finance assignment reviewed final

8/7/2019 Finance Assignment Reviewed Final

1/19

MBA FULL-TIME

BHREAC

Finance and Financial Management

ASSIGNMENT 2010-2011

Ahmed Kamal Pasha

Darshan Bhinde

Kaustubh Manohar

Pranal Rai

Rony George

Chiao-Wen Chang


2/19

TABLE O ONTENTS

Q ESTION 1 ................................ ................................ ................................ ............................. 3

PARTA ................................ ................................ ................................ ................................ ................. 3

PART B ................................ ................................ ................................ ................................ ................. 5

Q ESTION 2 ................................ ................................ ................................ ............................. 7

PARTA ................................ ................................ ................................ ................................ ................. 7

PART B ................................ ................................ ................................ ................................ ................. 9

Q ESTION 3 ................................ ................................ ................................ ........................... 11

PARTA ................................ ................................ ................................ ................................ ............... 11

PART B ................................ ................................ ................................ ................................ ............... 11

PART C ................................ ................................ ................................ ................................ ............... 12

PART D ................................ ................................ ................................ ................................ ............... 13

Q ESTION 4 ................................ ................................ ................................ ........................... 14

PARTA ................................ ................................ ................................ ................................ ............... 14

PART B ................................ ................................ ................................ ................................ ............... 14

PART C ................................ ................................ ................................ ................................ ............... 16

PART D ................................ ................................ ................................ ................................ ............... 17

PART E ................................ ................................ ................................ ................................ ............... 18

BIBLIOG APHY ................................ ................................ ................................ ...................... 19


3/19

Question

Part A

Millions

Selling price per unit 16.00Direct manufacturing cost per unit 3.50

Stock % of next year's sales anticipated 0.20

Overhead Charges (% of revenue) 0 .10

R&D cost a lrea dy incurred 1.50

R&D cost required 0.30

Cost of new product ion fac il it ies 10.40

Tax % 0.30

Space Rent per month 0.10

PROFIT& LOSS

OU

T

Millions 0 1 2 3 4 5 6 7

Revenues 4.00 4.80 4.80 4.80 4.80 4.80 4.80

Fixed cos ts -0.14 -0.14 -0.14 -0.14 -0.14 -0.14 -0.14

Direct Manufacturing Cost -0.88 -1.05 -1.05 -1.05 -1.05 -1.05 -0.84Capital Allowances -2.08 -2.08 -2.08 -2.08 -2.08

Overhead Charges -0.40 -0.48 -0.48 -0.48 -0.48 -0.48 -0.48

Cost of Stock -0.06 -0.06 -0.06 -0.06 -0.06 -0.06

Space Rent -0.10 -0.10 -0.10 -0.10 -0.10 -0.10 -0.10

Capital Gain/Loss NEW 0.50

Capital Gain/Loss OLD -0.60 0.00

PBT -0.60 0.35 0.89 0.89 0.89 0.89 2.97 3.74

Tax(30%) 0.18 -0.10 -0.27 -0.27 -0.27 -0.27 -0.89 -1.12

Capital Gai n/Loss -0.42 0.24 0.62 0.62 0.62 0.62 2.08 2.62

CASHFLO

STATEME

T

Millions 0 1 2 3 4 5 6 7

Outlay -10.40 0.50

Working Capita l -0.30 0.30

Fixed cos ts -0.14 -0.14 -0.14 -0.14 -0.14 -0.14 -0.14

Direct Manufacturing Cost -0.88 -1.05 -1.05 -1.05 -1.05 -1.05 -0.84

Cost of Stock -0.06 -0.06 -0.06 -0.06 -0.06 -0.06

Capital Gain/Loss NEW 0.50

Opportunity cost for space rental to someone e lse -0.06 -0.06 -0.06 -0.06 -0.06 -0.06 -0.06

Opportunity cost for resal e of old eqiupment -0.60

Revenues 4.00 4.80 4.80 4.80 4.80 4.80 4.80

PBT -11.30 2.87 3.49 3.49 3.49 3.49 3.49 5.06

Tax 0.18 -0.10 -0.27 -0.27 -0.27 -0.27 -0.89 -1.12

NCF -11.12 2.76 3.22 3.22 3.22 3.22 2.60 3.94

PVF(14%) 1.0000 0.8772 0.7695 0.6750 0.5921 0.5194 0.4556 0.3996

PV -11.12 2.42 2.48 2.18 1.91 1.67 1.18 1.57

NPV 2.30

IRR 0.22

Net Present Value 2.30

Internal Rate ofReturn 0.22


4/19

Underlying Assumptions

y , 00,000 is already spent on & and so its considered as sunk cost

y 00,000 further required in & is the working capital

y he new equipment bought for 0, 00,000 will be sold at the end of project for 00,000 i.e. capital gain

y he old equipment already under company ownership will be used as nothing ismentioned regarding the efficiency / productivity of the old machines.However, as thesemachines can be sold today at 00,000 therefore there is an opportunity cost attachedto this, hence will be considered as part of cash flow in year 0.

y he old equipment will have no worth at the end of years

y he space being used for manufacturing has an opportunity cost of 0,000

y Overhead charges are not included in the cash flow statement as these charges are an

internal transaction and there is no real cash flow.

y Similarly the space charges are not included in the cash flow statement as there is noreal or incremental cash flow in or out of the company.

y he stock level maintenance is considered as a working capital

Interpretationof PV, IRR & DiscountedPaybackPeriod

et Present Value [ PV] is a measure of the profitability of an investment, expressed incurrent pound terms. Since the NPV is positive in this case, it is feasible for the company to goahead with the project because a positive NPV interprets into the venture being successful andbringing in surplus profits after covering all project related costs. he outcome of this venturecan bring about growth for the company in the medium and possibly the long term. Such news ifmade public can have a positive effect on share price of thecompany.

Internal RateofReturn [IRR] is the rate at which the NPV is zero. If the I is greater than therequired rate of return, the project can be implemented as planned. In this case, the I ( %)is greater than the required rate of return ( %), implying that the investment can be accepted.

Yea ilative N ilative PV ummilative

011.12 -11.12 -11.12

1 2.76 2.4223878 -8.6976

2 3.22 2.4800985 -6.2175

3 3.22 2.175525 -4.0420

4 3.22 1.9083383 -2.1337

5 3.22 1.6740262 -0.4596

6 2.60 1.1841044 0.7245

7 3.94 1.5736248 2.2981

iscounted Payback Pe iod 5.1 yea s


5/19


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10/19

Wynn esorts,Ltd 96.2 Resorts & Casino Industry) Currently the PE ratioof 96.2 mayseemmuchhigher thanregional standards. PE ratiosofaverage US companiesrangebet een 12 - 18. But hencompared to PE ratiosof itscompetitors like Las Vegassands, hichhasa PE ratioof 78.2 it mayseemovervalued. If ecompare thecurrent PE ratio ith the PE ratio 52 eeksago 420.4) it seems that PE ratiohavedrasticallydropped. Therecouldvariousreasons that maydrive the PE. In thiscasereasonscouldbe that since theshareprices ererelatively low 52 weeksago, it might havebeenviewedbysomeasundervaluedstockandhencepeoplewerewilling topaymore forthestockresulting in thehigh PE ratio. Thecasinoandentertainment industryareusuallyhighlygrowthorientedandhenceweseehigherPE ratios in this industry.

Toconclude, PE mayhavevaried interpretations. The factors that maydrive PE ratiosarediscussedbelow.

y Earnings calculation : Theearningsconsidered in the PE calculationsmaybedifferentfordifferent companies. Certaincompaniesconsiderfutureearnings tocalculate PEwhileothersconsidercurrent orpast earnings.

y AccountingMethods : Earningsofcompaniesmaydependonvarious factors includingdifferent accountingpoliciesand thedepreciationmethodusedby thecom panies.

y MarketPriceoftheStock : Priceof thestockcanvariablychangedue tomanyreasonslikemarket newsorchange individendpoliciesormajorannouncementsby thecompanies.

y Sector: PE ratiosalsovaryasperthesectoror industryacompanybelon gs to. Like PEratiosof thecasino industry isrelativelyhigherand PE ratios inoil companiesare muchlower.

y GrowthStage: PE ratiosalsovarydependingon thedifferent growthstages of theorganisation. PE ratio sofnewcompaniesmaybe low ingeneral whencompared togrowthorientedcompanies.


