Part A: 20 Marks

Brandon Ltd is considering the following expansion.

Details are as follows:

		Stock	Stock A	Sales		Working
	Year	Market	Share	Units	Year	Capital
	t	Index	Price			Outlays
	1993	2005	5.00	510000	0	$     2,100
	1994	2201	5.50	550000	1	$     2,600
	1995	2410	5.75	540000	2	$     3,200
	1996	2520	5.90	560000	3	$     3,700
	1997	2602	6.00	565000	4	$     4,100
	1998	2835	6.10	590000	5	$     4,500
	1999	2650	6.00	600000	6	$     4,000
	2000	2502	5.90	610000	7	$     3,500
	2001	2854	6.50	615559	8	$          –
	2002	3210	7.00	669000
	2003	3420	7.25	700000

Project Life: 8 years

Capital outlays are as follows:

·      Beginning of project: $1,500,000

·      Upgrade at end of third year: $700,000

 

Scrap / Salvage value: $25,000

The firm applies the reducing balance method of depreciation to its projects. For tax purposes the Tax Commissioner allows the use of straight line depreciation.

 

The investment analyst has decided to forecast the sales (units) by using time-trend projections.  These are to be adjusted from year four onwards to account for the increased sales resulting from the upgrade, which is estimated as 0.5 million units per year. 

 

Product price is expected to be 55 cents per unit for the first five years, and 80 cents thereafter.  Production cost is estimated to be 12 cents per unit.  Other operating costs (which do not include depreciation) are $55,000 per year for the first five years and $60,000 per year for the rest of the project life.

 

Company tax rate is 34%

Government bond yield is 5.2%

The managers believe that the degree of risk of the proposed project is basically the same as that of the existing business’ risk.  The analyst would like to use a risk-adjusted discount rate calculated by employing the CAPM.

 

Required:

 

Calculate the Accounting Rate of Return (ARR), Payback Period, NPV and IRR.  ARR has many variants and you are required to define your method used for your calculation.

 

Part B: 10 Marks

 

Consider a portfolio comprising of a $3 million investment in Ariel Ltd and a $5 million investment in in Snowy Ltd. Assume that the standard deviations of the returns for the shares are 0.4 and 0.25 respectively. Assume also that the correlation between the returns on the shares in these companies is 0.7. Assume a 4% chance of abnormally bad market conditions and that returns follow a normal probability distribution.

 

Required:

 

a.     Explain the ‘Value at Risk’ (VaR) approach to examining risk

b.     Calculate the value at risk of each individual investment and then of the portfolio.

c.     Calculate the value of risk for the portfolio if the correlation between investments increases to .85

d.     Calculate the value of risk for the portfolio if the correlation between investments increases to 1

e.     Calculate the value of risk for the portfolio if the correlation between investments decreases to .55

f.      Discuss your findings

 

 

 

Assessment Criteria:

 

Student work will generally be assessed in terms of the following criteria:

 

1.         Effectiveness of communication – ie readability, legibility, grammar, spelling, neatness, completeness and presentation will be a minimum threshold requirement for all written work submitted for assessment. Work that is illegible or incomprehensible and does not meet the minimum requirement will be awarded a fail grade.

 

2.         Accuracy – This will be the primary criterion for assessing the computational and procedural tasks.

 

3.         Demonstrated understanding – This will be evidenced by the student’s ability to be dialectical in the discussion of contentious issues. Few, if any, accounting concepts are scientific facts and stereotype answers will demonstrate poor understanding on the part of the student.

 

4.         Evidence of research – This will be evidenced by the references made to the statutes, accounting standards, books, journal articles and inclusion of a bibliography.

 

Note:

 

1.         All written work must conform with the University of Ballarat General Guide for the Presentation of Academic Work.

 

2.         For all written work students must ensure that they submit their own original work. Any act of plagiarism will be severely penalised.