Discussion questions and practical exercises:

Word Count: 1002
Total pages: 7
Question A-1
The real owners of a company are its shareholders. The objective of maximising a firm’s market value to shareholders is achieved by increasing the price of existing ordinary shares. This market price reflects the value of the firm as seen by its owners.
An accountant’s position within a corporation can have numerous responsibilities with equal importance. The majority of attention for an accountant is indeed conferred to the company’s balance sheets and profit and loss statements as these are vital in maintaining control over the company’s financial position; however accountants play a vital role in making key financial decisions that contribute to creating wealth for the shareholders. Methods such as budget forecasting and capital budgeting techniques are utilised and performed by accountants to determine which projects should be undertaken to maximise profits. They construct and provide the financial information necessary for directors to make an informed and calculated decision on where to invest the funds provided by shareholders.
Companies have an endless life span and to simply focus on either short term or long term profits would be contrary to the interests of the company and its shareholders. Investors will react strongly to every investment and dividend decision by either increasing or decreasing the share price. A strong focus must therefore be given to every investment and dividend decision made by the company to continue to maintain the confidence of the real owners of the company. By making good financial decisions today and creating wealth for the shareholders, the company will have greater funds to make financial decisions in the future.
Question A-2
Part A
(i)
Robert’s total life expectancy at his retirement age is 84 years
(ii)
The life expectancy table is based on a summary measure of mortality in a population. These life tables require accurate data on deaths (by age and sex) and on the population (by age and sex). If the overall level of mortality in a population is known, it is quite possible to construct reasonable estimates of life expectancy using the life tables. As Australia records all information on deaths in the population, a considerably accurate and reliable measurement of life expectancy can be achieved.
(iii)
As each individual person reaches their next birthday, the life expectancy table shows an increase in their total life expectancy because it takes into consideration the consistent trend of people living longer. Technological improvements in the fields of health and medicine are continually occurring, and as a person lives another year longer, these improvements take effect in society which slightly increases a person’s total life expectancy as they reach another birthday.
Part B
(i)
1. First five years after retirement:
EAR = (1 + i)^m – 1
EAR = (1 + .11/4)^4 -1 = 11.46%
2. Periods beyond the first five years after retirement:
EAR = (1 + i)^m – 1
EAR = (1 + .12/12)^m -1 = 12.68%
(ii)
FV = PV (1 + i)^n
FV = 900,000 (1+.1146)^5 = 1,548,237.93
FV = 1,548,237.93 (1+.1268)^13 = 7,308,808.80
Solving for interest rate:
I = (FV/PV)^1/n -1
I = (7,308,808.80/900,000)^1/18 -1
I = 12.33%
The effective interest rate for Roberts expected investment return is 12.33%
Part C
(i)
The present value of Option A is $900,000
Part D
(i)
Cash flow diagram for ordinary annuity on page 7.

(ii)
The present value of Option B at Robert’s retirement date is $872,121.20
Calculator 1: Calculator 2:
FV – 7,448,367.233 PMT - -125,000
PMT - -125,000 N - 18
N – 18 I – 12.65465%
Comp I = 12.65465% Comp PV – 872,121.20
(iii)
The equivalent rate of return that Robert is earning from Option B is 12.65%
FVIFA = FVn / PMT
FVIFA = 7,448,367.233 / 125,000
FVIFA = 59.58 – Under appendix C 59.58 equates to 12.65%
Part E
(i)
Cash flow diagram for annuity due on page 7.
(ii)
The present value of Option C at Robert’s retirement date is $719,306.23
Calculator 1: Calculator 2:
FV – 7,337,247.265 PMT - -110,000
PMT - -125,000 N - 18
N – 18 I – 13.80%
Comp I – 13.80% Comp PV – 719,306.23
(iii)
The equivalent rate of return that Robert is earning from Option C is 13.80%
FVIFA = FVn / PMT
FVIFA = 7,377,247.265 / 110,000
FVIFA = 67.06 – Under appendix C 67.06 equates to 13.80%
Part F
I would recommend option B to Robert as it represents the highest future value of $7,448,367.233. Although it ranks second with a present value of $872,121.20, and an interest rate of 12.65%, this present value and interest rate would earn Robert more in the long term, then having a slightly higher present value and lower interest rate with option A, or a much lower present value and higher interest rate with option C.
Part G
(i)
If Robert selected Option B, the issues that would need to be considered are firstly that the calculations for this option are based on his projected investment return from his previous performances, and that exceptionally profitable investments may be difficult to find and maintain over 18 years. Secondly, if Robert were to pass away prematurely before reaching the predicted age of 84, he would forfeit any further annuity payments. The estimated future value of the cash flows for this option is also based on Robert reaching the age of 84.
Thirdly, superannuation funds are not immune to the effects of a global financial crisis and as the annuity payments are stretched over a relatively long period of 18 years, if the retirement fund were to go into liquidation in the near future he could potentially lose the remaining payments owed to him by the fund.
(ii)
As Robert’s current health problems require infrequent hospitalisation, this could represent a significant risk to him not reaching his average life expectancy regardless of whether they are life threatening at this stage.
His family history of one in three family members dying before reaching their average life expectancy also creates additional risk. The current health problems that Robert is experiencing may indicate that he has the particular gene causing premature death to life expectancy.
Option C seems the more appropriate payment choice given that the payments continue on regardless of whether Robert passes away before reaching his average life expectancy, however taking into consideration other factors such as the possibility of another GFC and the likelihood of the retirement fund going into liquidation over the 18 year period, this may not be the best option.
The payment choice i would recommend based on the above factors is Option A. A lump sum payment would avoid the risks of another GFC and losing any remaining payments, as well as maintaining the predicted future value of the income stream by receiving the whole payment up front.

Question A-3
Part A
(i)
Assessable Income: $3,545,000
Company sales $3,500,000
Investment Income $45,000
Total Income
Less allowable deductions $3,230,000
Direct costs of operations $2,500,000
Operating expenses
Other $700,000
Financing expenses
Interest $30,000
Taxable income $315,000
Tax liability (315,000 x .30) $94,500
(ii)
Dividends:
The dividends paid to shareholders did occur in the 2010 financial year, however they were paid out of profits from years prior to the 2010 financial year and thus do not represent an allowable deduction for the company.
Bank Loan:
The loan of $395,000 that is owed to the bank does not constitute an allowable deduction, however any expenses incurred on those borrowings such as the $30,000 interest expense are an allowable deduction.
Part B
The maximum number of fully franked dividends that the company can distribute is $220,000
$315,000 – $94,500 = $220,500
Part C
The amount of imputation credits associated with the maximum dividend payment is $94,500
Cash flows for Questions D i and E i: