Financial Assignment: Share Prices of Qantas Airways & Westpac

Question

Task: The assignment consists of two parts: Part A of focuses on financial instruments of two companies, QANTAS and Westpac Banking Corporation. Part B is about the fundamentals of capital budgeting.
Part A: QUANTAS and WESTPAC Share Prices
1. What is the current price of ordinary/common shares of AMP and Westpac? How has each evolved over the past 5-years? Explain how clips of news reported in the press (e.g. newspapers, TV or periodic financial journals) have moved the share prices of both Qantas and Westpac shares. Use a graph each series to illustrate your discussion. 2. Define Systematic and unsystematic risk. How might the current COVID-19 pandemic affect systematic risk and/or unsystematic risk of both Qantas and Westpac?
Part B: Capital Budgeting
Neridas Drilling Ltd requests you to evaluate two new capital budgeting proposals and provide your recommendations. You are required to submit a report by responding to the underlisted questions.
Instructions are as follows:
Provide an evaluation of two proposed projects, both with identical initial outlay of $400,000. The required rate of return on both projects is set at 15%. The expected after-tax cash flows from each project are presented in the table below.
In evaluating these projects, please respond to the following questions:
1. Determine the net present value (NPV) of both projects. Should the projects be accepted or rejected? Explain in detail, including all calculations.
2. Determine the IRR for each of each project. Should the projects be accepted or rejected? Explain in detail, including all calculations.
3. Would your conclusions in parts (2) and (3) change if the required rate of return decreased to 12%? Explain in detail, including all calculations.
4. Under what circumstances will the NPV and IRR offer different recommendations, and which recommendation is preferred? Carefully explain
5. Determine the profitability index (PI) for each of these projects? By PI criterion, should the projects be accepted or rejected? Explain.
6. Define payback period. What is the payback period on each project? If Neridas Drilling Ltd imposes a 3-year maximum acceptable payback period, which of these projects should be accepted? What are the main limitations of the pay back method of capital budgeting?

Answer

PART A: QANTAS and WESTPAC Share Prices
Share Price Movements

Present report on financial assignment covers the discussion on changes in the share prices of Qantas Airways Limited and Westpac Banking Corporation. Both the entities belong to Australia and are one of the key players of their respective industry. Qantas operates in Airlines industry of Australia while Westpac belongs to its banking industry. The share price of Westpac has fluctuated within a range of AUD 22.00 to AUD 29.00 until the time COVID 19 did not start making its presence in the world. However, since the end of Feb’ 20 it has started declining further to the level of AUD 16.50 and thereafter in April’ 20 it has lowered down to AUD 15.96. March is the first time when the share prices of the company have fallen down to the level of AUD 15 or 16 when COVID 19 was declared as pandemic event by WHO. The news stories of WBC’s stock considered to prepare this financial assignment have been negative in the recent times. The InfoTrie Sentiment Analysis Group which scores the public limited companies on the scale of -5 to 5 basis press coverage sentiments by considering around 6000 news sources, has ranked WBC at -3 which implies that the scores are likely to impact the share prices of the bank further (Marketbeat, 2020). In 2018 as well, it is stated herein financial assignment that the share prices of WBC were hit worst with a fall of 5.4% as it announced its ex-dividend plans and after the time when request of settled penalty of $35 million for automated loan’s use assessment went unapproved in federal court and the judge proposed to increase the fine as higher as $100 million on account of its proven poor lending activities (Australian Associated Press, 2018).

Refer: Appendix (Table 1)

The share prices of Qantas Airways have also fluctuated widely over the past 5 years. In 2016, share prices fell down by 26% primarily because of loss of customer’s confidence since it announced its plans to cut down its domestic as well as international flights due to less demands (King, 2016). However, in 2017, Qantas proved to be one among the best performing stock. As per The Australian Financial Review (AFR) used in this section of financial assignment, Investment bank Goldman Sachs improved the ratings of company’s stock on account of its strong outlook which prompted the potential investors to buy its shares. The prime reasons for its aggressive increase of its share prices were the doubling of its dividend payments in 2017 from 7 to 14 cents per share and its buyback scheme involving buying back of its 143.6 million shares and thirdly its restructuring strategies wherein it reshuffled its top management and included high margin destinations in its scope (Ronngard, 2017). In a summarized picture, Qantas has achieved a 370% hike on its share prices over the last 5 years from AUD 1.16 to AUD 5.45 majorly on account of its sheer financial performance which has encouraged it to reinstate its dividend and promoted its buy back strategies (Prout, 2019). Further, it is noted herein financial assignment that after the announcement of its plans to be a carbon neutral company by 2050, its share prices in 2019 by 26.39% (Hall, 2019). However, since the pandemic COVID 19 has affected the country, the impact of the outbreak could be seen on Qantas Airways as well. The epidemic has caused Qantas to announce its reduced operations. The revenue of the company has recently got affected and due to which its prices in the market have down to the level of AUD 3 to 4.

