# Investment And Finance Questions

## Question 1

1. Balance of the account at the end of 45 years:

 Particulars Value Amount (A) \$      10,000.00 Time (B) 45.00 Interest (C) 13.00% Balance at retirement A*(1+C)^B Balance at retirement 10,000*(1+13%)^45 Balance at retirement \$ 2,446,414.02
 Particulars Value Balance at retirement (PV) \$ 2,446,414.02 Time (n) 33.00 Interest (i) 8.00% Yearly withdrawal PV/((1-((1+i)^-n)))/i) Yearly withdrawal 2,446,414.02/((1-((1+8%)^-33)))/8%) Yearly withdrawal \$   212,475.05
 Particulars Value Balance at retirement (A) \$ 2,446,414.02 Interest (B) 8.00% Withdrawal forever A*B Withdrawal forever 2,446,414.02 * 8% Withdrawal forever \$   195,713.12

1. Calculating current market value of the company’s debt:

 Particulars Value Face value (F) \$         7,500,000.00 Time (t) 15.00 coupon rate 5.00% yield year 1 (i) 5.50% Coupon payment (C) \$           375,000.00 Price (C*((1-(1/((1+i)^t)))/i))+(F/((1+i)^t)) Price (375,000*((1-(1/((1+5.5%)^15)))/5.5%))+(7,500,000/((1+5.5%)^15)) Price 7,123,590.71
 Particulars Value Face value (F) \$    75,00,000.00 Time (t) 14.00 coupon rate 5.00% yield year 2 (i) 6.50% Coupon payment (C) \$      3,75,000.00 Price (C*((1-(1/((1+i)^t)))/i))+(F/((1+i)^t)) Price (375,000*((1-(1/((1+6.5%)^14)))/6.5%))+(7,500,000/((1+6.5%)^14)) Price 6,485,942.74

The value of debt for the organisation declined due to the increment in yield.

 Particulars Value Risk free rate (Rf) 5.10% Market return (Rm) 9.20% company beta (beta0 0.68 Cost of equity Rf + Beta*(Rm-Rf) Cost of equity 5.10% + 0.68*(9.20%-5.10%) Cost of equity 7.89%

The beta of 0.698 indicates that the company’s share price is less volatile against price action of the market. Hence, the company with low beta tends to have small risk from investment for the investors.

 Particulars Value Preference shares value (p) \$                  1.00 Current value (c) \$                  1.63 Interest (i) 11% Cost of preference shares (i*p)/c Cost of preference shares (1*11%)/1.63 Cost of preference shares 6.75%
 Particulars Value Cost of equity (e) 7.89% Cost of preference shares (p) 6.75% cost of debt (d) 5.00% Equity (E) \$         65,50,000.00 Preference (P) \$           4,07,500.00 Debt (D) \$         64,85,942.74 Total capital (T=E+P+D) \$      1,34,43,442.74 Equity weight (WE=E/T) 48.72% Preference weight (WP=P/T) 3.03% Debt weight (WD=D/T) 48.25% WACC (WE*e)+(WD*d)+(WP*p) WACC (48.72%*7.89%)+(48.25%*5%)+(3.03*6.75%) WACC 6.46%
 Particulars Value Cost of equity (e) 7.89% Cost of preference shares (p) 6.75% cost of debt (d) 5.00% Equity (E) \$    65,50,000.00 Preference (P) \$      4,07,500.00 Debt (D) \$    64,85,942.74 Total capital (T=E+P+D) \$ 1,34,43,442.74 Equity weight (WE=E/T) 48.72% Preference weight (WP=P/T) 3.03% Debt weight (WD=D/T) 48.25% Tax (T) 20% WACC (WE*e)+((WD*d)*(1-T))+(WP*p) WACC (48.72%*7.89%)+((48.25%*5%)*(1-20%))+(3.03*6.75%) WACC 5.98%

