ACCTFIN 3500 Accounting and Finance Capstone Assignment
Questions:
According to your past experience, you believe there is a need for additional $240,000 for the three months’ period ending with the close of the harvest season. After meeting with your business banker, you are bit puzzled over what the additional financing will actually cost. The banker has quoted you an annual interest rate of 1% over Reserve Bank of Australia cash rate (let’s assume it’s currently 3% p.a.) and has also requested that the firm increase its current bank balance of $4,000 up to 20% of the loan.
(a) If interest and principle are all repaid at the end of the three-month loan term, what is the annual percentage rate on the loan offer make by the bank?
(b) If the bank were to offer to lower the rate to the Reserve Bank of Australia cash rate if interest is discounted, should you accept this alternative?
Part B
You own a portfolio of the following shares :
The risk-free rate is 7%. Also, the expected return on the market portfolio is 15.5%.
(a) Calculate the expected return on you portfolio.
(b) Calulate the portfolio beta.
(c) Given the information above, plot the security market line and plot the shares from your portfolio on the graph.
(d) From your plot in the part (c), which shares appear to be the winners and which ones appear to be the losers?
(e) Why should you consider your conclusion in part (d) to be less than certain?
Part C
An overseas investor has approached your investment advisory firm seeking to invest AUD 120 million in one of the two mining company’s ordinary shares. Your Chief Investment Officer has done some preliminary research on several listed mining companies financial returns and current financial position that has helped her to narrow the choice to two companies. You have been given the assignment to analyse and prepare a report as to which of the two mining company’s ordinary shares are better value for investment.
Based on your market research (qualitative and quantitative) on NEWCREST MINING LIMITED and ORICA LIMITED, you are required to prepare a recommendation report to the Chief Investment Officer as to the shares of which company provide better value for investment. The overseas investor requires high returns on investment as well as growth in value of shares. The investor is looking to park their funds for long term i.e. 10 years. In your report, include all the calculation and market information on which your recommendation is based.
Answers:
Part-A
|
a. Annual percentage rate on the loan offer | ||
|
1 |
Additional funds |
240000 |
|
2 |
Period (months) |
3 |
|
3 |
Interest rate p.a. (1%+3%) |
4.00% |
|
4 |
Existing bank balance |
4000 |
|
5 |
New bank balance |
48000 |
|
6 |
Addition (5-4) |
44000 |
|
7 |
Interest payable for three months (1*3/12*3) |
2400 |
|
8 |
Funds used (1-6) |
196000 |
|
9 |
Cost for three months (7/8) |
1.22% |
|
10 |
Cost annual |
4.99% |
Part-B
|
a. Calculate the expected return on portfolio | |||
|
SHARE |
PERCENTAGE OF PORTFOLIO |
CAPM |
Weighted average |
|
HARVEY NORMAN HOLDINGS LIMITED |
20.00% |
15.50% |
3.10% |
|
NATIONAL AUSTRALIA BANK LTD |
30.00% |
14.23% |
4.27% |
|
QANTAS AIRWAYS LIMITED |
15.00% |
17.20% |
2.58% |
|
ORIGIN ENERGY LTD |
25.00% |
12.10% |
3.03% |
|
BHP BILLITON LIMITED |
10.00% |
20.60% |
2.06% |
|
Expected return on portfolio |
15.03% | ||
|
b. Calculate the portfolio beta | |||
|
SHARE |
PERCENTAGE OF PORTFOLIO |
BETA |
Weighted average |
|
HARVEY NORMAN HOLDINGS LIMITED |
20.00% |
1 |
0.200 |
|
NATIONAL AUSTRALIA BANK LTD |
30.00% |
0.85 |
0.255 |
|
QANTAS AIRWAYS LIMITED |
15.00% |
1.2 |
0.180 |
|
ORIGIN ENERGY LTD |
25.00% |
0.6 |
0.150 |
|
BHP BILLITON LIMITED |
10.00% |
1.6 |
0.160 |
|
Portfolio beta |
0.945 | ||
Security Market Line
Figure 1: Security Market Line
Analysis of Stocks
The stocks lying below the security market line are considered overvalued and thus, deemed as not worth investing. The stocks lying above the security market line are considered undervalued and thus, deemed worth investing (Elton at al., 2009). From the figure shown above, it could be observed that four out of the five stocks namely Harvey Norman Holdings Limited, National Australia Bank Ltd, Qantas Airways Limited, and Origin Energy Ltd are lying below the security market line. Thus, these stocks are overvalued in the market; the investor should not make investment in these stocks. There is only one stock namely BHP Billiton limited that lie above the security market line. This means that BHP Billiton is undervalued and thus, it is worth investing.
