where, PV = Present Value of Loan = \$100,000

r= Interest Rate per period = (10%/4) = 2.5%

n = Nos. of Quarterly Installments = 20

Therefore, P =

=

=

=

As per the calculations above, the quarterly payment of Lee will be \$6,414.71.

Requirement c:

Dianne would receive the monthly payments after two years of investment. Hence, it is necessary to compute the investment value after two years. The future value of the investment can be computed by using the following formula:

FV =

Where, PV = Present value of investment = \$200,000

r= Interest Rate per compounding periods = (10%/12 months) = 0.83%

n = Nos. of Compounding Periods = (2 yrs. X12 months) = 24

Hence, FV =

=

=

Now, Dianne would receive \$2,44,078.19 through 150 equal monthly installments. The formula used for calculating the monthly payments is as follows:

P =

Where, PV = Investment Value after 2 years = \$2,44,078.19

r= Interest Rate per period = (10%/12 months) = 0.83%

n = Nos. of Monthly Installments = 150

Therefore, P =

=

=

=

Dianne would receive \$2,856.69 as monthly payments after 2 years from the stated investment.

Requirement i:

 % 8% 6% 7% Year 0 1 2 3 4 5 6 7 8 9 10 CFi \$0 \$0 \$6500 \$1500 \$0 \$0 -\$2500 \$0 \$0 \$10000 \$0

Requirement ii:

The formula, used for calculating the value of cash flows, is as follows:

Where, CFn = Cash flow of n period

r= Interest Rate

n = Period

Value of Cash Flow on Time1 :

ΣDCF1 =

=   = \$0

Value of Cash Flow on Time5 :

ΣDCF5 = =  +  + + +

=   +  + + +

=   +  + + +

=

The Australian government on 1st September introduced the treasury laws amendment bill that proposed the reduction of corporate tax rate for all the reporting entities from 30% to 25% (www.ato.gov.au 2018). For larger companies, government would bring into tax cut and witnessing overtime reduction in rates. Reduction rate in corporate tax rate is done for proposing and encouraging investment mainly highly mobile foreign direct investment. This reduction in taxation rate would help in lowering would help in increasing income for Australians in the long-run. Such acceleration in investment is done by building more productive and larger capital stock and generating knowledge spillovers and technology. Not only higher growth would be encouraged by building a more productive and larger capital stock, but it will also help in generating higher wages. It was indicated by some views on taxation of company that the corporate taxation rate should be reduced to 25% with the timing that is subjected to fiscal and economic circumstances. At the same time, there should be introduction of making arrangements for charging for the use of non-renewable sources of energy. It is indicated by the theoretical concepts that lowering the taxation rate would help in stimulating wages and investments. A large chunk of reduction in taxation rate of company would be met immediately by increasing the burden through personal income taxation. The reason is attributable to the fact that lowering Australian corporate taxation rate would immediately result in lowering franking credits for domestic shareholders that helps in offsetting their liabilities of personal income taxation (Stewart, 2017).

Nevertheless, the benefits attributable from any reduction in corporate taxation rate of Australia would largely go to owner of capital and foreign investors resulting from unique system of dividend imputation of Australia.  Australia is one of the few countries having the unique system of dividend imputation that effectively helps in lowering the taxation rate and in this regard, local companies operating in country are delivered with franking credits indicating that if the company is paying higher taxation rate or more amount of tax less amount then investors would be paying less (Faff, 2015). Dividend imputation is basically a mechanism that helps in providing some tax payers credits to residents for company tax that deemed to have been paid on behalf of company. Dividends are attached to the franking credits are the actual mechanisms for making delivery of tax credits to residents (Davis, 2016). For the tax residents of Australia, from the perspective of investment, the company taxation rate is irrelevant. Therefore, the impact of corporate tax rate is quite different because of system of tax imputation of Australia. For the Australian tax holders, the company tax rate is effectively a withholding tax as the amount is returned when the dividend payment is done. Reduction in corporate tax rate would have a direct benefits attributable to foreign investors and lower rate would attract new foreign investors to Australia. Moreover, arrangement by other foreign investors to make little payment or no taxation in Australia and reducing that the statutory rate does not impact them. A lower taxation rate would encourage investment and investment as potential returns generated would be higher (Loughran & McDonald, 2016). It is so because in the competitive global market, higher taxation rate would discourage investment in Australia and thereby dislocating economic activity.

If the corporation tax is highly disproportional, it is indicative of the fact that there will be lower business creation and fewer jobs. Amount of lower investment in capital would mean lower productivity and income for workers. For consumers, lower taxation rate would mean lower price and higher amount of product and services. Over the subsequent years, lower corporate taxation rate is correlated with skyrocketing revenue and revenue of government will also increase due to reduction in corporate tax rate of company (Adler & Stringer, 2016).

