The current share prices of AMP and Commonwealth Bank of Australia (CBA) are 3.22 and 71.94 as of 22nd September, 2018 (Asx.com.au. 2018).
The trend analysis of share price of AMP over 5 years can be evaluated
it can be inferred that the share prices have declined over the last few years. The highest was in the year 2015 and the current share price can be considered as the lowest in comparison to other years. This cannot be considered as a positive sign for the firm AMP..
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The trend analysis of share price of Commonwealt Bank of Australia (CBA) over 5 years
it can be inferred that the share prices have declined over the last few years. The highest was in the years 2015 and 2016 (85.39 and 85.53) and the current share price can be considered as the lowest in comparison to other years (Asx.com.au. 2018). The trend of the share prices cannot be considered as a positive sign for CBA as its share prices are declining over the past few years
The Royal commission was established in December, 2017. The major role of Royal Commission is to identify any Australian financial services are dealing in any misconduct activities. However, the activities of Royal commission can be considered as positive in the long run, however, in case of short run, it may cause collateral damage to the economy of Australia. In case of market risk (systematic risk), the impact will be negative, as interest rates will decline due to its wide impact in Australian economy. It has been observed that the interest rates of Australia has gone down to 1.5 percent (The New Daily. 2018). In case of unsystematic risk, it will have a negative impact on the share prices of the firms and this will cause the investors to lose their money. In addition to this, this will lead the banks to suffer reputational distress and hamper their brand image (Viney and Phillips 2015). It will also have a negative impact on Australian stock market as a whole. Therefore, it can be concluded that Royal commission will have a negative impact upon both systematic and unsystematic risk.
Royal commission have investigated upon the misconduct of both AMP and CBA. The major findings are as follows:-
This has caused a negative impact upon both AMP and CBA. In case of AMP, the market value of the firm has dropped by $4million. CBA had to pay a penalty of $700 million civil penalty as a result of its misconduct (CNBC. 2018).
When the news of misconduct came in, the shares of AMP went down by 5 percent which was the lowest since 2003. Since February when the inquiry of the commission started, the shares of AMP went down by 36 percent, which is not a very good sign for the firm.
In case of CBA, the bank paid a penalty of $700 million as civil penalty. However, the bank also declared 8.6 percent dividend yield which is exceptionally high (Mfam.com.au 2018). This attracted more investors. After the news, the share prices of CBA did fall to 67.45 percent during May and June, however, due to declaration of dividend, the prices got increased again in July, 2018 (The New Daily. 2018).
The difference between Net present value and Internal rate of return can be explained with the help of the following table:-
|
NPV |
IRR |
|
|
Definition |
Total summation of all the present values of cash flows is termed as Net present value of the project |
The rate of return in which summation of discounted cash inflows is equal to cash out flows is termed as IRR |
|
Significance |
It represents the total amount of surplus from the project |
It represents the break-even point of the project |
|
Value |
NPV is expressed in absolute terms of value |
IRR is expressed in percentages |
|
Changes in expected rate of return |
If expected rate of return decreases, NPV will increase and vice versa |
Changes in expected rate of return do not have any impact on IRR |
|
: |
Table 1: Difference in Net Present Value and Internal rate of return
(Source: Weber 2014)
The calculations of Net Present Value can be evaluated with the help of the following table:-
|
Project X |
Project Y |
|||
|
Rate of return |
12% |
Rate of return |
12% |
|
|
Initial investment |
($300,000) |
Initial investment |
($300,000) |
|
|
Inflow year 1 |
$80,000 |
Inflow year 1 |
$160,000 |
|
|
Inflow year 2 |
$140,000 |
Inflow year 2 |
$160,000 |
|
|
inflow year 3 |
$130,000 |
inflow year 3 |
$160,000 |
|
|
Inflow year 4 |
$160,000 |
Inflow year 4 |
$160,000 |
|
|
Inflow year 5 |
Inflow year 5 |
$160,000 |
||
|
Inflow year 6 |
Inflow year 6 |
$160,000 |
||
|
NPV |
$68,973.25 |
NPV |
$166,049.91 |
|
Table 2: Calculation of Net Present Value of the projects
(Source: Created by Author)
From the above table, it can be inferred that the NPV of Project X is $68,973.25 and NPV of project Y is $166,049.91. The calculations have been shown in the excel spreadsheet.
