Fashion Capital Companies Bond Management

Question: Describe about the Facts and Report for Fashion Capital Companies Bond Management. Answer: Value of bonds of Capital Fashion Ltd. Value of a bond = C*(1-(1/ (1+i) ^n))/I + F/ (1+i) ^n Where: C = Interest paid on bonds I = required rate of return N = number of years to maturity F = face value Where C = 87.5, I = 6%, N = 12 years, F = $1000 Value of bond = 87.5* (1-(1/(1.06)^12))/0.06 + 1000/ (1.06) ^12 = $1230.5 Value of Preference shares of Agri Credit Ltd. Value of preference share = dividend at end of year 1 / required rate of return = 2.5 / 7% = $35.71 Value of Equity of Southern Cross Electricals Ltd. Value of equity for constant growth = expected dividend / (required rate of return growth rate) Growth rate for Southern Cross Electricals Ltd = (present dividend/past dividend) ^1/n 1 Assuming dividends grow at the same rate as the earnings of the company, we substitute earnings per share for dividend per share Growth rate = (3.06/1.49)^1/5 1 = 15.4% Dividend at end of year 1 = current dividend * growth rate = 1.32 * 1.154 = $1.52 Value of equity = 1.52 / (0.15 0.154) = -$380.8 The values of all investments and their market price are presented below: Investment Market price Value Overvalued/undervalued Bonds $1314 $1230.56 $-83.44 (overvalued) Preference shares $25.5 $35.71 $10.21 (undervalued) Equity shares $36.75 $-380.82 $-417.57 (overvalued) The bonds are selling at a price higher than their intrinsic value. Returns from bonds are in the form of coupon payments and the face value of bond redeemed at maturity. If the bond is selling at a value higher than its value, the bond holder will receive less than the purchase price of the bond and therefore his returns will be low. The bond is overvalued in this case and it is expected that the price of the bond will fall in the future as the market corrects itself. Preference shares have their intrinsic value more than the market price making the shares undervalued. The price of the shares is expected to increase in the future as the market will correct itself. The equity shares have a negative value because the growth rate of the earnings of the company is higher than the required rate of return by the shareholders. Since the value of shares is less than the market price, the shares are overvalued and the price is expected to fall in the future. Based on the above, it is advised that the investor should invest in preference shares as they are undervalued and the price of the share is expected to increase in the future providing higher returns to the investor in the form of capital gains. Trends and prospects of the three industries. Apparel Retail Industry The industry is expected to grow at the rate of 3.3% in the next five years. (IBIS world, 2016). The industry saw slowdown in the previous years due to poor economic conditions which led to decrease in demand, also immense competition in the industry reduced profit margins for the players. However, now with the increasing trend of online selling and improved economic conditions, the demand for retail good is increasing. Also, domestic players are facing competition from international players which has forced them to increase their establishments and product offerings. (Euromonitor, 2016) Financial Services Industry The financial services industry is the highest contributor of income in Australia. The industry is highly regulated and developed. Funds management and superannuation are the major products being offered by the industry and is the most reputed around the world. (FSC, 2014). The industry is expected to grow at a fast rate as a result of many technological innovations prevailing in the industry. Increase in the use of online services for carrying out trading transactions has made the industry quite accessible and easy to operate. (treasury.gov.au, 2016). Australia even exports the financial services and exports contribute to the growth of the industry. (austrade.gov.au, 2016) Electrical Appliance Industry The electrical appliance industry is very competitive. There is huge demand for the appliances in Australia as a result of busy lives of the people. The customers are ready to pay premium prices for highly designed appliances which can make their everyday tasks easy. The industry is expected to continuously grow in the future due to increasing need of appliances and the ease of their availability through online selling. The suppliers are in a constant effort to improve the efficiency of the appliances as the water and electricity rates are on a rise. These highly designed appliances will be in great demand in the future. (Euromonitor, 2016) With a decrease in the growth rate by 3%, the resulting growth rate of Southern Cross Electrical Ltd. will be 12.4%. Dividend at the end of year 1 = 1.32 * 1.124 = $1.48 Value of equity share = 1.48 / (0.15 0.124) = $57.06 Investment Price Value Difference Bond $1314 $1230.56 $-83.44 (overvalued) Preference share $25.5 $35.71 $10.21 (undervalued) Equity share $36.75 $57.06 $20.31(undervalued) We see that both preference shares and equity shares are undervalued. However, the equity shares are more undervalued as compared to preference shares and hence it would be recommended to invest in equity shares rather than preference shares. Required rates of return at which the market price and the value of the investment would be equal, the investor will be indifferent to all the three options. This required rate of return is calculated below: Bond = (C + (F P)/n) / (F+P)/2 = 87.5 + (1000-1314)/12) / (1000+1314)/2 = 5.3% Preference shares = D0 / P0 = 2.5 / 25.5 = 9.8% Equity = D1 / (P + g) = 1.52 / 36.75 + 15.4% = 19.6% At the above required rates of return, the value of investment is equal to its market price and the market is said to be efficient. According to efficient market hypothesis, there are no losers or gainers as investors are equally informed and as such the investments are priced correctly. References IBIS World, (2016), Clothing Retailing in Australia: Market Research Report, retrieved from https://www.ibisworld.com.au/industry/default.aspx?indid=407 Austrade.gov.in, (2016), Financial Services: A Sophisticated Hub for the Asia- Pacific, retrieved from https://www.austrade.gov.au/International/Buy/Australian-industry-capabilities/financial-services Euromonitor, (2016), Apparel and Footwear in Australia, retrieved from, https://www.euromonitor.com/apparel-and-footwear-in-australia/report Euromonitor, (2016), Consumer Appliances in Australia, retrieved from, https://www.euromonitor.com/consumer-appliances-in-australia/report FSC, (2014), Financial Services is Now Australias Largest Industry, Media Release, Sydney, Financial Services Council Treasury.gov.au, (2016), The Strength of Australias Financial Sector, retrieved from, https://fintech.treasury.gov.au/the-strength-of-australias-financial-sector/