Requirement i:

The monthly holding period returns are calculated by using the formula, stated below:

Ri =

Where,  = Current Month’s Closing Stock Price

= Previous Month’s Closing Stock Price

Requirement ii:

The average monthly holding period returns are calculated by using the formula, stated below:

Average Monthly Returns =

By using the above formula, the Average monthly holding period returns of NAB, BHP and All Ordinary Index are calculated in the following table:

 NAB BHP AORD Date Closing Price Return Closing Price Return Closing Price Return 31-01-2016 24.19 15.57 4947.90 29-02-2016 26.24 8.47% 16.86 8.29% 5151.80 4.12% 31-03-2016 27.19 3.62% 20.68 22.66% 5316.00 3.19% 30-04-2016 27.15 -0.15% 19.08 -7.74% 5447.80 2.48% 31-05-2016 25.43 -6.34% 18.65 -2.25% 5310.40 -2.52% 30-06-2016 26.54 4.36% 19.52 4.66% 5644.00 6.28% 31-07-2016 27.34 3.01% 20.43 4.66% 5529.40 -2.03% 31-08-2016 27.87 1.94% 22.38 9.54% 5525.20 -0.08% 30-09-2016 28.00 0.47% 23.07 3.08% 5402.40 -2.22% 31-10-2016 28.93 3.32% 24.41 5.81% 5502.40 1.85% 30-11-2016 29.70 2.66% 25.06 2.66% 5719.10 3.94% 31-12-2016 30.33 2.12% 26.64 6.30% 5675.00 -0.77% Average Monthly Return 2.14% 5.24% 1.29%

Requirement iii:

The formula of annual holding period return, used in the following table is as follows:

Annual Holding Period Returns =  – 1

Where,  = Monthly Return of Last month

= Monthly Return of First month

 NAB BHP AORD Date Closing Price Return Closing Price Return Closing Price Return 31-01-2016 24.19 15.57 4947.90 29-02-2016 26.24 8.47% 16.86 8.29% 5151.80 4.12% 31-03-2016 27.19 3.62% 20.68 22.66% 5316.00 3.19% 30-04-2016 27.15 -0.15% 19.08 -7.74% 5447.80 2.48% 31-05-2016 25.43 -6.34% 18.65 -2.25% 5310.40 -2.52% 30-06-2016 26.54 4.36% 19.52 4.66% 5644.00 6.28% 31-07-2016 27.34 3.01% 20.43 4.66% 5529.40 -2.03% 31-08-2016 27.87 1.94% 22.38 9.54% 5525.20 -0.08% 30-09-2016 28.00 0.47% 23.07 3.08% 5402.40 -2.22% 31-10-2016 28.93 3.32% 24.41 5.81% 5502.40 1.85% 30-11-2016 29.70 2.66% 25.06 2.66% 5719.10 3.94% 31-12-2016 30.33 2.12% 26.64 6.30% 5675.00 -0.77% Annual Holding Period Return 1.90% 4.58% 1.15%

Requirement iv:

The formula for Standard Deviation, used below, is as follows:

 NAB BHP AORD Date Closing Price Return Closing Price Return Closing Price Return 31-01-2016 24.19 15.57 4947.90 29-02-2016 26.24 8.47% 16.86 8.29% 5151.80 4.12% 31-03-2016 27.19 3.62% 20.68 22.66% 5316.00 3.19% 30-04-2016 27.15 -0.15% 19.08 -7.74% 5447.80 2.48% 31-05-2016 25.43 -6.34% 18.65 -2.25% 5310.40 -2.52% 30-06-2016 26.54 4.36% 19.52 4.66% 5644.00 6.28% 31-07-2016 27.34 3.01% 20.43 4.66% 5529.40 -2.03% 31-08-2016 27.87 1.94% 22.38 9.54% 5525.20 -0.08% 30-09-2016 28.00 0.47% 23.07 3.08% 5402.40 -2.22% 31-10-2016 28.93 3.32% 24.41 5.81% 5502.40 1.85% 30-11-2016 29.70 2.66% 25.06 2.66% 5719.10 3.94% 31-12-2016 30.33 2.12% 26.64 6.30% 5675.00 -0.77% Annual Holding Period Return 1.90% 4.58% 1.15%

Requirement iv:

The formula for Standard Deviation, used below, is as follows:

