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Assignment#1
(Looking for someone with a sound knowledge of Managerial/Corporate
Assignment#1
(Looking for someone with a sound knowledge of Managerial/Corporate Finance)
Part A:
Corporate investment decision to diversify and its impact on Firm
Value
“If shareholders can undo/redo a certain corporate
decision on their own, there is no
relevant value from such move by a given firm.” – The
real implication of Modigliani and
Miller (MM) 1958 theorem
The above principle initiated by the Founding Fathers of
Corporate Finance (MM) could be
applied to all corporate finance decisions.
In the context of finance, especially from your INVESTMENT
(e.g. investing in Financial
Assets such as shares, bonds, ETFs, and such) COURSES,
diversification has been one of the
top tools in optimalising your investment portfolio as it
could maintain average returns while
reducing the total risk of your portfolio investment. BUT
could a firm adopt this same
principle and add value to its shareholders? The assigned
article in Part A touches on this
particular issue, with the focus on our New Zealand
corporate landscape.
QUESTIONS/TASKS
You are working as a consultant for a listed firm in New
Zealand. The company’s
management team is now considering corporate
diversification, with a belief/claim that
such practice would further add value to shareholders. These
executives ask you to seek
further information and provide insights that could aid
their decision. Upon your search,
you came across the following article (shared on our Stream
website in the ‘reading list’).
You plan to use it as your main source while also searching
for other relevant literature and
information (e.g. online).
Al-Maskati, N., Bate, A.J., and Bhabra, G.S. (2015),
“Diversification, corporate
governance and firm value in small markets: evidence from
New Zealand”,
Accounting and Finance, Vol. 55. 627-657.
2
Please provide the answers to Questions 1 to 3:
1. According to the main findings of the article, provide an
executive summary on whether
corporate investment decision to diversify helps or harms
shareholders’ interest, in a
New Zealand context. Also provide brief explanations why and
what factors to look out
for.
(Tips: This is a rather straightforward question. About two
(or three) pages of double-spaced typewritten
texts should be sufficient for the answers.)
2. Based on your own evaluations, provide further
considerations or aspects one should also
consider beyond what
is mentioned in the article. Justify your points well.
(Tips: There can be two aspects. This should be not more
than 1.5 double-spaced pages for EACH
aspect. Back up your points with information beyond the
assigned article.)
3. If this setting were changed to be for ‘China’ instead,
how would your conclusions
(e.g. from Q1)
change, in your opinions?
(Tips: This question should be not more than two
double-spaced pages. Back up your points with
information beyond the assigned article.)
Part B:
Advanced techniques in Investment decision – Real Option Analysis
Chemis Pharmaceutical Incorporation (CPI) is a medium-sized
pharmaceutical supplier for
Australasian region. CPI has just attained a 15-year
exclusive right to launch a new nasal spray
which helps with clogged nose faster than any other ones
available in the over-the-counter
market (assumed no rivals or substitutions for a foreseeable
future) called ‘Ouvertin’. With the
co-operations of the marketing/production/financial teams of
CPI, the estimated average cash
flows for launching ‘Ouvertin’ emerge as follows:
3
Half-year Cash flows
0 -10000000
1 200000
2 300000
3 360000
4 400000
5 600000
6 800000
7 1000000
8 1000000
9 1200000
10 1200000
11 1400000
12 1600000
13 1600000
14 1200000
15 1000000
16 1000000
17 1000000
18 1000000
19 1000000
20 1000000
21 1000000
22 800000
23 800000
24 600000
25 600000
26 600000
27 400000
28 400000
29 400000
30 400000
The product is within the same line of CPI existing business
while its cost of capital is 11.5%
per year. In addition, launching Ouvertin will not alter the
company’s cost of capital. The
launching of Ouvertin will cost $10 million at any point in
time during the next fifteen years
and is fixed (at $10 million). The 15-year government bond
YTM is observed as 3.5% per year
in the government bond market. The pharmaceutical product
market is quite volatile in its
nature. The six-month stock return variance on this
industry’s stock portfolio in the relevant
markets is estimated as 21%. For simplicity, let’s assume
that the rate of decay on the product.
launching project is constant through time.
4
Questions:
1. Should CPI should go ahead with the launching of the new
product – Ouvertin?
Provide a numerical justification in the context of ‘real
option analyses. The use of
Black and Scholes model in Excel (submitted separately) to
justify your numbers is.
also required.
Note:
-Assume e = 2.718
Part C:
Applying newly emerged technique from recent research.
Memphis Tiger Company
You are working as a financial consultant for Memphis Tiger
Company, a (hypothetical)
publicly traded firm. Carly Santana, the CEO of the company,
has been frustrated with the
traditional ‘cost of capital’ calculations typically
introduced in conventional finance textbook
for several reasons. Ms. Santana turned to a journal that is
most popular among ‘corporate
finance’ practitioners called ‘Journal of Applied Corporate
Finance’. It is a highly regarded
journal that summarises/digests the latest development and
debates in corporate finance to
audiences. In a rather recent issue, she has found an
article that offers a new way to calculate
the cost of capital for a company called ‘EACC’ (The article
will be shared on Stream website,
through the reading list. It is written by Gerard Olson and
Michael Pagano of Villanova
University -USA). Ms. Santana is extremely excited about
this and has asked you to do the
following for her:
Olson, G.T., and Pagano, M.S. (2017), “The Empirical
Average Cost of Capital: A New
Approach to Estimating the Cost of Corporate Funds”,
Journal of Applied Corporate
Finance, Vol. 29. 101-110.
QUESTIONS
1. Calculate EACC for Memphis Tiger Company based on
the data source provided (in
the Excel file posted on Stream). This dataset was prepared
(collected and manually
keyed in) by an intern who delivered it in a rush due to
work overload placed on him
lately. Also provide a brief discussion on which version of
‘total capital’ should be used
if the company’s stock is thinly traded in the share market.
Note
– Use Microsoft Excel application wherever possible. Submit
your Excel work file along with the answers well.
written in a Words file.
– There is no particular setting of how many pages the
report should contain. It should be complete and yet concise e.g. not over 20
pages of a Word file.
I will include additional sources and information relevane to the assignement
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