Refer: Appendix (Table 2)

What is the role of systematic and unsystematic Risk in the present context of financial assignment?
Risk refers to the degree of uncertainty associated with any event. In the areas of financial markets where people invest their savings so as to obtain returns on their investment, there exists risk of uncertain returns. From the purview of stock market returns provided within this financial assignment, risk is generally categorized in two major categories which are: Systematic Risk and Unsystematic Risk.

Systematic risk is the risk that is not confined to any particular company or industry rather it is an inherent risk that prevails in the stock market due to the macroeconomic conditions that cannot be controlled. The factors mentioned in the financial assignment that lead to the systematic risk are recession, inflation, change of interest rates or currency exchange rates, wars and so on (Kiselakova, Horvathova, Sofrankova & Soltes, 2015). No individual company or sector can influence the systematic risk. Some of the common examples of Systematic risk are interest risk, purchasing power risk or market risk.

On the other side, it is also clear on this financial assignment that unsystematic risk is the type of risk that generally remains company or industry specific. Such risks are directly attributable to an individual investment or to a small investment group and hence are controllable by the companies or industries to which it is associated (Jeyachitra, Selvam & Gayathri, 2010). Examples of such risks are business risk, liquidity risk, regulatory risk, operational risk, political risk, technological risk. Unsystematic risk is also known as diversifiable risk, specific risk or residual risk. Diversification of unsystematic risk can almost eliminate it.

As COVID 19 has been declared as a pandemic event affecting all the people across the world, the economies of various nations have been significantly being affected out of its outbreak. COVID 19 has imposed systematic risk on the stock markets of majority the countries as it is not confined to a particular industry or a company from one country. The spread of Corona Virus is rapidly covering the entire world and is causing huge economic losses to the countries. Like other economies Australia, the numbers of positive cases of Corona Virus are increasing with each passing day and by far there are 6311 confirmed cases with 59 deaths (The Courier, 2020). The spread of virus has drastically impacted the short term outlook of Australia’s economy (Jericho, 2020).

According to the research on financial assignment, Westpac Banking Corporation is being one of the top four banking corporations of Australia is also affected with the impacts of COVID 19. Interest rates in the banking sector of Australian Economy have slashed down to historic low of 0.25% on account of overall economic slow-down (Walton, 2020). The loan repayments from the customers are being deferred to 6 months. Since the last one month share prices of Westpac has reduced by 43.29% and is presently reported as AUD 15.96 (dated 11^th April’ 20). The business of Westpac has certainly slowed down but at the same time the bank remains strong to combat the adverse macroeconomic events such as COVID 19 due to sufficient buffer of its liquid assets to help the country’s businesses.

Alike all the airlines across the world, Qantas has certainly been affected by COVID-19 outbreak. Due to tightened travel restrictions on account of Corona Virus pandemic, the demand of airlines has been severely reduced. Amid Corona Virus outbreak, Qantas Airlines is now announcing measures like cutting down its networks, employees and the fleets (Davies, 2020). The international operations of the company are being forced to be completely suspended until the situation becomes normal. With the limited operations in scope, Qantas has suffered significant economic losses in terms of both its profitability and revenue (Cullinane, 2020). A few months before the Pandemic, Qantas has been operating successfully on was focused on new aircraft orders and followed by the announcements of its 1H results in Feb’ 20 its stock price had reported a steep increment from almost AUD 1.00 to AUD 6.67 but currently it is being traded at AUD 3.18 (as on 7^th April’ 20) (CAPA, 2020). Qantas Airways has recently deferred its interim dividend of $ 201 million till September’ 20 and has also stood down its 20000 workers temporarily (Freed, 2020) (Featherstone, 2020).

PART B: CAPITAL BUDGETING
The present report on financial assignment discusses the financial feasibility of two capital investment proposals of Neridas Drilling Limited. Given the information regarding the initial investment required for the projects amounting to $400,000 and the required rate of return for the projects as 15%, use of multiple capital appraisal techniques will be made so as to identify which project should be invested in so as to achieve profitability and higher cash inflows.

