Investment And Finance Questions

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November 15th, 2023

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	(WEe)+(WDd)+(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	(WEe)+((WDd)(1-T))+(WPp)
WACC	(48.72%7.89%)+((48.25%5%)(1-20%))+(3.036.75%)
WACC	5.98%

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

Year	Cash flow (A)	Dis-rate (B)	*Dis-cash flow (AB)**	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 (AB)**
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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