CASE STUDY – intro to applied finance.
Your client was recently injured at work and has received a compensation payout of $1,000,000 (received in a lump sum). Already financially stable, your client would like to help provide for their grand children’s future and therefore has decided to invest the lot. Your client has identified three investment options that they are interested in and want your professional advice as a finance expert on which investment you believe they should choose.
Option 1: involves placing the $1,000,000 into a Savings Maximiser account at the local bank. This account is guaranteed to return $100,000 at the end of each year for 10 years (starting at the end of the first year) after which time the client would then get their $1,000,000 investment back.
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Option 2: involves investing the total of $1,000,000 to buy 3 small 2 bedroom units. Each unit will then be rented out for $35,000 a year with the rent received at the end of the year commencing at the end of year 1. The rent is guaranteed as the apartments are rented out to a University and they have signed a rental contract for ten years. After the ten years the University has agreed via a signed contract to buy the units for a total of $1,500,000 in cash.
Option 3: involves investing in a brand new scheme whereby the client would be required to invest the total of $1,000,000 into an olive oil business, $250,000 upfront to plant the olive trees and set up the factory, and then $75,000 a year for 10 years for picking the olives and factory maintenance. The factory will not generate any olive oil for the first two years. At the end of the third year the factory is expected to generate $95,000 of olive oil and will increase production by $30,000 per year. Ten years after the olive trees are planted they cease yielding a commercial quantity of oil and the factory is sold to a neighbouring farmer for $100,000 in cash.
You have perused a number of other potential investment opportunities and in analysing these investment opportunities you have decided that the minimum required rate of return that the chosen investment will need to generate for your client is 12% per annum.
You are required to write a 1000 word report for your client that covers the following:
– An introduction to the report;
– A discussion, analysis and ranking of each investment using Net Present Value (NPV), Internal Rate of Return (IRR) and the Payback Period (PP);
– A discussion overall which investment should be chosen (i.e. what is the best investment for the client to choose and why)
– A discussion of the risks involved in each investment;
– A discussion of the limitations of using the NPV, IRR and the PP to evaluate investments;
– A conclusion to the report;
– An appendix to your report that includes the calculations for the NPV, IRR and PP for Investment 1, 2 and 3.
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