1. Calculating ARR, Payback period, NPV and IRR of the project:

 Year Cash flow (A) Dis-rate (B) Dis-cash flow (A*B) Cum-cash 0 \$ -1,25,000.00 1.00 \$ -1,25,000.00 \$ -1,25,000.00 1 \$     42,000.00 0.88 \$     36,842.11 \$    -83,000.00 2 \$     42,000.00 0.77 \$     32,317.64 \$    -41,000.00 3 \$     42,000.00 0.67 \$     28,348.80 \$       1,000.00 4 \$     42,000.00 0.59 \$     24,867.37 \$     43,000.00 5 \$     42,000.00 0.52 \$     21,813.48 \$     85,000.00
 Particulars Value Benchmark ARR 13.60% 12.00% Payback period 4.0 3.0 NPV \$     19,189.40 IRR 20.22%
 Year Cash flow (A) Dis-rate (B) Dis-cash flow (A*B) 0 \$ -1,40,000.00 1.00 \$ -1,40,000.00 1 \$     55,000.00 0.88 \$     48,245.61 2 \$     55,000.00 0.77 \$     42,320.71 3 \$     55,000.00 0.67 \$     37,123.43 4 \$     55,000.00 0.59 \$     32,564.42 NPV \$     20,254.18
 Particulars Value NPV \$     19,189.40 t 5 i 14% Project 1 EAA NPV/((1-((1+i)^-n)))/i) Project 1 EAA 19,189/((1-((1+14%)^-5)))/14%) Project 1 EAA \$       5,589.56
 Particulars Value NPV \$     20,254.18 t 4 i 14% Project 2 EAA NPV/((1-((1+i)^-n)))/i) Project 2 EAA 20,254.18/((1-((1+14%)^-4)))/14%) Project 2 EAA \$       6,951.33

According to the EAA project 2 needs to be accommodated, as it has higher value and can generate more income for the organisation.

1. Calculating the profit margin at spot rate, while finding the critical AUD/USD value and detecting the ideal rate:

 Particulars Value Sales (A) \$           1,00,00,000 Cost of sales (B) AUD        88,00,000 Spot rate AUD/USD 20th of August (C) \$                   0.9200 Cost of sales in USD (D=B*C) \$              80,96,000 Profit (E=A-D) \$              19,04,000 Profit % at current spot rate (F=E/A) 19.04%
 Particulars Value Sales (A) \$     1,00,00,000 Cost of sales (B) AUD 88,00,000 Profit % (C) 14% Profit needed (D=A*C) \$        14,00,000 Cost (E) \$        86,00,000 Critical AUD/USD (E/B) \$             0.9773
 Particulars Value Sales (A) \$     1,00,00,000 Cost of sales (B) AUD 88,00,000 Profit % (C) 20% Profit needed (D=A*C) \$        20,00,000 Cost (E) \$        80,00,000 Ideal AUD/ USD (E/B) \$             0.9091

The first step is to determine whether payment is to be conducted on different currency, as the home currency of the company. The second step is to detect volatility present within the currency conversion rate. Third step is to detect whether the price action will benefit or harm the currency conversion value. The two examples in which hedging are not needed is that when the government fixes the currency exchange rate. The second example is when the payments in not made in foreign currency, where the risk from volatile currency market does not affect the company (Clark & Judge, 2017).

The future contract is for January, while the actual payment will be conducted on February, which indicates the risk from volatile currency market is high, as adequate hedging will not be conducted for the last month. The future contract with a tenure will 20 February would be beneficial for reducing the risk attributes of the currency market, while the current contract cannot nullify the risk involved in currency conversion (Do & Vu, 2018).