11/19

Question 3

PartA

Analysis ofterms ofrights issue forLloyds Banking Group

umberofshares issuesbycompanybeforerights issue 0) = 27.161 billion Initial pricepershare P 0) = 91.50pInitial valueof the firm V 0) = 24.85 billion

Fundsexpected toberaisedby therights issue F) = 13.51 billion Subscriptionprice forright P s) = 37p

100P0

PspercentageDiscount v!

= 37/91.50)*100= 40.44%

Ps

F

PriceonSubscripti

equiredFundsN)(issuedbetosharesnewofNumber !(

= 13.51 billion/0.37= 36.51 billionshares

N

N0

sharesneoNumber

goutstandinsharesoNumber=N(R)rightaacquiretosharesoNumber

(!

= 27.161/36.51= 0.74 oldshares

N0

N

goutstandinsharesoNumber

sharesneoNumber=issuerightstheoTerms

(!

= 36.51/27.161

= 1.34 newshares

NN (

!

!

0

FV0

haresNeharesOld

FundsNeValueInitial( x)pricerights-Ex

= 24.85 + 13.51)/ 27.161 + 36.51)= 0.6025 or60.25p

priceonSubscripti-pricerightsxrightofaluelTheoretica !

= 60.25 37= 23.25p

PartB

Illustrationofneutral impactonwealth

Numberofsharesheldby the investor = 720shares

i) ExerciserightsInitial investment = 720*0.9150

= 658.8Numberofnewsharesasrights = 720* 1.34

= 965 shares


12/19

Exerciseofrightsat 37p = 965 *0.37= 357.05

Total investment 1015Valueofnew investment = 720 + 965)* P x1015 Change inwealth = 0

ii)

Sellright

sInitial investment = 7 20*0.9150

= 658.8Valueof 720shares followingrights issue = 720*0.6025

= 433.8Decline invalue = 225Proceeds fromsaleofrightsat 23.25p = 965 *0.2325

225 Change inwealth = 0

PartC

Thepossiblereasons foremploying three important perspectivesofrights issuesarediscussed below.

seofdeepdiscounts

1. Deepdiscounts 40.44% in Lloydscase)helpensure that market priceofsharesnevergobelow thesubscriptionpriceofrightsbeing issued. Ensuring thisdifference isakeydeterminant in thesuccessof therights issue.

2. Since thecapital toberaised isalmost 55% of the initial valueof the firm 24.85 billion),issuingrightsat aconventional discount of 20% resulting inasubscriptionpriceof 18.3p)wouldresult in the termsbeing0.67 newshares. Thiswouldnot be anattractiveoffering forthecurrent shareholdersandso, adeeperdiscount isdefinitelyrequired.

seof underwriting1. Deepdiscounting leads toa largernumberof total shareswithclaimson the firmsearnings,

dividendsandassets leading toadverse reactions from investorswhoseldomdifferentiatebetweenreal andnominal changes. Thus thepresenceofunderwriters isnecessary toabsorbsuchrisks.

2. Also, deepdiscountingmaybeviewedby investorsasa failure toarrangeunderwritingandso, associationswith large investment bankswouldhelpeliminate this fear.

3. From theunderwritersperspective, thiswouldbeagoldenopportunity toownapart ofalargebanking firm like Lloydsandwouldbehighlyprofitable in the long term.

Highcostof underwriting

1. Underwritersnormallychargeanominal feeof 2% of theproceedsof the issue. In Lloyds

case, thepriceof issueswasdiscountedby 40.44% anda feeof 2% wouldnot beattractiveforunderwriters to takeon theriskofabsorbingunsoldrights. Thi sclearly justifies theuseofhigherthanaverage fees.


13/19

PartD

Thepossiblereasons forapositivemarket reactionandan increase in thepriceof thesharesovertheperiodbetween theannouncement of the issueand thereleaseof the issueoverarediscussedbelow.1. If thesharemarket foreseeshigherreturnsand thushigherprofitabilityon thenewcapital

beingraisedby Lloydsdue topriorinformationabout investment proposals tied to thiscapital, thesharepriceswould increaseassoonas theri ghts issue isannounced.2. Shareprices fluctuateondemandandsupply. If Lloydsshareswere inhighdemandpriorto

theannouncement, thesharepriceswould inevitably increase.3. It couldbeargued that insidertradingor leakageof informationwouldspark speculationofa

possible increase inshareprices. Also, the involvement ofhighprofileunderwriters in therights issuemight stirpublic interests in favourof thecompany . These factorswould lead toincreased tradingandaproportional increase ins hareprices.

4. Shareprices increaseproportionally toan increase in thedividendpayout ratio. A possiblestepof thisnatureby Lloydsbefore theannouncement of therights issuewouldcauseadefinite increase inshareprices.


14/19

Question 4

PartA

easons why Novembercalls trade athigherprices thanSeptembercalls

In the normal market scenario, share prices rarely change drastically and would take time toincreaseordecrease. Investorsspend inbuyingoptionpremiumsconsidering that sharepriceswouldchangeandprofits can bebooked. During the short spanof an options life, there arefewerchances that at thematuritydate, thesharepricewouldchange tosuchanextent that itwould trespass thesumof theoptionexecutionandoptionpremiumpri ce. The longer the timethat acall has torun tomaturity, thegreaterwouldbe thescope for theprice todrift above theexerciseprice. bviouslya longermaturityperiodwouldgivemore time forprices to fall belowtheexerciseprice;howeverpotenti al gainsand lossesarenot symmetricallydistributed. Thereare limits to lossesbut not to thegains. Thissuggests that theoptionpremium isdirectlyrelatedtomarket volatilityandhencerelated to the time left tooptionmaturity. The longer themat uritydateavailable, themore likely for investors to invest inoptionsas therearehigherchancesofmakingprofit in long termoptions. Becauseof thisreason, thepremiumpricesattached to longmaturityoptionsaregenerallyhigher than theshort mat urityoptionsandhence theNovembercallsare tradingonhigherprices than the Septembercalls.

Valueof Call

Time Value

ST

Valueofcall premium Time tooptionmaturity

PartB

Comparison betweenCall,Put andStraddle Options

From thequestion,

Share Exercise Price X = 190 NovemberExpiring Call Premium C 0 = 50NovemberExpiring Put Premium P 0 = 22

Call OptionST = X + C0ST = 190 + 50 = 240


15/19

Profit/Loss

+

C0 = 50

240

X=190 Share Price

- 50

_

Put Option

ST = X - P0ST = 190 22 = 168

Profit/Loss

+

P0 = 22

168

X=190 share Price

Straddle Option

Foraprofitablestraddle:

ST X > C0 + P0 R X ST > C0 + P0ST > X + C0+ P0 ST < X C0 P0ST > 190 + 50 + 22 S T < 190 50- 22ST > 262 S T < 118

When investing in the call option, the investor would receive gains only if the share price atmaturitywill gohigher than 240p.Consequently in theput option, gainswouldbeattainedonly ifthe share pricegoes below 168p. Investing ina straddle option, the investor will face a losswhen theshareprice isbetween 118pand 262p, elseprofitswouldbereali ed.


16/19

Profit/Loss

+

Put Call

168 240

118 190 262 Share Price

_

Exercise Put Cost = 50 + 22 Exercise Call

Inan ideal world, predicting thedirectionofshareprices isnot easy;however it ismuchsimplertoanticipatewhetherthemarket will bestableorvolatiledep endingon important market driving

factors. In thissituation, investingmoney ineitheracall oraput isdangeroussince themarketisunpredictableandmight oppose thedirectionof investment with the investorendingup losingthewholepremiumamount . When investorssense futurevolatility instocks, theycanadopt thestraddle technique toavoid lossesandmakeprofits. Inastraddle investment, the investorspendsmoney inboth thecall andput options. Althoughmorepremiumsarespent inastraddle ,it ismuchsafersince ifsharepricesshoot up, call optionsgenerateprofitsandwhensharepricesplummet, put optionsmitigate losses. owever, investing inastraddleoption isquestionablewhen theshareprice ispredicted tobestable fora longp eriod.

PartC

easons whyoptions areconsiders are zero sumgames

Options are considered as ero sum games in which one participants writer/Investor) gainresult only fromanotherparticipants writer/investor)equivalent losses. Thenet change in totalwealthamongboth theparticipantswill be ero, only thewealth shifts fromone toanother.

