part 1

IT Software Project As a senior analyst for the company you have been asked to evaluate a new IT software project. The company has just paid a consulting firm $50,000 for a test marketing analysis. After looking at the project plan, you anticipate that the project will need to acquire computer hardware for a cost of $400,000. The Australian Taxation Office rules allow an effective life for the computer hardware of five years. The equipment can be depreciated on a straight-line (prime cost) basis and there is no expected salvage value after the five years.

Your company does not have any available space where the project can be located for five years and you anticipate a new office will cost $80,000 to rent for the first year. You expect that the project will need to hire 3 new software specialists at $50,000 (each specialist) in the first year for the full five years to work on the software.

The project will use a van currently owned by the company and although the van is not currently being used by the company, it can be rented out for $5,000 per year for five years (inclusive inflation). The book value of the van is $20,000. The van is being depreciated straight-line (with five years remaining for depreciation) and is expected to be worthless after the five years.

Expected annual marketing and selling costs will be incurred during the life of the project (5 years), with the first year expecting to be $200,000. The produced software is expected to sell at $100 per unit while the cost to produce each unit is $40. You expect that 10,000 units will be sold in the first year and the number of units sold will increase by 20% a year for the remaining four years. The project will need working capital of $50 000 to commence the business (in year 0) and the project’s life (in year 5). The company tax rate is 30%, and the discount rate is 10%.

Based on the information presented above, answer the following questions (1) – (3).

In evaluating the new IT software project, are the cost of $50,000 spent on marketing analysis and the use of van relevant for capital budgeting decision? Explain your answer(s). Show workings.
Calculate the incremental free cash flow during the project’s life (at the end of Years 1 through 5). Show workings.
Calculate the NPV, payback period and IRR of the project. Should the project be accepted? Show workings and explain your answer(s).

part 2

Risk and return

You are considering an investment in the stock market and have identified three potential stocks, they are Crown (ASX: CWN), Tencent (HKG: 0700) and Commonwealth Bank (ASX: CBA).  The historical prices for the past 10 years are shown in the table below.  Assume no dividend is distributed during this period.

Year
Crown
Tencent
Commonwealth (CBA)

2010
7.76
29.04
53.63

2011
8.57
40.40
52.15

2012
8.09
37.94
50.39

2013
11.59
54.28
64.10

2014
16.68
108.70
73.83

2015
13.61
132
88.85

2016
12.27
144.90
78.67

2017
11.4
204.40
81.66

2018
13.25
463.60
78.87

2019
11.95
346
69.91

(6 marks)

Calculate the return and risk (standard deviation) of each stock.

(3 marks)

Explain the relation (positive or negative) between risk and return based on your answers in part (1).

(6 marks)

Calculate the correlation coefficient between (a) Crown and Tencent and (b) Tencent and CBA.

(3 marks)

Calculate the expected (annual) return and standard deviation if you owned a portfolio consisting of 50% in Crown and 50% in Tencent.

(3 marks)

Calculate the expected (annual) return and standard deviation if you owned a portfolio consisting of 40% in CBA and 60% in Tencent.

(4 marks)

Which portfolio (parts 4 or 5) provides better diversification? Explain your answer(s).