 100% Hedged with forward contract Particulars Value Value Sales (A) \$             1,00,00,000 \$             1,00,00,000 Expected forward rate of AUD/USD \$ 0.9173 \$ 0.9173 Expected forward rate of USD/AUD 1/\$ 0.9173 1/\$ 0.9173 Expected forward rate of USD/AUD (B) AUD                   1.09 AUD                   1.09 Sale (FC=A*B) AUD  1,09,01,351.01 AUD  1,09,01,351.01 Cost of sales (D) AUD          88,00,000 AUD          88,00,000 Profit % from hedge (S-D)/S 19.3% 19.3%
 50% Hedged with forward contract Particulars Value Value Sales (A) \$             1,00,00,000 \$             1,00,00,000 Spot rate AUD/USD 20th of February \$1.05 \$ 0.85 Spot rate USD/AUD 20th of February 1/ 1.05 1/0.85 Spot rate USD/AUD 20th of February (B) AUD                   0.95 AUD                   1.18 Expected forward rate of AUD/USD \$ 0.9173 \$ 0.9173 Expected forward rate of USD/AUD 1/\$ 0.9173 1/\$ 0.9173 Expected forward rate of USD/AUD (C) AUD                   1.09 AUD                   1.09 Sale (FC=A/2*B) AUD     47,61,904.76 AUD     58,82,352.94 Sale (S=A/2*C) AUD     54,50,675.51 AUD     54,50,675.51 Sales (T=FC+S) AUD 1,02,12,580.27 AUD 1,13,33,028.45 Cost of sales (D) AUD          88,00,000 AUD          88,00,000 Profit/Loss from 50% hedge (T-D)/T 13.83% 22.35%
 100% Hedged with Call option Particulars Value Value AUD Call (A) \$                   0.8800 \$                  0.8800 Premium (B) \$                   0.0200 \$                  0.0200 Total call value (C=A+B) \$                   0.9000 \$                  0.9000 Spot rate AUD/USD 20th of February (D) \$                   1.0500 \$                  0.8500 Spot rate AUD/USD 20th of August \$                   0.9200 \$                  0.9200 Profit or loss from hedging (E=D-C) \$                   0.1500 \$                  0.0500 Sales (F) \$           1,00,00,000 \$          1,00,00,000 Sales [G=(F*(1/(-E+D)))] AUD     1,11,11,111 AUD    1,11,11,111 Cost of sales (H) AUD   88,00,000.00 AUD  88,00,000.00 Profit from hedge (I=F-H) AUD   23,11,111.11 AUD  23,11,111.11 Profit % from hedge (I/G) 20.80% 20.80%
 100% Hedged with put option Particulars Value Value AUD Put (A) \$                   0.7500 \$                  0.7500 Premium (B) \$                   0.0005 \$                  0.0005 Total call value (C=A+B) \$                   0.7505 \$                  0.7505 Spot rate AUD/USD 20th of February (D) \$                   1.0500 \$                  0.8500 Spot rate AUD/USD 20th of August \$                   0.9200 \$                  0.9200 Profit or loss from hedging (E=D-C) \$                  -0.2995 \$                -0.0995 Sales (F) \$           1,00,00,000 \$          1,00,00,000 Sales [G=(F*(1/(-E+D)))] AUD        74,10,152 AUD    1,33,24,450 Cost of sales (H) AUD   88,00,000.00 AUD  88,00,000.00 Profit from hedge (I=F-H) AUD  -13,89,848.09 AUD  45,24,450.37 Profit % from hedge (I/G) -18.76% 33.96%
 100% Hedged with forward contract Particulars Value Value Sales (A) \$             1,00,00,000 \$             1,00,00,000 Spot rate AUD/USD 20th of February \$1.05 \$ 0.85 Spot rate USD/AUD 20th of February 1/ 1.05 1/0.85 Spot rate USD/AUD 20th of February (B) AUD                   0.95 AUD                   1.18 Sale (S=A*B) AUD     95,23,809.52 AUD  1,17,64,705.88 Cost of sales (D) AUD          88,00,000 AUD          88,00,000 Profit % from no hedge (S-D)/S 7.6% 25.2%

The two low cost hedging strategies that can be used by the organisation are the currency swaps and future contracts. The currency swaps can allow the organisation to take adequate loans in USA, while transferring the money to Australia on the spot rate and making the payments after receiving the 10 million dollars to the loan-providing bank. The future contracts can be used for minimising the damage conducted from the currency volatility (Álvarez-Díez, Alfaro-Cid & Fernández-Blanco, 2016).

Reference and Bibliography:

Álvarez-Díez, S., Alfaro-Cid, E., & Fernández-Blanco, M. O. (2016). Hedging foreign exchange rate risk: Multi-currency diversification. European journal of management and business economics, 25(1), 2-7.

Clark, E. A., & Judge, A. P. (2017). The determinants of foreign currency hedging: does foreign currency debt induce a bias?. Evaluating Country Risks for International Investments, 499-536.

Do, V., & Vu, T. (2018). The additional cost of hedging in foreign currency loans. Australian Journal of Management, 43(2), 305-327.

Gotze, U., Northcott, D., & Schuster, P. (2016). Investment appraisal. Springer-verlag berlin an.

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