a) How does maximising the price of a firm’s share equate to maximising shareholder wealth? (3 marks) b) Can an individual be indifferent to receiving a dollar now or a dollar one year from now? Explain. (4 marks) Question 2 [16 marks] a) Mr. and Mrs. Peabody have recently had a daughter and want to send her to private school. School fees from kindergarten through to school year 7 (primary school) is to be $32,000, while those from school year 8 to year 12 (secondary school) is to be $50,000. Mr. and Mrs. Peabody’s daughter is due to start school when she is five years old. For simplicity, assume there are 8 years of school from kindergarten to year 7 inclusive (kindergarten, yr. 1, 2,…yr. 7). Additionally, assume that fees need to be paid, as a lump sum, at the beginning of both primary and secondary school. Required: Draw a simple time line of the payments to help explain your answer. How much money must Mr. and Mrs. Peabody set aside now if fixed-term deposit rates from five to 10 years are currently 4% p.a. compounded monthly, and from 10 to 20 years are currently 6% p.a. compounded monthly? There is a penalty of 10% for withdrawal of funds from a fixed-term deposit before maturity. (7 marks) b) You are considering two alternate investments – one a perpetuity and the other a stream of uneven cash flows. The perpetuity pays $25,000 in perpetuity from year 6 onwards, while the uneven cash flow investment pays the following cash flows in years 2 to 7: Yr 2: $80,000, Yr 3: $70,000, Yr 4: $60,000, Yr 5: $50,000, Yr 6: $40,000 and Yr 7: $30,000. Required: If you can only buy one of the above investments at a rate of return of 6% per annum, which would you prefer? Which would you prefer if you could achieve a rate of return of 8% per annum? Provide detailed workings. (9 marks)
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