Net Present Value (NPV)

Firstly, the NPV of both the projects is determined in the present case. NPV is a key technique of capital budgeting as it takes out the present value of net cash flows by deducing all the cash flows from the cash inflows that are expected to take place in the given project duration (Imegi & Nwokoye, 2015). Higher the NPV, higher are the chances of profitability of project. A project with negative NPV shall not be taken into consideration as it implies that the project will have more cash outflows than the quantum of its cash inflows. In the present scenario, Project B has higher cash inflows than Project A. Hence, Project B has higher NPV which shows that Project B must be preferred over Project A as the former will be more profitable.

Internal Rate of Return (IRR)
Use of IRR is then made which is another common capital budgeting tool. IRR is the rate which is used to discount the projects and at which the NPV of the project becomes zero i.e. the sum of present value of all the cash flows and the initial investment becomes nil. IRR is used to determine the profitability of an investment. Higher the IRR, higher involves the profitability of the project. In the present case, hit and trial method is used to determine the IRR and it has been found the Project B has higher IRR than Project A, hence the former one is to be selected.

Scenario Analysis at 12%
Moving forward in this financial assignment, scenario analysis is being performed to evaluate the effectiveness of the both the proposed projects in the present case if the required rate of return falls down to 12%. With the reduction in the rate of return which is used as a rate of discounting the future cash flows so as to determine their present value, the NPV has ramped up in both the cases but still Project B outperforms the other project in question. However, there is no change in the IRR as process of determination of IRR is independent of the discounting rate usage. The IRRs of both the concerned projects are higher than 12% (revised rate of return). Hence both are acceptable but Project B is to be preferred over Project A.

Different Recommendation Case
Project A will be selected when:

• It has more cash inflows than project B.
• It has lower cost of capital then Project B.
• It has higher Project Duration.

Profitability index (PI)
PI is yet another important measure of identifying project’s profitability outlined within the financial assignment. It determines the ratio of present value of all the cash flows to the initial investment required for the project (Baker, Dutta & Saadi, 2010). Higher the profitability index the more is the project profitable to a business. In the present case of financial assignment, Project B is to be ranked first than Project A as the former has higher rank as per PI measure.

Payback Period and its Limitations
The last method that is being used under the current case of financial assignment is the Payback Period Method. Under this method a period is calculated which signifies the time within which the project will be able to recoup its initial project cost. In the present case of financial assignment, the payback period of project A is 3 years with the project duration of 5 years whereas Project B is able to recoup its initial investment in 2.22 years which is even lesser than half of the period of total project duration of 6 years. If the company has 3-year maximum acceptable payback period then it has an option to choose either of the two projects. However, it is also stated in the financial assignment that considering the lower payback period of Project B it must be preferred over Project A.

Payback Period

Though the payback period methods provides a suitable basis for decision making but it entails certain limitations due to which it loses its reliability. Following are the limitations of Payback Period provided within the financial assignment:

• It ignores the present value of cash flows obtained in the financial assignment: While calculating the payback period this method does not take into account the present values of the cash flows that are going to occur in future unless discounted payback approach is not applied. In the absence of consideration of present values of the cash flows the results might not be obtained as accurate (Baker & English, 2011). 
• The cash flows after Payback Period are ignored: Payback period do not consider the incremental cash flows that occur after achieving the payback period, inclusion of such cash flows might influence the decision making.

Recommendations:
Considering the above analysis on financial assignment, it would be suggest to the company to opt for Project B.

References
Australian Associated Press. (2018) [Online]Westpac shares fall 5% as markets punish banks in torrid trading. Available at: https://www.theguardian.com/australia-news/2018/nov/13/westpacs-record-35m-fine-rejected-by-judge-due-to-information-vacuum Accessed on 12.02.2020

Baker, H.K. and English, P. (2011). Capital budgeting valuation: Financial analysis for today's investment projects. Financial assignment John Wiley & Sons.

Baker, H.K., Dutta, S. and Saadi, S., (2010). Management views on real options in capital budgeting. Journal of Applied Finance, Forthcoming.

