INDIVIDUAL ASSIGNMENT Question 1. There are a few companies with negative beta. Assuming that you find a company with a beta = 2.5. a. What will the stock profitability ratios change if the market profitability ratio increases 5%? If the market profitability ratios decreases 5%? b. You have USD 1 million to invest in a share portfolio that is well diversified. Now you receive an additional USD 20,000 from the will. Which of the following actions will bring safety for the profitability ratios portfolio? i. Invest USD 20,000 in Treasury Bonds (with beta = 0). ii. Invest USD 20,000 in the Stocks with beta = 1. iii. Invest USD 20,000 in the Stocks with beta = 0,25. Answer: In the stock market in the countries with developed market economy, the information about listed companies such as profits, risks and other important
Trang 1Global Advanced Master of Business Administration
INDIVIDUAL ASSIGNMENT CORPORATE FINANCE
mmm Leaner: mmm
Class : GaMBA4.C165
Trang 2INDIVIDUAL ASSIGNMENT Question 1 There are a few companies with negative beta Assuming that you find a company with a beta = -2.5.
a What will the stock profitability ratios change if the market profitability ratio increases 5%? If the market profitability ratios decreases 5%?
b You have USD 1 million to invest in a share portfolio that is well diversified Now you receive an additional USD 20,000 from the will Which of the
following actions will bring safety for the profitability ratios portfolio?
iii Invest USD 20,000 in the Stocks with beta = -0,25
Answer:
In the stock market in the countries with developed market economy, the information about listed companies such as profits, risks and other important information are published daily in the market to help investors review, consider which suitable investment plan will offer them the best results One of the most important parameter reflecting the risk is the beta coefficient (β) provided by the professional financial research organizations
Risk beta coefficient (β) is defined as a coefficient to measure the level of volatility, also known as a measure of systematic risk of a security or a portfolio relative to the overall market Beta is used in the capital asset pricing model (CAPM)
to calculate the expected profitablity ratios of an asset based on its beta coefficient and profitablity ratios in the market
Formual of beta coefficient :
Beta = Covar (R I , R m )/Var (R m )
In which:
• Ri: profitablity ratios of the stock
Trang 3• Rm: profitablity ratios of the market (the VN-Index).
profitablity ratios of the market
Estimate β in reality
In fact, the stock traders use regression models based on historical data to estimate β
In countries with developed financial markets, there are some companies specializing
in identifing and providing information about β coefficient For example, in the U.S., people can find information about β from the service provider such as Value Line Investment Survey, Market Guide and Standard & Poor's Stock Reports In Canada, information about β is provided by Burns Fry Limited
The relationship between Risk and Return
Expected profit of stock has a direct variable relationship with the risk of that stock, it means that investors expect high risk stock will have high profit and vice versa In other words, investors hold risky stock only when the expected profit is large enough to offset the risks In the previous section, we discussed β coefficient is used to measure the risk of a stock Therefore, the expected profit of a stock has a direct variable relationship with its coefficient β
Assuming that financial market is efficient and investors diversify the
investment portfolio so that the risk of the system is negligible Thus, only system-wide risks affect the profits of the stock The stocks with the greater beta, the greater the risk is, therefore, it requires high profits to offset the risk According to the
CAPM model, the relationship between profit and risk is expressed by the formula:
r = β x (r m – r f ) + r f hay (r - r f )= β x (r m – r f ) (1)
Trang 4In which:
r: expected profitability ratios of the stock
rf : profitability ratios without risks (profitability ratios of short-term bonds )
rm : profitability ratios of market portfolio
β : the sensitivity of the profitability ratios of the stock with the market fluctuation
Thus the profitablity ratios requirements of investors are affected primarily by the risks If a stock has a beta coefficient:
= 1: the fluctuation of the stock price will be equal to the fluctuation of the market
<1: theleveloffluctuation ofthestockpriceislowerthanthefluctuationofthe market.
market.
Specifically, if a stock has a beta is 1.2, in theory; the fluctuation of this stock will be 20% higher than the fluctuation of the market
In the situation that we find a company with beta = -2.5,
a What will the stock profitability ratios change if the market profitability ratio
increases 5%? If the market profitability ratios decreases 5%?
Expected stock profitability ratios will reduce 12.5%
Expected profitability rate of the shares will increase 12.5%
b One million dollars for investing in well diversified stock portfolio is
available Now we receive additional USD 20,000 from the will, to choose
Trang 5which action will bring safety for profitability ratios portfolio, we will analyze the following:
From formula (1) we have:
Treasury bonds
With β=1, profitability ratio of stock r2 = profitability ratio in the market rm
With β=-0.25, we have r3 =rf -0.25*(rm-rf)
1 If r m < r f we will invest in stock with r 3 (β=-0.25)
3 If r m > r f we will invest in stock with β =1
Question 2: If you can either keep cash or invest in stock with an interest rate
of 8% You can not sell stock when you need money, so, you have to make up for the cash deficit by using a bank credit quota with 10% of interest rate Should you invest more or less in stock in each situation below?
a Sometimes you are not sure about future cash flows
b Bank interest rate rises to 11%
Trang 6c Interest rates of stock and bank loan interest rates increase at the same rate.
