Financial Case Studies: Retirement Annuity, Stock Investment, Capital Budgeting And Share Analysis

Case Study 1:-

The rate of return, required by Smith, to accumulate AUD 1,600,000 after 15 years, is computed below:

Computation of Required Rate of Return:
Particulars		Amount Save Time On Research and Writing Hire a Pro to Write You a 100% Plagiarism-Free Paper. Get My Paper
Fund Required after 15 years	A	$1,600,000
Current Value of Investment Asset	B	$900,000
Less: Withdrawal for Children’s trust	C	$25,000
Balance of Investment Asset	D=B-C	$875,000
Balance Fund required	E=A-D	$725,000
Annual Savings	F	$25,000
Period (in yrs.)	G	15
Required of Return	H=RATE(G,F,0,(-E),0)	8.84%

The required rate of return in accordance to the financial information of Company P, provided, is calculated below:

Calculation of Required Rate of Return:-
Particulars		Amount
Total Book Value of Equity	A	$50,000,000
Net Income	B	$5,000,000
Total Dividends Paid	C	$2,000,000
Total nos. of Shares Outstanding	D	1000000
Current Market Price per share	E	$55
Dividend per share	F= C/D	$2
Earning Per Share	G=B/D	$5
Retention Rate	H=1- (F/G)	60%
Return on Equity	I=B/A	10%
Dividend Growth Rate	J=HxI	6.00%
Expected Dividend	K=Fx(1+J)	2.12
Required Rate of Return	L=J+(K/E)	9.85%

The required rate of return of Company P is 9.85%. If Smith would invest in Company P, then he would get (10% – 9.85%) 0.15% lesser returns than his expected returns. As the variance is insignificant, Smith may invest in the stocks of Company P.

There are several capital budgeting processes used for evaluating long time projects. However, amongst those various techniques, Net Present Value and Internal Rate of Return consider the time value of money and provide more appropriate outcome. Hence, these two methods are applied for applied for evaluating the new expansion.

The initial investment outlay for the project is as follows:

Initial Investment Outlay:
Particulars		Amount
Cost of Building	A	30000
Cost of Equipment	B	20000
Working Capital Investment	C	10000
Total Initial Investment Outlay	D=A+B+C	60000

The operating cash flows, expected to be generated in each year, are shown below:

Opetating Cash Flow:
Particulars		Amount
Annual Sales	E	80000
Variable Cost	F=Ex60%	48000
Depreciation on Building	G=A/20	1500
Depreciation on Equipment	H=B/5	4000
Other Fixed Costs	I	10000
Total Annual Cost	J=F+G+H+I	63500
Net Operating Income	K=E-J	16500
Less: Tax	L=Kx40%	6600
Operating Profit after Tax	M=K-L	9900
Add: Depreciation on Building	G	1500
Add: Depreciation on Equipment	H	4000
Net Operating Cash Flow	N=M+G+H	15400

At the end of the fourth year, the project would generate the terminal cash flow, as stated below:

Terminal Year Cash Flow:
Particulars		Amount
Market Value of Building	O	25000
Market Value of Equipment	P	6000
Total Expected Sales Proceedings	Q=O+P	31000
Less: Book Value of Building	R	24000
Less: Book Value of Equipment	S	5000
Profit on Sale of Assets	T=Q-R-S	2000
Tax on Profit	U=Tx40%	800
Net Terminal Year Cash Flow	V=Q-U	30200

The net present value and the internal rate of return of the new expansion plan are computed in the following table:

Capital Budgeting Analysis:
Particulars	0	1	2	3	4
Initial Investment Outlay	-60000	0	0	0	0
Annual Operating Cash Flow	0	15400	15400	15400	15400
Terminal Year Cash Flow	0	0	0	0	30200
Net Cash Flow	-60000	15400	15400	15400	45600
Cost of Capital	12%	12%	12%	12%	12%
Discounted Cash Flow	-60000	13750	12276.79	10961.42	28979.62
Net Present Value	5967.83
IRR	3.43%

As the table, the plan would generate positive NPV and therefore, can be considered for investment. However, the internal rate of return of the project is 3.43%, which is very low in comparison to the cost of capital. Hence, from the investors’ perspective, the project might not be profitable enough.