Since, both the Net present values are positive, therefore, both the projects will be accepted.
|
Project X |
Project Y |
|||
|
Rate of return |
12% |
Rate of return |
12% |
|
|
Initial investment |
($300,000) |
Initial investment |
($300,000) |
|
|
Inflow year 1 |
$80,000 |
Inflow year 1 |
$160,000 |
|
|
Inflow year 2 |
$140,000 |
Inflow year 2 |
$160,000 |
|
|
inflow year 3 |
$130,000 |
inflow year 3 |
$160,000 |
|
|
Inflow year 4 |
$160,000 |
Inflow year 4 |
$160,000 |
|
|
Inflow year 5 |
Inflow year 5 |
$160,000 |
||
|
Inflow year 6 |
Inflow year 6 |
$160,000 |
||
|
IRR |
23% |
39% |
||
Table 3: Calculation of IRR of the projects
(Source: Created by Author)
From the above table, it infers that IRR of project X is 23 percent and IRR of project Y is 39 percent. This further suggests that the break-even point of both projects are 23 percent and 39 percent respectively. The required rate of return of both the projects is 12 percent. In case of both the projects, IRR has exceeded the required rate of return of the investor. Therefore, it can be inferred that both the projects will be accepted since IRR is greater than the required rate of return from the project (Burns and Walker 2015).
If the required rate of return is decreased to 10 percent from 12 percent, then the changes in calculations can be evaluated with the help of the following diagram:-
|
Project X |
Project Y |
|||
|
Rate of return |
10% |
Rate of return |
10% |
|
|
Initial investment |
($300,000) |
Initial investment |
($300,000) |
|
|
Inflow year 1 |
$80,000 |
Inflow year 1 |
$160,000 |
|
|
Inflow year 2 |
$140,000 |
Inflow year 2 |
$160,000 |
|
|
inflow year 3 |
$130,000 |
inflow year 3 |
$160,000 |
|
|
Inflow year 4 |
$160,000 |
Inflow year 4 |
$160,000 |
|
|
Inflow year 5 |
Inflow year 5 |
$160,000 |
||
|
Inflow year 6 |
Inflow year 6 |
$160,000 |
||
|
NPV |
$86,711.66 |
$188,344.06 |
||
|
IRR |
23% |
39% |
Table 4: Calculation of NPV and IRR with rate of return 10 percent
(Source: Created by Author)
It can be inferred that if the required rate of return is changed, then, it would not have any impact on internal rate of return. However, expected rate of both the projects have decreased, which led to rise in Net present value as NPV is inversely proportional to the discounting factor (Brigham et al. 2016). This resulted in increase of surplus of both the projects as NPV has increased by a considerable amount.
Therefore, both the projects will still be accepted, even if rate of return decreases from 12 percent to 10 percent.
It can be inferred that if Net present value is positive, then the project is said to be accepted. If IRR is above expected rate of return, then, the project is said to be accepted. However, there are few cases, where both these techniques offer different recommendations.
If the net present value is positive, however, at the same time, if IRR is lesser than the expected rate of return, then, the project will be said to be rejected. This is the only when, NPV and IRR give different recommendations. When, IRR is less than the required rate of rate, the project will be rejected, even if the NPV of the project is positive, though it depends upon the investor regarding which recommendations he should follow (Chittenden and Derregia 2015).
References
Asx.com.au. (2018). Home – Australian Securities Exchange – ASX. [online] Available at: https://www.asx.com.au/ [Accessed 22 Sep. 2018].
Brigham, E.F., Ehrhardt, M.C., Nason, R.R. and Gessaroli, J., 2016. Financial Managment: Theory And Practice, Canadian Edition. Nelson Education.
Burns, R. and Walker, J., 2015. Capital budgeting surveys: the future is now.
Chittenden, F. and Derregia, M., 2015. Uncertainty, irreversibility and the use of ‘rules of thumb’in capital budgeting. The British Accounting Review, 47(3), pp.225-236.
CNBC. (2018). UPDATE 3-Australia’s AMP counts the cost of past misdeeds, shares dive. [online] Available at: https://www.cnbc.com/2018/07/27/reuters-america-update-3-australias-amp-counts-the-cost-of-past-misdeeds-shares-dive.html [Accessed 22 Sep. 2018].
Mfam.com.au (2018). How the royal commission will affect the banks (CBA, NAB, WBC, ANZ) – Monthly Newsletter, May Edition – MF & Co.. [online] MF & Co. Available at: https://www.mfam.com.au/73700/how-the-royal-commission-will-affect-the-banks-cba-nab-wbc-anz-monthly-newsletter-may-edition [Accessed 22 Sep. 2018].
Viney, C. and Phillips, P. (2015). Financial Institutions, Instruments and Markets. 8th edition.
Weber, T.A., 2014. On the (non-) equivalence of IRR and NPV. Journal of Mathematical Economics, 52, pp.25-39.
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