Question 1
Liquidity risk is a risk emanating from the difficulty of marketing an investment asset. It arises when the asset cannot be bought or sold quickly hence minimizing risk. A bond investor will be forced to sell the bond at a lower than indicated value. A bond with low interest can lead to price volatility, therefore, hurting the holder's return upon selling it.
Default risk is the probability that an individual or a company will be unable to meet their debt obligations. As an investor purchase a bond, they are buying a certificate implying that the money is borrowed and therefore repayable by the issuer in future with interest. Therefore the ability to pay will determine the price and the bond yield.
Delegate your assignment to our experts and they will do the rest.
Taxability risk is a risk that applies to an instrument previously issued with a tax-exempt status losing its status before its maturity. It is often applicable to municipal bonds and demonstrates that since they carry a lower interest rate than taxable bonds, an investor will end up with a lower yield than previously anticipated.
Question 2
According to CAPM expected return on a risky asset depends on three components that work together to measure the risk-return of an asset. The three are Beta which is a measure of risk in an asset compared to the overall market risk. If the Beta is 1, the asset has the same volatility with the market, but a higher beta implies more volatility. The other factor is Market risk premium which is the difference between overall market return and the return of the risk-free asset. Lastly, there is the risk-free return which is equivalent to the current yield on treasury bonds.
Question 3
Opportunity cost of holding cash =(C/2) X R = 95,000/2 X 0.048 = $2280
Trading Cost = (T/C) XF = (98,000 X52) =5,096,000/95,000 X 50 = 2682.11
Total cost =2280 + 2682.11 = $4962.11
Part B
Question 1
Market to book ratio = Total book value /Total market value
Tobin’s q =total market value /Total asset value
0.96 = (20,000 X 1.93)/Total asset value
Total asset value =38600/0.96
= 40,208.3
Market book ratio =40,208.3/38,600 = 1.04
Question 2
Future value = P (1+r) n
First instalment =25,000 (1+0.0975) 3 =33048.64
Second instalment = 30,000 (1+0.0975) 2 = 36135.2
=33048.64 +36135.2 + 45000 =114183.84
Question 3
Market price of KL airlines =
= 1.3575 + 1.433 +1.3341 + 19.05 =23.17
Question 4
Total cost = 689,000
Number of years = 4 Annual operating cost =$41000
Required rate of return 13%
Equivalent annual cost = asset price X discount rate/ Annuity factor (1 – (1 + Discount rate) n )
Annuity factor = (1 – (1/(1+0.13) 4 ))/13% =29.745
Equivalent annual cost =$689,000/29.745 + $41,000 =$64,163.56
Question 5
Sales price $38
Variable cost per unit =$18.50
Fixed cost $32,000
Operating cash flow $19700
Operating cash flows =(P – v)Q – FC
19700 = (38 -18.5)Q – 32,000
19700 = 19.5Q -32,000
19.5Q =51700
Q =2651.28
Question 6
Arithmetic average return = 12.2%
Geometric average return = 11.5%
Blume’s formula R(T) = X Geometric average + X Arithmetic average
= X 11.5% + X 12.2%
= 0.0329 + 0.0871
= 0.12 or 12%
Question 7
The boss approach is incorrect because the new figure will not show the actual value of the capital project. The best approach would be to assume that the capital structure remains the same. The weighted average floatation cost for the project is then estimated. A new initial investment that reflects the weighted average floatation cost of the capital mix is then calculated. The WACC can then be used to calculate a new present value.
Question 8
Market value of equity = 320,000 X 19 =6,080,000
Total value =6,080,000 + 1,200,000 = 7,280,000
Wacc =E/V X re + D/V X rd X (1 –Tc)
=6,080,000/7,280,000 X 0.154 + 1,200,000/7,280,000 X 0.08 (1 – 0.36)
= 0.129 + 0.0084
=0.137 or 13.7%
Question 9
Effective interest rate = (1 + i) n -1
= (1 +12%) 1 – 1
= 12%
Question 10
Number of units sold per month = 345 unit price = $59 credit policy = net 30 increased units =55 interest rate =0.4% and variable cost =$32
Monthly benefits of the policy per unit (P-v ) X increased quantity
= (59 – 32) X 55 = $1485 per month
Incremental investments = PQ + v(Q I – Q)
The carrying cost will be PQ + v(Q i -Q) X r
=(59 X 345 + 32 X 55) X 0.004
=88.46
Net benefit will be $1485 – 88.46 = 1,396.54
Present value = 1396.54/0.004 =349135