	CBA	Market Index
Date	Stock price	Monthly Return	Yearly Return	Market price	Yearly Return
Jun-11	30.20			5327.00
Jul-11	31.29	3.63%	3.63%	5310.40	-0.31%
Aug-11	29.56	-5.54%	5447.80
Sep-11	31.97	8.17%	5316.00
Oct-11	30.76	-3.80%	5151.80
Nov-11	31.94	3.84%	4947.90
Dec-11	32.88	2.93%	5056.60
Jan-12	33.40	1.60%	5344.60
Feb-12	33.85	1.36%	5218.20
Mar-12	35.12	3.73%	5288.60
Apr-12	33.38	-4.95%	5058.60
May-12	35.88	7.49%	5222.10
Jun-12	38.87	8.34%	5681.70
Jul-12	38.91	0.09%	0.09%	5451.20	-4.06%
Aug-12	39.64	1.88%	5774.90
Sep-12	41.05	3.55%	5773.70
Oct-12	42.43	3.36%	5861.90
Nov-12	44.20	4.17%	5898.50
Dec-12	45.81	3.65%	5551.60
Jan-13	49.56	8.18%	5388.60
Feb-13	50.10	1.10%	5298.10
Mar-13	54.11	8.00%	5505.00
Apr-13	49.25	-8.97%	5296.80
May-13	50.96	3.47%	5624.60
Jun-13	54.67	7.27%	5623.10
Jul-13	55.85	2.16%	2.16%	5382.00	-4.29%
Aug-13	54.60	-2.24%	5473.80
Sep-13	58.33	6.84%	5470.80
Oct-13	59.67	2.29%	5403.00
Nov-13	59.65	-0.03%	5415.40
Dec-13	56.91	-4.59%	5205.10
Jan-14	59.30	4.18%	5353.10
Feb-14	61.50	3.72%	5314.30
Mar-14	62.66	1.89%	5420.30
Apr-14	64.80	3.41%	5217.70
May-14	64.24	-0.87%	5125.30
Jun-14	66.51	3.55%	5035.70
Jul-14	67.17	0.98%	0.98%	4775.40	-5.17%
Aug-14	62.19	-7.42%	4914.00
Sep-14	66.47	6.89%	5168.60
Oct-14	66.67	0.30%	4979.90
Nov-14	70.75	6.11%	5120.40
Dec-14	73.78	4.30%	4901.00
Jan-15	78.31	6.13%	4664.60
Feb-15	79.57	1.61%	4518.00
Mar-15	75.71	-4.85%	4535.40
Apr-15	72.49	-4.25%	4406.30
May-15	72.52	0.05%	4339.00
Jun-15	74.59	2.85%	4289.40
Jul-15	66.92	-10.29%	-10.29%	4135.50	-3.59%
Aug-15	64.82	-3.14%	4133.70
Sep-15	68.39	5.51%	4467.20
Oct-15	70.80	3.52%	4420.00
Nov-15	76.23	7.68%	4388.10
Dec-15	70.12	-8.02%	4325.70
Jan-16	64.99	-7.31%	4111.00
Feb-16	69.42	6.81%	4184.70
Mar-16	68.46	-1.37%	4360.50
Apr-16	71.74	4.79%	4070.10
May-16	68.91	-3.95%	4369.90
Jun-16	68.41	-0.73%	4500.50
Average Yearly Return	-0.69%	-3.48%
Total Risk Associated (SD)	4.76%	3.70%
Systematic Risk of CBA	0.26507622
Unsystematic Risk of CBA	0.73492378