Analysis On Farm Financing And Portfolio Investments

Part A – Farm Financing

(a). As per the given situation, owner of the Grains Plus forecasted that after the harvesting season he will need $240,000 additional for the period of 3 months.  He was confused regarding the annual percentage rate of the borrowing. The rate of interest charged by the banker was 1% more than the Reserve Bank’s cash rate, that is, 4%. Furthermore, he is required to keep a balance of 20% of the loan. The annual percentage rate (APR) is a charge states sometimes as normal APR or sometimes as effective APR. It explains the rate of interest for the complete year that is, annualized rate of interest, rather than simply the monthly rate as charged against loan, credit card and mortgage loan.

Additional fund required by the owner of Grains Plus = $ 240,000 for three months

Annual interest rate = 1% +3% = 4%

Amount required for additional balance = ($240,000 * 20%) – $4000

     = $48000 -$4000

     = $44,000

Therefore, total requirement = $ 240,000 + $ 44,000 = $ 284,000

Interest @ 4% for 3 months will be = $ 284,000 * 4% * 3/12 =$ 2,840

Total amount to be repaid = $244,000 + $ 2,840 = $ 246,840

 Annual percentage rate = $2,840/$240,000*12/3*100 = 4.73% (Vicknair & Wright, 2015).

(b). Both the government and Reserve bank of Australia is in the view that for the growth of the people as well as the country, they must sets out three objectives. These are:

• The welfare and economic prosperity of the individuals of Australia
• Achieving and maintaining full employment level within Australia
• Stabilisation of Australian currency

The stabilisation of currency generally interprets the price stability that is, stabilisation of Australian dollar with regard to the purchasing power of services and goods. To achieve this they must control the inflation rate.

If the bank offers a rate that is lower than the Reserve bank of Australia, say at 2%, then the owner and operator of Grains plus must accept this offer as the annual percentage rate for the loan offer previously made by the bank is 4.73%, which is much higher as compared to the rate of 2% (Keynes, 2016).

• Expected return of the portfolio:

E(R) = W1*R1 +W2*R2+W3*R3+W4*R4+ W5*R5, where, W = weights of share and R = expected return of share (Martin, 2016).

E(R) = 0.20*0.16 + 0.30 *0.14 + 0.15*0.20 + 0.25*0.12 + 0.1*0.24

E(R) = 0.032+0.042+0.03+0.03+0.024

E(R) = 0.158 or 15.8% (Arrow, K. J., & Kruz, M. (2013).

• Beta of the portfolio

Beta of the portfolio = W1*B1+W2*B2+W3*B3+W4*B4+W5*B5, where, W = weights of share and B = beta of share (Uppal & Zaffaroni, 2016).

Portfolio beta = 0.20*1 + 0.30 *0.85 + 0.15*1.20 + 0.25*0.60 + 0.1*1.60

= 0.20+0.255+0.18+0.15+0.16

Portfolio beta = 0.95

• Plotting the security market line (SML)

Required return = Rf + β (Rm – Rf)

= 0.07 + 0.95 (0.155 – 0.07)

= 0.07 + 0.081

= 0.151 or 15.1%

• From the graph it is appeared that the shares of Harvey norman holdings limited, Qantas airways limited and BHP billion limited’s share are the winners as their expected rate of return is more than the required rate of return and National Australia bank limited and Origin energy limited’s share are the losers as their expected return is less than the required rate of return (De Giorgi, Post & Yalcin, 2013).
• The result is less than certain as there is problem in estimation of the security market line (SML) with certainty. For example, there is problem in specifying the portfolio of the market (Jylha, 2015).

Recommendation report:

Newcrest mining limited is based in Australia and engaged in the mining, development, exploration and sale of gold-copper concentrate and gold. They are the leading gold mining organization and their operation is extended beyond Australia. Their mission is to delivering superior quality returns from developing. Finding and operating the copper and gold mines. Their asset portfolio involves operating mines for using various efficient methods of mining for the bigger ore bodies in association with the selective underground methods for mining to maximise the deposits of high grade epithermal (adenergy.com.au, 2017). On the other hand, Orica limited is the largest provider for commercial explosive and inventive system for blasting for quarrying, mining, gas, oil and construction market. They are also the leading provider of sodium cyanide for the extraction of gold and provide ground assistance related services in tunnelling and mining. Their main objective is to make their clients successful all over the globe. Their main strategy is to obtain the position of trusted partner for their customer’s choice through delivering, creating and developing civil blasting and mining (Orica – Clever Resourceful Solutions, 2017).

 Looking at the above figures, it is identified that required rate of return of the company is 1.35%, whereas the same is 9.35% for Orica limited. It shows that, with regard to the required return factor, Orica limited is much better than Newcrest mining limited. Further, the value of the stock of Newcrest mining limited is underpriced as compared to the constant dividend growth model, whereas the stock value of Orica limited is overpriced as compared to the constant dividend growth model. Apart from these two measures, if the holding period return is considered, it is identified that the monthly holding period return for Newcrest mining limited is 6.6% and that of Orica limited is 0.425%. it is clearly identified that the holding period return for Newcrest mining limited is much better than Orica limited. Therefore, if the investor planning for long-term investment then Newcrest mining limited must be preferred. However, if the investor is looking for constant return, he shall go for Orica limited. Here in the given situation, the investor has AUD 120 millions and looking to invest for 10 years that is for long-term period. Therefore, the investor must invest his fund in Newcrest mining limited as the holding period return for this company is much better as compared to Orica limited.

References:

Arrow, K. J., & Kruz, M. (2013). Public investment, the rate of return, and optimal fiscal policy (Vol. 1). Routledge.

De Giorgi, E. G., Post, T., & Yalcin, A. (2013). A concave security market line.

https://www.adenergy.com.au/, A. (2017). Newcrest Mining Limited. Newcrest.com.au. Retrieved 10 April 2017, from https://www.newcrest.com.au/

Jylha, P. (2015). Margin constraints and the security market line.

Keynes, J. M. (2016). General theory of employment, interest and money. Atlantic Publishers & Dist.

Martin, I. (2016). What is the Expected Return on the Market?. The Quarterly Journal of Economics, qjw034.

Orica – Clever Resourceful Solutions. (2017). Orica.com. Retrieved 10 April 2017, from https://www.orica.com/

Uppal, R., & Zaffaroni, P. (2016). Portfolio Choice with Model Misspecification: A Foundation for Alpha and Beta Portfolios.

Vicknair, D., & Wright, J. (2015). Annual Percentage Rate And Annual Effective Rate: Resolving Confusion In Intermediate Accounting Textbooks. American Journal of Business Education (Online), 8(3), 207.

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