S =

Where, = Monthly Returns

= Average Monthly returns

n= Nos. of Monthly Returns

 NAB BHP AORD Date Closing Price Return Closing Price Return Closing Price Return 31-01-2016 24.19 15.57 4947.90 29-02-2016 26.24 8.47% 16.86 8.29% 5151.80 4.12% 31-03-2016 27.19 3.62% 20.68 22.66% 5316.00 3.19% 30-04-2016 27.15 -0.15% 19.08 -7.74% 5447.80 2.48% 31-05-2016 25.43 -6.34% 18.65 -2.25% 5310.40 -2.52% 30-06-2016 26.54 4.36% 19.52 4.66% 5644.00 6.28% 31-07-2016 27.34 3.01% 20.43 4.66% 5529.40 -2.03% 31-08-2016 27.87 1.94% 22.38 9.54% 5525.20 -0.08% 30-09-2016 28.00 0.47% 23.07 3.08% 5402.40 -2.22% 31-10-2016 28.93 3.32% 24.41 5.81% 5502.40 1.85% 30-11-2016 29.70 2.66% 25.06 2.66% 5719.10 3.94% 31-12-2016 30.33 2.12% 26.64 6.30% 5675.00 -0.77% Standard Deviation 3.60% 7.54% 2.99%

Requirement vi:

The CAPM Formula for Expected Return is as follows:

Er  = rf  + (β x rmp)

Where, rf  = Risk Free Rate

β= Beta

 NAB BHP Beta 1.23 0.9 Risk Free Rate 2.95% 2.95% Market Return 6.50% 6.50% Expected Return 7.32% 6.15%

Requirement viii:

The formula of Portfolio Return & Portfolio Beta are given below:

Pr  = (w1 x r1) + (w2 x r2)

βp = (w1 x β1) + (w2 x β2)

Where, w1 = Weightage of NAB

w2 = Weightage of BHP

r1 = Average Monthly Return of NAB

r2 = Average Monthly Return of BHP

β1 = Beta of NAB

β2 = Beta of BHP

 NAB BHP Beta 1.23 0.9 Portfolio Weightage 30% 70% Portfolio Return 4.312% Portfolio Beta 1.00

Requirement ix:

Based on analysis of CAPM and SML, the portfolio of assets in which the investor would be making investment is in the shares of BHP Billiton and shares of NAB (Beaumont, 2015) It can be seen from the computation that return generated by the portfolio would be 4.312% with value of portfolio beta is 1. However, the average return generated by shares of BHP is more than that of BHP Billiton Limited. On other hand, the deviation of return generated from the shares of BHP Billiton is more than that of NAB. Therefore, returns generated by individual stocks has its own risks and returns and making a portfolio of both the assets would lead to generation of average monthly return of 1.29% and with annual holding period of 1.15% and variation of 2.29%.

References list:

Adler, R., & Stringer, C. (2016). Practitioner mentoring of undergraduate accounting students: helping prepare students to become accounting professionals. Accounting & Finance.

Balachandran, B., Henry, D., & Vidanapathirana, B. (2016). Long-Term Price Reaction to Dividend Reduction in an Imputation Environment–Evidence from Australia.

Balachandran, B., Khan, A., Mather, P., & Theobald, M. (2017). Insider ownership and dividend policy in an imputation tax environment. Journal of Corporate Finance.

Baykov, A., & Pavuk, O. (2017). Financial Market in the Context of Globalization: Experience of Economic and Legal Analysis. Accounting and Finance, (1), 120-131.

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Davis, K. (2016). DIVIDEND IMPUTATION and the Australian financial system.

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Loughran, T., & McDonald, B. (2016). Textual analysis in accounting and finance: A survey. Journal of Accounting Research, 54(4), 1187-1230.

Loughran, T., & McDonald, B. (2016). Textual analysis in accounting and finance: A survey. Journal of Accounting Research, 54(4), 1187-1230.

Ratiu, R. V. (2015). Financial reporting of European banks during the GFC: a pitch. Accounting & Finance, 55(2), 345-352.

Reducing the corporate tax rate. (2018). Ato.gov.au. Retrieved 2 April 2018, from https://www.ato.gov.au/General/New-legislation/In-detail/Direct-taxes/Income-tax-for-businesses/Reducing-the-corporate-tax-rate/

Scholes, M. S. (2015). Taxes and business strategy. Prentice Hall.

Stewart, M. (2017). Australia’s Hybrid International Tax System: Limited Focus on Tax and Development. In Taxation and Development-A Comparative Study (pp. 17-41). Springer, Cham.

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Unda, L. A. (2015). Board of directors characteristics and credit union financial performance: a pitch. Accounting & Finance, 55(2), 353-360.

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