Confidential Part: Total 60 Marks Please Use The Answer Shee

Confidentialpart Atotal 60 Marksplease Use The Answer Sheet Provid

Confidential part Atotal 60 Marks please Use The Answer Sheet Provided. CONFIDENTIAL PART A [Total: 60 marks] Please use the answer sheet provided. QUESTION 1 a) Find the present value of an income stream that has a negative flow of RM100 per year for 3 years, a positive flow of RM200 in the 4th year, and a positive flow of RM300 per year in Years 5 through 8. The appropriate discount rate is 4% for each of the first 3 years and 5% for each of the later years. Thus, a cash flow accruing in Year 8 should be discounted at 5% for some years and 4% in other years. All payments occur at year-end. [10 marks] b) Rahman is trying to determine the cost of health care to college students and parents’ ability to cover those costs. He assumes that the cost of one year of health care for a college student is RM1,000 today, that the average student is 18 when he or she enters college, that inflation in health care cost is rising at the rate of 10% per year, and that parents can save RM100 per year to help cover their children’s costs. All payments occur at the end of the relevant period, and the RM100/year savings will stop the day the child enters college (hence 18 payments will be made). Savings can be invested at a nominal rate of 6%, annual compounding. Rahman wants a health care plan that covers the fully inflated cost of health care for a student for 4 years, during Years 19 through 22 (with payments made at the end of Years 19 through 22). How much would the government have to set aside now (when a child is born), to supplement the average parent’s share of a child’s college health care cost? The lump sum the government sets aside will also be invested at 6%, annual compounding. [10 marks] c) You are saving for the college education of your two children. One child will enter college in 5 years, while the other child will enter college in 7 years. College costs are currently RM10,000 per year and are expected to grow at a rate of 5% per year. All college costs are paid at the beginning of the year. You assume that each child will be in college for four years. You currently have RM50,000 in your educational fund. Your plan is to contribute a fixed amount to the fund over each of the next 5 years. Your first contribution will come at the end of this year, and your final contribution will come at the date when you make the first tuition payment for your oldest child. You expect to invest your contributions into various investments, which are expected to earn 8% per year. How much should you contribute each year in order to meet the expected cost of your children’s education? [10 marks] [Total: 30 marks] QUESTION 2 Benang Industrial Tools is considering a 3-year project to improve its production efficiency. Buying a new machine press for RM611,000 is estimated to result in RM193,000 in annual pretax cost savings. The press falls in the MACRS five-year class (table 1), and it will have a salvage value at the end of the project of RM162,000. The press also requires an initial investment in spare parts inventory of RM19,000, along with an additional RM2,000 in inventory for each succeeding year of the project. If the tax rate is 35 percent and the discount rate is 12 percent, should the company buy and install the machine press? Why or why not? [30 marks] Table 1: Modified ACRS depreciation allowances PART B [Total: 40 marks] INSTRUCTION: Answer ALL questions. QUESTION 1 a) A 10-year, RM1,000 par value bond pays an 8% coupon with quarterly payments during its first five years (you receive RM20 a quarter for the first 20 quarters). During the remaining five years, the security has a 10% quarterly coupon (you receive RM25 a quarter for the second 20 quarters). After 10 years (40 quarters), you receive the par value. Another 10-year bond has an 8% semiannual coupon. This bond is selling at its par value, RM1,000. This bond has the same risk as the security you are thinking of purchasing. Given this information, what should be the price of the security you are considering purchasing? Calculate and justify your answer. [20 marks] b) Recently, SMJC Hospital Inc. filed for bankruptcy. The firm was reorganized as American Hospitals Inc., and the court permitted a new indenture on an outstanding bond issue to be put into effect. The issue has 10 years to maturity and an annual coupon rate of 10%. The new agreement allows the firm to pay no interest for 5 years. Then, interest payments will be resumed for the next 5 years. Finally, at maturity (Year 10), the principal plus the interest that was not paid during the first 5 years will be paid. However, no interest will be paid on the deferred interest. If the required annual return is 20%, what should the bonds sell for in the market today? Calculate and discuss your answer. [20 marks] END OF QUESTION

Paper For Above instruction

The financial decision-making process relies heavily on the valuation of cash flow streams, the understanding of project feasibility, and accurate bond pricing. These tasks involve applying present value techniques, risk-adjusted discounting, and depreciation methods to evaluate investment opportunities and debt instruments effectively within different market conditions.

Question 1a: Present Value of a Stream with Varying Discount Rates

The problem involves calculating the present value of a series of cash flows with alternating negative and positive flows over an 8-year span. Specifically, a negative RM100 per year for the first three years, RM200 in year four, and RM300 annually from years five through eight, with discount rates changing from 4% to 5% after year three.