Conclusion in Part (d) to be Less Than Certain
The conclusion given in part-d above indicates that prices of four stocks lying below the security market line may fall in future because these stocks are overvalued. Further, one stock namely BHP Billiton may experience hike in the price because this stock is undervalued. However, these perditions are based on the theoretical analysis. The practical situation in the market differs; the prices are determined by the demand and supply forces. Further the demand of stocks in influenced by many factors which includes non-financial factors also (Kurth, 2013). Thus, there is a possibility that the conclusions made in part-d above may be less than certain.
Part-c
Report: Investment Analysis
Introduction
The report is aimed to analyze two mining stocks such as Newcrest Mining Limited and Orica Limited to find out which one suits best for investment. There is an overseas investor with a budget of AUD 120 million and time horizon of 10 years.
Financial Performance Analysis
Newcrest Mining Limited operates with the total market cap of AUD19.25 billion (Yahoo finance, 2017) while Orica Limited operates with a total market cap of AUD6.7 billion (Yahoo finance, 2017). In the recent years the mining industry in Australia has been facing sluggish demand the effects of which could be observed on the financial performance of the companies (Webster, 2016). The revenues and net margins of both the companies have been observed to be slopping down:
It could be observed that the revenues of both the companies are falling down in the past three years. However, Newcrest Mining Limited is in better position as compared to Orica Limited.
It could be observed that financial years 2014 and 2015 have not been good for both the companies. However, the profitability is simulating to some extent in the year 2016. In 2016, Newcrest earned net margin of 10.08% while Orica could manage only 6.74%.
Fundamental Analysis
Dividend growth model has been applied in computing theoretical value of the shares. For this purpose, the cost of equity has been computed using CAPM model. The cost of equity of Newcrest has been worked out to be 1.10% and that of Orica is 10.06% .The cost of equity of Newcrest is low because its beta is negative.
The theoretical price computed under dividend growth model of Newcrest goes negative because its growth rate is higher than the cost of equity. Therefore, here the growth rate is taken zero. Under the zero growth rate Model, the price is worked out to be AUD13.59 The actual price of the stock in market is AUD25.13 which is higher than what is computed under the zero growth rate Model. Thus, it could be inferred that the stock is overvalued. The theoretical price of Orica Limited under the dividend growth rate model is worked out to be AUD12.26 (Appendix-A). The actual price of Orica Limited is AUD17.81 which is higher than the theoretical price. Thus, Orica Limited is also overvalued.
Technical Analysis
The analysis of price movements over the period of one year is depicted in the chart given below:
The chart shows fluctuations in the price of Newcrest and Orica over the period of one year. It could be observed that Newcrest has been more volatile than Orica over period. The average return of Newcrest has been found to be 82.29% with the standard deviation of 13.86%. While in the case of Orica, the average return is -5.06% with a standard deviation of 7.78% (Appendix-B).
Conclusion
Based on the results of fundamental and technical analysis, the investor should choose Newcrest Mining Limited over Orica Limited for investment.
References
Elton, E.J., Gruber, M.J., Brown, S.J., Goetzmann, W.N. 2009. Modern Portfolio Theory and Investment Analysis. John Wiley & Sons.
Kurth, S. 2013. Critical Review about Implications of the Efficient Market Hypothesis. GRIN Verlag.
Webster, L. 2016. Australia's mining and resource sector has seen its worst days, expert says. Retrieved April 17, 2017, from https://www.abc.net.au/news/2016-07-27/expert-says-australias-mining-downtunr-has-hit-the-bottom/7663938
Yahoo finance. 2017. Newcrest Mining Limited: Summary. Retrieved April 17, 2017, from https://in.finance.yahoo.com/quote/NCM.AX?p=NCM.AX
Yahoo finance. 2017. Orica Limited: Summary. Retrieved April 17, 2017, from https://in.finance.yahoo.com/quote/ORI.AX?p=ORI.AX
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