Introduction To Corporate Finance -

# Introduction To Corporate Finance

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## Finance Assignment Question

Question 1:

1. Undertake a DuPont analysis of your allocated company for the past two full financial years. Collect the DuPont component ratios measuring the three key ROE drivers (expense control, asset utilization and debt utilization) from DatAnalysis. Calculate ROA and ROE yourself from these. Note overall strengths and weaknesses.
2. Drill down with further selective ratio analysis and evaluation. This should focus particularly on the weaknesses you noted in part a) above. This analysis should try to explain what you found in part a) and find any other problem areas not addressed by DuPont analysis. Simply presenting and discussing all possible ratios without any clear justification is not the purpose of this exercise and will be viewed negatively by your marker. Instead, be concise, logical and purposeful, and incorporate the company’s context.

Question 2Collect the company’s 5-year growth rate (CAGR) in operating revenue as at the end of the most recent financial year. (If the company has not been listed that long, use the 1 or 3-year rate – whichever is longer – as a proxy.) If this CAGR can be expected to continue, what is your prediction for operating revenue for the 2019/20 financial year?

Question 3: Collect the company’s interest expense from the profit and loss statement for the year ending 30 June 2015 and divide this figure by average long-term debt in the balance sheet for the last two financial years. Use this as a very rough approximation of the quoted annual interest rate that the company would have to pay on new long-term debt. Now hypothetically assume that on 1 July 2015, the company took out a 20 year amortized loan of \$750,000 to buy some equipment and that the rate of interest on that loan is fixed for the first 3 years at the rate you calculated above. The loan requires monthly payments, due on the last day of the month. How much interest will the company be able to claim as an annual tax deduction in the first financial year (1 July 2015 to 30 June 2016) and in the third financial year?

Question 4: Assume that the company has just received a large amount of cash from selling assets and wants to use this cash to repay \$1 million in debt maturing in two years. In the meantime, the necessary cash can be invested into one of the following investments: (1) a fund with a quoted fixed rate of 4.0% compounded semi-annually; (2) a fund with a quoted fixed rate of 3.90% compounded monthly; (3) zero-coupon bonds maturing in two years and currently trading at \$92.46 per \$100 face value. Which investment fund should be chosen: 1, 2 or 3? (Assume the investments have equivalent risk.) How much cash will be invested?

Question 5: Hypothetically assume that on 29 February 2016 the company issued 10 years, semi-annual fixed coupon bonds at par, which are given a BB rating and have a spread of 350 basis points over the yield on an Australian government bond of equivalent maturity.

1. What is the yield on the company’s bonds?
2. How would the yield have been different if the company’s bonds had been the shorter term? Explain with reference to data and to the relevant component(s) of market interest rates.
3. You have a pessimistic outlook for the Australian economy during the coming year. Given this, what do you predict will happen to the spread on the company’s bonds over the coming year and why? Ensure you mention the relevant component(s) of market interest rates in your answer.

4. What do you expect to happen to the price of the company’s 10-year bonds if your prediction in question 3 is correct?

Question 6

1. Use CAPM to estimate the required return on the company’s shares as at 30 June 2014. To do this, use the yield to maturity on that date of a 10-year Australian Treasury bond as a proxy for the risk-free rate, assume the market risk premium is 6.4% and use the company’s current beta (thus assuming the beta has not changed since mid-2014).
2. Recalculate the required return on the company’s shares as of 30 June 2015. What has happened to the required return and why? In the absence of any other change, what does theory predict should have happened to share prices?

3. Explain would happen to the company’s required return if average risk aversion in the market fell.

Question 7: Collect and evaluate the company’s FCF and ROIC for the past two full financial years. Assume that the company’s cost of capital (WACC) was the same as the required returns (costs of equity) you calculated in Question 6.

## Finance Assignment Solution

### Question 2

Collect the company’s 5-year growth rate (CAGR) in operating revenue as at the end of the most recent financial year. (If the company has not been listed that long, use the 1 or 3-year rate – whichever is longer – as a proxy.) If this CAGR can be expected to continue, what is your prediction for operating revenue for the 2019/20 financial year?

Answer: The JBH Company’s 5 year growth rate (CAGR) in operating revenue for 2014/15 is 5.98% and the operating revenue for 2014/15 is \$ 3,652,770,000. Assume the same growth rate in operating revenue continues. Based on this information, the operating revenue for the 2019/20 financial year can be calculated as shown below:

Prediction for operating revenue for 2019/20

=Operating revenue for 2014/15*(1+CAGR) ^5

=\$3,652,770,000*(1+0.0598) ^5

=\$484,882,400