You have been asked to provide preliminary advice on whether or not your company
ID: 2615672 • Letter: Y
Question
You have been asked to provide preliminary advice on whether or not your company's Super fund should make an investment in the shares of Metro Tunnel Melbourne Pty ltd., a large construction company which is leading a consortium that is proposing to build a rail tunnel between St Kilda to and Parkvill. The tunnel is scheduled to open in 20X4. Projected cash flows of the tunnel project
20X0 –450
20X1 –500
20X2 –550
20X3 –650
20X4 –200
20X5 200
20X6 300
20X7 320
20X8 340
20X9 360
20Y0 400
Each year after 20Y0 400
All projections exclude inflation.
The current domestic nominal risk-free rate is 6% whilst the real rate is approximately 4%. The market risk premium for the project has been estimated at 7%.
Required
Consider the short term and long term effects of the success of project by undertaking an analysis of the proposed tunnel project and advice on whether or not the Super fund should invest in shares of Metro Tunnel Melbourne Pty ltd. Relevant calculations must be shown. Incorporate risk in your analysis.
State clearly all assumptions that you make. In this question only reasoned assumptions regarding a discount rate are encouraged.
Present the calculation in a professional manner by using an integrated software package such as Microsoft excels spreadsheet.
Explanation / Answer
Market risk premium = Expected rate - risk free return ,
Expected rate = Market risk premium + risk free return
Here , Nominal rate will be used in calculation as , all the cash flow projections are not including inflation factors.
Nominal rate = real + inflation
So, Expected rate ( discounting) = 7 + 6 = 13%
NPV for long term = NPV ( for 10 years) +NPV ( perpetual cash inflow of 400 there after)
NPV for perpetual income = annual cash flow / discounted rate = 400/ 0.13 = $3076.92
NPV for long term = ($1,142.120) + $3076.92 = $ 1934.803.
Term Year Cash flow(CF) PV(CF) @ 13% 0 20X0 ($450.00) ($450.000) 1 20X1 ($500.00) ($442.478) 2 20X2 ($550.00) ($430.731) 3 20X3 ($650.00) ($450.483) 4 20X4 ($200.00) ($122.664) 5 20X5 $200.00 $108.552 6 20X6 $300.00 $144.096 7 20X7 $320.00 $136.019 8 20X8 $340.00 $127.894 9 20X9 $360.00 $119.839 10 20Y0 $400.00 $117.835 NPV ( for 10 years) ($1,142.120)Related Questions
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