QUESTION 1
Following a weekend drive to Noosa Sunshine Coast to test out his new BMW X6 car, Mr Jack Bourne identified his ‘dream’ retirement home at the end of 2010. The property is currently (end 2010) valued at $850,000 and is likely to appreciate in value over the next 15 years (his anticipated retirement date from now) as follows:
-Years 1 to 5 by 8% p.a., -Years 6 to 10 by 10% p.a., and -Years 11 to 15 by 15% p.a.
Jack is told by his financial advisor that he can earn a net 14% p.a. rate of return on any investment funds he puts aside to pay for his ‘dream’ retirement home over the 15 year term. Moreover, as a result of an inheritance from his grandpa, Jack also anticipates that he will be able to add a lump sum of $300,000 to these investment funds (used to pay for his retirement home) in 3 years from now.
a) Given the information provided above, approximately what amount must Jack invest on an annual basis in order to be able to buy his dream home at retirement?
i) At the end of each of the next 15 years? (1.5 marks)
ii) At the beginning of each of the next 15 years? (1.5 marks)
iii) Utilizing your time value of money skills, briefly explain why the amounts calculated in i) and ii) are the same or different. (maximum 100 words) (1 marks)
b) Assuming that the actual amount paid by Jack at the end of 15 years to acquire his dream retirement home was $1.5m, calculate the annual rate of increase in the value of the property expressed as:
i) a nominal interest rate. (1.5 mark)
ii) an effective interest rate. (1.5 mark)
iii) Utilizing your time value of money skills, briefly explain why the amounts calculated in i) and ii) are the same or different. (maximum 100 words) (1 marks)
- c) Jack unfortunately died exactly 8 years after moving into his dream retirement home and, in his will, specified that upon his death the house was to be immediately sold and the net proceeds made available to his second son, James Bourne. Calculate the amount that James will receive from the property sale based on the following information collected in relation to the property over the period of ownership by Jack: (4 marks)
– Property prices in the area where the property was located increased by a nominal 5% p.a. compounded quarterly for the first 3 years after purchased by Jack.
– Property prices in the area where the property was located increased by a nominal 8% p.a. compounded half-yearly for years 4 to 7 after purchased by Jack.
– Property prices in the area where the property was located increased by a nominal 18% p.a. compounded monthly in the final year prior to Jack’s death.
– Agent fees on the sale of the property amounted to 1.2% of the gross sales price.
– Assume that the retirement home was purchased at the price of $1.5m as in Part (b).
d) Assume that James was a graduate from UQ Business School and he learnt that hedge fund managers always outperform the market. Therefore, he decides to use the amount of the net sale proceeds following his father’s death to purchase an annuity from the Queensland Investment Fund after paying the fund a fee of $10,000 for their professional services. Calculate the amount that James will receive from the annuity given that the annuity from the Queensland Investment Fund had the following features: (4 marks)
– Monthly payments at the end of each month.
– Total term of 8 years
– Residual value of the annuity (at end of the total term) is equal to 50% of the purchase
price
– Nominal rate of return provided by the annuity is 8% p.a. compounded monthly.
e) As a business school graduate, James also understands that the net present value is the most important measure for investment appraisal. Using all the information provided above, if James wanted to know what the amount of the residual value of the annuity would have been worth as a present value at the end of 2010 assuming a nominal discount rate of 8% p.a., what would this amount have been? (4 marks)
QUESTION 2
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− Use the spreadsheet “Q2-Stock-FLT.xlsx” on to complete this question. The spreadsheet contains information output from Bloomberg Terminal.
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− All financial statement numbers are in millions of dollars unless otherwise indicated.
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− Financial Year (FY) 2015-2017 are historical financial statement information whereas FY2018-2019 are forecasts.
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− Assume today is 30th June 2017 and you have just been paid a dividend and that the next dividend will be received in exactly one year (assume dividend is paid annually).
− The stock price as at 30th June 2017 was $38.30.
a) You expect the company to maintain the same reinvestment rate into perpetuity as at 30th June 2017. Return on new investment is 16.6%. You expect the dividend payout ratio remain constant for the next three years and then it will subsequently increase to 70% from year 4 onwards. Using the dividend discount model, calculate the intrinsic value for stock today. Assume the cost of equity is 10%. (5 marks)
b) Based on your answer in Part(a) ,would you recommend to buy ,sell or hold the stock?Give the recommendation and briefly discuss the difference between the intrinsic value and stock price. (no more than 200 words) (4 marks)
c) One of your project managers tells you that there is a good investment opportunity with a positive NPV. You decide to take on this investment opportunity. Expecting that the return on new investment will increase by 5% p.a. in the next few years, what would be an appropriate financial strategy for the distribution of company’s earnings? In your response, discuss how the stock price would change in relation to the new strategy, and why. (Maximum 200 words, no calculation required.) (5 marks)
d) Using the same assumption above, except that new projects earn a return equal to the cost of equity, what is the intrinsic value of stock? What is the value of the growth opportunity? (5 marks)
Now assume you bought this share two years ago:
e) If you bought the share in the company on the 1st July 2015 at $34 and the share price exactly one year ago was $31, what is your capital gain per share today in percentage terms? (2 marks)
f) Use the information in part (e), if you reinvested the dividends you received in more FLT shares, what is your wealth on 30th June 2017 on a per share basis? Assume that you have bought 1000 shares. (4 marks)
g)Suppose CTD is a good comparable firm to the company. CTD is reporting a P/E ratio of 17.41 for the year of 2017. What is the firm’s share price if you use CTD’s P/E ratio to evaluate the company? (5 marks)
h) Compare the Dividend Growth Model you used for part a), which method do you prefer (i.e. Dividend Growth Model vs. P/E ratio)? There is no right or wrong answer. Your discussion should include the pros and cons of each method. Your marks will be justified based on how well you justify your case. (maximum 400 words) (20 marks) (If you use any referencing to back up your argument, you must reference it according to Harvard Referencing Style.)
