Question

Part a.

            You have bought a property and have four different options on how to pay for the property purchase. The four options are:

1. $ 200,000 p.a. paid every year for five years with the first payment paid at the end of the first year.

2. $250,000 p.a. for six years with the first payment paid at the end of the first year.

3. $1,000,000 at the end of the fifth year and $1,250,000 at the end of the 10^th year.

4. A $20,000 deposit paid now plus $100,000 p.a. paid forever from the rental of the property. The first $100,000 is paid at the end of the first year.

Required:

Using a required rate of return of 12% p.a., rank the order in which you would pay for the property from cheapest to most expensive, and provide the PV of each option.

                                                                                                                         

Part b.

Luke and Monica are proud parents of baby Lily who is 2 years old. They want to send Lily to Presbyterian Ladies’ College (PLC), a prestigious private girl college, when Lily enters secondary college. They estimate that to fully fund the cost of Lily’s secondary education they will need to have $120,000 at the time Lily is 13 years old. They currently

have $10,000 in an education fund for Lily which will be invested at 8% per annum until she reaches 13. They also intend to make monthly contributions into an investment account that pays 12% per annum (i.e 1% per month) with annual compounding. What is the monthly contribution if they were to achieve their saving objective of $120,000 when Lily is 13 years old?

                                                                                                                          

Part c.                                                                                                

XYZ company is expected to pay a dividend per share of $1.1 for the coming year. It expected that company can maintain a dividend growth of 15% a year for the next 3 years. Given an in-depth analysis, it comes to term that the growth rate will decline to 5 per cent per annum and remains at that level indefinitely. The required rate of return on the shares is 12 per cent per annum.

1. Calculate the current share price.

2. If the market for the company is $20.00, will you recommend to buy this stock?

                                                                                               (4+2 marks)

Answer 1

Part a:

Option 1: $720,955.24

Option 4: $8533,33.33

Option 3: $969,893.40

Option 2: $1,027,851.83

Part b

Required monthly contribution: $355.59

Part c

1. $21.34
2. Purchase the shares because these are undervalued. The market price is only at $20, when its value in accordance with the DDM reaches $21.34.