d You adjust the forecast of future cash needs lower
Answer :
a In the case we are uncertain about the cash flow in the future; we should invest less
in stocks When we are unsure about the future cash flow, which means that we are not sure about the demand for the capital in the future Then we should reduce investment in stocks for the occurrence of lack of money, the cost of interest on bank loans will be higher than rates of investment stocks leading to the financial cost incurred in this case
b If the interest rate rises to 11%, we should also invest less in stocks Because when interest rates increase, this means borrowing costs will increase while the interest rate
of stock investment is unchanged This causes the increase in financial costs, so, we should less invest in stock
c If the bank interest rate and stock interest rate increase at the same ratio, as the first Because once the bank interest rate and stock investment rate increase respectively, this means that the difference between bank interest and interest rate stock investment is unchanged This leads the financial costs do not change, so we remain the same rate as the original investment
d If we adjust the demand of forecasts for future cash lower, we should be invest more in stocks When the future cash needs decreasing, this means the amount of idle money increasing In this case, we should invest more in stock in order to increase the effectiveness of financial investment
Question 3 VDEC company is concerning about the cost of using capital for the company According to the current investigations, we have the following data Suppose the corporate income tax rate is 40%.
Debit: The Company can increase unlimited debt by selling the coupon bonds
with interest rate of 10% annually; the bonds have denominations of USD 1,000 The
Trang 7cost of commissions paid to the underwriter is USD 30 / stock, issuance cost is USD
20 / stock, the term is 10 years
Preferred stock: The Company may sell preferred stock unlimitedly in
number with price of USD 100 / stock, the interest rate is 11% / year Issuance cost is USD 20 / stock
Common stock: The Company's common stock is currently being sold at
USD 80 / stock The company expects to pay dividends in cash USD 6 / stock next year Company's dividend growth of 6% / year and does not change in the future Stock will be sold at the price less than USD 4 / stock, the issuance cost is USD 4 / stock Company can sell with unlimited quantities
Retained profit : The Company expects to keep USD 225,000 of profit in the next
year If there is not retained profit, the company will issue new common stock
a Calculate the cost for each funding source
b Calculate the average capital cost, assuming the target capital structure is:
Long term debt Preferred stock Common stock
Total
40%
15%
45%
100%
(1) Determine breaking point of retained profit
(2) Calculate the cost of using marginal capital and the cost of using average capital related to the entire new funding sources
c Use information about the investment opportunities in the following table to draw the line of using of Weighted Marginal Cost of Capital – (WMCC) and
Project Primary investment IRR
Trang 8B C D E
USD 200,000 USD 100,000 USD 200,000 USD 100,000
16.0 14.2 13.7 10.0
e Do you have any advice about financial sources that the company should choose? Total optimal funding for the company? And explain your point of view
Answer:
a Cost of using capital for each funding source:
Cost of selling a bond = Nominal value – Commission cost –Issuance cost = 1.000-30-20= USD 950
+ Cost of using capital for Coupon bonds project:
950= 100[(1- (1+ rd )-10] / rd
+ Capital cost of preferred stock:
rp = Dp / ( Pp – f ) = ( USD 100x 11% ) / ( USD 100 - USD 20 )
+ Capital cost of common stock:
re = ( DIV1 / Po ) + g = 6/80 + 6%
+ Capital cost of new common stock:
rne = ( DIV / Pne ) + g = [ 6/ ( 800- 4 – 4 ) ] + 6%
b Part b.1 : Identify the breaking point of Retained profit
Trang 9
Thus, there is a breaking point occurs when USD 225,000 of retained profit
is used up.
Part b.2: Cost of using marginal capital and drawing the graph for choosing
the options:
Range of capital
source
Ri – capital cost
Wi capital ratio
WACC cost for using average capital
0 < I < USD 500,000 re = 13.5%
rp = 13,.75%
rd = 6.51%
45%
15%
40%
10.74%
I > USD 500,000 re = 14.33%
rp = 13.75%
rd = 6.51%
45%
15%
40%
11.11%
To select investment projects, we should draw the line of cost for using Weighted
the same graph as follows:
Trang 10Based on the graph: we see
• A project with investment capital: USD 100,000 with profitability rate IRR = 17.4% higher than the cost of using Weighted Marginal Cost of Capital – (WMCC) (10, 74%)
• Project B with investment capital: USD 200,000 profitability rate IRR = 16.0% higher than the cost of using Weighted Marginal Cost of Capital (10, 74%)
• C project with investment capital: USD 300,000 has the highest profitability rate IRR = 14.2% higher than the cost of using Weighted Marginal Cost of Capital (10, 74%)
• D project with investment capital: USD 600,000 profitability rate IRR = 11.7% higher than the cost of using Weighted Marginal Cost of Capital (10, 74%)
• E project with investment capital: USD 700,000 profitability rate IRR = 10.0%, lower than the cost of using Weighted Marginal Cost of Capital (10, 74%)
17,4
16.0
14,
2
11,
7
11,
0
10,0
10,74
A
B
C
D
WMCC WACC (%)
IOS
E
I (1.000$
)
100 200 300 500 600 700
Trang 11Thus, the lines of investment opportunities of the four projects A, B, C, D are
located higher than WMCC line (the cost of using Weighted Marginal Cost of Capital) so, the profit from each project is expected to be higher than the cost of using Weighted Marginal Cost of Capital and in accordance with the objective of maximizing the value of assets of the company Therefore, VDEC Company should invest in four projects A, B, C, D with optimum total funding for the company is USD 1,200,000 The company should not invest in the project E as it is inefficient project financially because the project's profitability rate is lower than the cost of using Weighted Marginal Cost of Capital.