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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. Fo...

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#### Question Preview:

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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## Solution Preview

Solution – 1

In order to maximize the shareholder's property, managers are actually the only people who work on behalf of these shareholders, day-to-day management activities and activities to maximize the wealth of the firm's owners.
Therefore, the primary responsibility of the manager is to maximize the shareholder's money.

Yes, an individual be indifferent to receiving a dollar now or a dollar one year from now, since the present value of a dollar may change from one year now.
Let us consider the explanation by using technical point.

Suppose the rate of interest is 4% per annum, then 1\$ present value will become

PV of 1\$=11.041

=0.96

Therefore, the present value of 1\$ will become 0.96\$ one year from now, at the 4% rate of interest.

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