Profit

Investors Position

+C0

X S T

-C0

Loss Writers Position


17/19

Thepossibilityofprofits forboth the investorsandwriters inacall option tradingwouldbeas

follows:

Share Price Investor Writer If ST < X -C +CIf ST > X S T-(X+C) (X+C) - ST

From theabove figureandprofit/loss illustrationsassociatedwithcall options for investorsand

writers, it canbe inferred that while investorsattainprofits throughhighsharepriceat expiration

time (ST), writers would have losses in thesameproportion. On theotherhand, when writers

attain profit through low share prices at expiration time, investors wi ll have the same losses

(premiumamount paid tobuy thecall). It proves that theprofit ofone is thesameas the lossof

the other and balances each other out. This justifies that options are ero sum games for

investorsandwriters.

PartD

Analysis forcoveredcall usingcalloption

Coveredcall isamethod inwhich thewriterofacall invests in theunderlyingasset tocontrol

riskexposure. In thismethod, therisk forlarge losses ismitigatedby thechancesofhighgains

on the shares being held. owever the combined profits in a covered call is less than that

generatedby investing inshareswhosepricesexceeds theexercisepriceplus thevalueofcall.

Exercise Price X = 230OctoberCall Premium C0 = 18

Share

Price

Call

ExercisePrice

Price of

Call

Liability of

a Call atexpirydate

Net profit

oncall

Profit/Loss

onshare

Profit/Loss

oncoveredcall

210 230 18 0 18 -20 -2

In theaboveexample, there isanet lossof 2p, considering that moneyhasonlybeen invested

inbuying thecall at anexercisepriceof 230ppluscall premiumof 18p.

Beforeapplying the concept of the covered call, the writer would lose 20p in the transaction.

When thematurityshareprice is 210p, the total loss incurredwouldbeof 18p. From thewriters

perspective, the investorwould lose thecall premium, however thewriterwouldhave topay 20p

as thecurrent market price is 210pandasper theobligation, thewriterhas topay 230p to the

investor, thusendingup ina 20pdifferencepershare.

Usingacoveredcall, thewriters loss isdecreased to 2p from 20pbycapturing theprofit fromthecall premium, thusreducingexposure toapparent risk.


18/19

Part E

Reasons why buying and sellingofoptions involves a highdegreeofriskexposure

Bothbuyingandsellingofoptions involve highdegreesofriskexposure, thoughselling isriskierthanbuyingoptions. The risk involved insellingcanalsobecompared to therisk involved in

futures tradingwhererisksareseenevenonhighprofit percentages.

As thesellerof theoptions, thewritercollects thepremium from thebuyerinexchange forbearing theriskofei therbuyingorselling theunderlyingcommodity. Asabuyer, themaximumlossan investorcan incuris the lossofpremium if thesharepriceat maturityperiod is less thantheexecutionprice. owever, losses fortheoptionsellercanbeunlimitedwhen t hemarketclimbsskyhigh. Thewriterofacall optioncan losemoremoney thanashort sellerof that stockon thesameriseofstockprice. Thisexemplifieshow leverage inoptionscanworkagainst theoption traders.

Someof themajorriskspertaining tobuyingoptionsare:y Riskof losing theentire investment inarelativelyshort periodof time y Riskcreatedbyspecificexerciseprovisionsofaspecificoptioncontracty Regulatoryagenciesmay imposeexerciserestrictions, whichstops investorfrom

realisingpotential value

Theriskspertaining tosellingoptionsare:y Optionssoldmaybeexercisedat any timebeforeexpiration y Coveredcall traders forgo theright toprofit when theunderlyingstockrisesabove the

strikepriceof thecall optionsso ldandcontinue toriska lossdue toadecline in theunderlyingstock

y Call optionscanbeexercisedoutsideofmarket hourssuch that effectiveremedyactionscannot beperformedby thewriterof thoseoptions

y Writersofstockoptionsareobligatedunder theoptions that theysoldeven ifa tradingmarket isnot availableorif theyareunable toperformaclosing transaction

y Thevalueof theunderlyingstockmaysurgeorditchunexpectedly, leading toautomaticexercises


19/19

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finance assignment reviewed final

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