Question

b. Charge Car P/L is considering a project to launch charging stations for electric cars around Australia. The initial investment is expected to be $100,000,000 and the term of the project is 6 years. The required rate of return from the project is 14% p.a. The annual cash flows are outlined in the following table:

End of year	Cash flow p.a. ($m)
Year 1	20
Year 2	22
Year 3	25
Year 4	30
Year 5	34
Year 6	37

1. Based on Charge Car’s required rate of return would you recommend proceeding with this investment? Present all calculations to support your answer. [2.5 marks]
2. Would you change your opinion if Charge Car’s required rate of return increased to 16% pa? Present all calculations to support your answer. [2.5 marks]

c. Bobby Brown has just turned 48 years of age and has come to you seeking retirement advice. During your discussion the following information was communicated:

• Bobby wants to retire on his 65^th birthday;
• he currently has $198,000 in his superannuation fund;
• he contributes $800 per fortnight into his super account; and
• the investment returns are 8% p.a.

In addition to the super fund, Bobby has also invested $100,000 today (his 48^th birthday). The investment is in a direct share portfolio which produces average returns of 6% p.a. after tax. The investment returns are paid every 6 months.

When Bobby retires at the age of 65, he will use his super and non-super investments to purchase an ordinary annuity which will provide him with a regular monthly income stream until he reaches life expectancy at 83 years of age. The rate of return for the annuity will be 4% p.a.

Bobby is concerned that he may live beyond life expectancy and wishes to ensure he has a residual value of $150,000 remaining in his annuity when he turns 83. He will use the money to supplement the aged pension.

Task

1. What will be the value of Bobby’s financial assets when he retires at age 65? Present all calculations to support your answer. [5 marks]
2. What will be the annual pension amount that Bobby will receive until age 83? Returns are compounded annually at year-end. Present all calculations to support your answer. [5 marks]

Question 2 [20 marks]

This question relates to Topic 1 and LOs 2, 3 and 5

a. Tony is applying for a new home loan. He wishes to borrow $250,000 and make his repayments monthly. The interest rate the bank has quoted him is 4% per annum and the inflation rate is 3% pa.   

1. Is this the real rate of interest or the nominal rate of interest? [1 mark]
2. Explain the difference between the real rate of interest and the nominal rate of interest. [3 marks]
3. Calculate the real rate of interest and the nominal rate of interest for Tony. [3 marks]
4. Is it possible for the real rate of interest to equal the nominal rate of interest? Explain. [3 marks]

b. The Reserve Bank of Australia has announced a 0.25% decrease in the cash rate. What effects does this have on the economy and the financial markets? Provide examples of who might benefit from this decrease and those who may not.

Answer 1

b. When the discounting rate is 14% p.a,

Time Years		0	1	2	3	4	5	6
Cash Flows(A)		-100	20	22	25	30	34	37
Discounting Rate(B)	1.14	1	0.877193	0.769468	0.6749715	0.5920803	0.5193687	0.455587
Discounted CashFlows (A*B)	-100	17.54386	16.92829	16.874288	17.762408	17.658535	16.8567

The cash flows in the respective periods are taken in the cash flows column. The discounting rate is taken at 10% and the cash flows are discounted accordingly.

Net Present Value = Sum of the present value of Cash Inflows - Present Value of Cash Outflows = 103.624 million - 100 million = $3.624 million

Hence, we should accept the project when the discounting rate is 14% p.a.

When the discounting rate is 16% p.a,

Time Years		0	1	2	3	4	5	6
Cash Flows(A)		-100	20	22	25	30	34	37
Discounting Rate(B)	1.16	1	0.862069	0.743163	0.6406577	0.5522911	0.476113	0.410442
Discounted CashFlows (A*B)	-100	17.24138	16.34958	16.016442	16.568733	16.187843	15.18636

Net Present Value = Sum of the present value of Cash Inflows - Present Value of Cash Outflows =

= 97.55 million - 100 million = $ - 2.45 million

Hence , we should not accept the project when the discounting rate is 16% p.a.