CAPA (2020). [Online] Qantas cuts deep, but well placed to weather COVID-19. Available at: https://centreforaviation.com/analysis/reports/qantas-cuts-deep-but-well-placed-to-weather-covid-19-518552 Accessed on 12.02.2020

Cullinane, D. (2020) [Online] Airline and travel stocks feel the impact of coronavirus. Available at: https://smallcaps.com.au/airline-travel-stocks-asx-feel-impact-coronavirus/ Accessed on 12.02.2020

Davies, A. (2020). [Online] More Qantas flights revealed to have been crewed by staff with Covid-19 Available at: https://www.theguardian.com/business/2020/apr/09/more-qantas-flights-revealed-crewed-staff-covid-19-coronavirusAccessed on 12.02.2020

Featherstone, T. (2020). [Online]. Why you can't rely on your dividends. Available at: https://www.afr.com/wealth/investing/why-you-can-t-rely-on-your-dividends-20200319-p54bsm Accessed on 12.02.2020

Freed, J. (2020). [Online] Qantas shares jump after it unveils coronavirus strategy, share buyback. Available at: https://www.reuters.com/article/us-qantas-results/qantas-shares-jump-after-it-unveils-coronavirus-strategy-share-buyback-idUSKBN20D2SC Accessed on 12.02.2020

Hall, K. (2019). [Online] Available at: Why the Qantas share price just hit a new record high. Available at: https://www.fool.com.au/2019/03/25/the-qantas-share-price-has-flown-370-higher-in-the-last-5-years/ financial assignment Accessed on 12.02.2020

Imegi, J.C. and Nwokoye, G.A. (2015). The Effectiveness of capital budgeting techniques in evaluating projects’ profitability. African Research Review, 9(2), pp.166-188.

Jericho, G. (2020). [Online]With the coronavirus, here's what's really going to matter for the Australian economy. Available at: https://www.theguardian.com/business/grogonomics/2020/mar/22/with-the-coronavirus-heres-whats-really-going-to-matter-for-the-australian-economy Accessed on 12.02.2020

Jeyachitra, A., Selvam, M. and Gayathri, J. (2010). Portfolio Risk and Return Relationship—An Empirical Study. Asia Pacific Business Review, 6(4), pp.57-63.

King, M. (2016). [Online] 3 reasons why the Qantas Airways Limited share price has dropped 26% this year. Available at https://www.fool.com.au/2016/06/02/3-reasons-why-the-qantas-airways-limited-share-price-has-dropped-26-this-year/ Accessed on 12.02.2020

Kiselakova, D., Horvathova, J., Sofrankova, B. and Soltes, M. (2015). Analysis of risks and their impact on enterprise performance by creating enterprise risk model. Polish Journal of Management Studies, 11.

Marketbeat (2020). [Online] Westpac Banking Stock Price, Forecast & News. Available at: https://www.marketbeat.com/stocks/NYSE/WBK/Accessed on 12.02.2020

Prout, L. (2019). [Online] The Qantas share price has flown 370% higher in the last 5 years. Available at: https://www.fool.com.au/2019/03/25/the-qantas-share-price-has-flown-370-higher-in-the-last-5-years/ Accessed on 12.02.2020

Ronnard, H.(2017). [Online]. How Did Qantas Share Price Soar More than 80% This Year? Financial assignment Available at https://www.moneymorning.com.au/20171006/qantas-share-price-soar-80-year.html Accessed on 12.02.2020

The Courier. (2020). [Online] Coronavirus: How many confirmed COVID-19 cases and deaths in Australia? Available at: https://www.thecourier.com.au/story/6687088/coronavirus-how-many-confirmed-covid-19-cases-and-deaths-in-australia/ Accessed on 12.02.2020

Walton, S. (2020). [Online] What the Big Four Banks are doing to stimulate Australia’s economy. Available at:https://www.ig.com/en/news-and-trade-ideas/how-the-rba_s-latest-rate-cut-will-impact-the-big-four-banks-200320 Accessed on 12.02.2020

Yahoo Finance (2020) [Online] AMP: Historical Data. Available at: https://finance.yahoo.com/quote/amp.ax/Accessed on 12.02.2020

Yahoo Finance (2020) [Online] Qantas Airways Limited (QAN.AX): Historical Data. Available at: https://au.finance.yahoo.com/quote/QAN.AX/history?period1=1428969600&period2=1586822400&interval=1mo&filter=history&frequency=1mo Accessed on 12.02.2020

Yahoo Finance (2020) [Online]Westpac Banking Corporation (WBC.AX): Historical Data. Financial assignment Available at:https://au.finance.yahoo.com/quote/WBC.AX/history?period1=1428796800&period2=1586649600&interval=1mo&filter=history&frequency=1mo Accessed on 12.02.2020

Appendices
Table 1

WESTPAC SHARE PRICES

QANTAS SHARE PRICES

Table: 2

Table 3