To compute this, each cash flow must be discounted at the appropriate rate, considering that the later years’ discounting involves a change in the rate. The valuation involves splitting the cash flows into two segments: years 1-3 discounted at 4%, and years 4-8 discounted at 5%. For example, the present value of year 8’s cash flow (RM300) requires discounting at 5% for the successive years to reach the present, involving compound discounting over multiple years. Similarly, the cumulative present value of all cash flows sums up these discounted amounts to establish the total present value of the income stream.

Question 1b: Estimating the Government’s Investment to Cover Healthcare Costs at Birth

This problem involves projecting the healthcare costs for a student over four years, accounting for inflation, and estimating the appropriate savings to fund these costs. The initial cost is RM1,000, with a 10% annual increase, and the savings are RM100 annually, invested at 6%. The challenge is to determine the lump sum necessary when the child is born to cover the inflated healthcare costs during years 19 to 22, considering the inflation and growth of savings.

The inflation-adjusted healthcare cost in year 19 is calculated by compounding RM1,000 at 10% annually for 19 years, resulting in a rapidly increasing cost. The government’s required set-aside should be the present value of all payments from year 19 to 22, discounted back to time zero at 6%. Calculating this involves summing the present values of four inflated costs, which incorporate the future value of the annual savings and the inflation rate during the period.

Question 1c: Contributions for Children’s College Costs

This calculation involves determining the equal annual contribution needed over five years to adequately fund two children’s college education, starting in years 5 and 7 respectively. The current college cost of RM10,000 will grow at 5% annually, requiring a future value calculation to estimate the total cost in the year each child begins college.

The estimated future costs are then discounted back to the present, considering an 8% investment return. By setting the future value of total college costs equal to the future value of the series of contributions, the appropriate annual contribution can be computed, ensuring each child's education expenses are fully funded.

Question 2: Investment and Depreciation Analysis

This question involves calculating whether a new machine purchase is financially viable given projected savings, salvage value, depreciation, taxes, and discount rate. The initial cost of RM611,000, annual savings, salvage value, and depreciation schedule based on MACRS guidelines form the core of the analysis.

The key steps include calculating the annual depreciation, tax shields, net cash flows, and then discounting these cash flows at 12%. Comparing the net present value of all cash flows, including initial investment and salvage, allows determining whether the project adds value for the company.

Part B: Bond Pricing and Market Valuations

Question 1a: Valuation of a Variable-Rate Bond

The bond described has differing quarterly coupons in its first and second halves, with a final face value repayment at maturity. Given the parity bond paying semiannual coupons at 8%, its price indicates the market’s required yield, which can be used to price the variable-rate bond.

By calculating the present value of all coupon payments and the face value discounted at the yield implied by the semiannual coupon bond, the fair price of the variable-rate bond can be derived. The valuation must account for the changing coupon rates, ensuring that the present value reflects the risk and time value of money accurately.

Question 1b: Valuation of a Reorganized Bankruptcy Bond

The restructured bonds have deferred interest payments, with no interest paid for the first 5 years, and full principal plus deferred interest paid at maturity. Given a required return of 20%, the present value of all future cash flows, including deferred interest repayment at Year 10, is calculated.

This calculation involves discounting each cash flow—interest deferrals and principal repayment—by the market rate, considering the periods when payments are deferred. The resulting bond price reflects the risk-adjusted value of the reorganized debt, indicating the impact of deferred payments on bond valuation.

References

• Damodaran, A. (2012). Investment Valuation: Tools and Techniques for Determining the Value of Any Asset. Wiley Finance.
• Brealey, R. A., Myers, S. C., & Allen, F. (2017). Principles of Corporate Finance. McGraw-Hill Education.
• Fabozzi, F. J. (2016). Bond Markets, Analysis and Strategies. Pearson Education.
• Ross, S. A., Westerfield, R., & Jaffe, J. (2013). Corporate Finance. McGraw-Hill Education.
• Gordon, P., & Olson, J. (2018). Modern Financial Management. Cengage Learning.
• Hull, J. C. (2018). Options, Futures, and Other Derivatives. Pearson.
• Lintner, J. (1956). "Distribution of Income of Corporations Among Dividends, Retained Earnings, and Taxes." American Economic Review, 46(2), 97–113.
• Meziani, H., & AitBoudad, A. (2017). Financial Modeling for Strategic Decisions. International Journal of Economics and Financial Issues, 7(3), 245–251.
• Schiller, R. (2015). Financial Markets and Institution. McGraw-Hill Education.
• Stickney, C. P., Brown, P., Wahlen, J., & Schipper, K. (2010). Financial Reporting, Financial Statement Analysis, and Valuation. Cengage Learning.