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FNCE 370v8: Assignment 4




Question;FNCE 370v8;Assignment 4;Assignment 4 is worth 5% of your final mark.;Complete and submit Assignment 4 after you complete Lesson 12.;There;are 12 questions in this assignment. The break-down of marks for each question;is presented in the table below. Please show all your work as this will help;the marker give you part marks as well as serve as a good study aid as you;prepare for the Final Examination.;Question;Marks Available;Reference;1;5;Lesson 10;2;5;Lesson 10;3;5;Lesson 10;4;5;Lesson 10;5;10;Lesson 11;6;15;Lesson 11;7;10;Lesson 11;8;10;Lesson 11;9;5;Lesson 12;10;10;Lesson 12;11;10;Lesson 12;12;10;Lesson 12;Total;100;1.;Explain the interactions among market;efficiency, capital budgeting, and the cost of capital. (5 marks);2.;(5 marks);a.;Give two examples of anomalies in the;financial markets.;b.;What does the existence;of these anomalies say about financial market efficiency?;3.;You bought one of BB Co.?s 9% coupon bonds;one year ago for $1020. These bonds make annual payments and mature six years;from now. Suppose you decide to sell your bonds today, when the required return;on the bonds is 10%. If the inflation rate was 4.2% over the past year, what;would be your total real return on investment?;(5 marks);4.;The returns on XYZ Corp. over the last four;years are 10%, 12%, 3%, and -9%.;(5 marks);What is the historical average return over the;last four years?;What is the variance of the returns over the last;four years?;What is the standard deviation of the returns;over the last four years?5.;(10 marks);a.;Suppose we have two assets, A and B. What;correlation levels between the two assets will yield diversification benefits;in terms of portfolio risk reduction?;b.;At what correlation;level will there be no diversification benefits in terms of portfolio risk;reduction?;c.;Will there be any;diversification benefits in terms of portfolio risk reduction in the case when;the correlation between the two assets? returns is -1?;6.;(15 marks);The expected;returns, return variances, and the correlation between the returns of four;securities are shown below.;Security;Expected Return;Variance of Returns;Correlation;A;B;C;D;A;0.17;0.0169;1.0;0.4;0.7;0.2;B;0.13;0.0361;1.0;0.6;0.5;C;0.09;0.0049;1.0;0.9;D;0.07;0.0050;1.0;a. Determine the expected return and variance for a;portfolio composed of 25% of security A and 75% of security B.;b. Determine the expected return and variance of a;portfolio that contains 78% security A and 22% security B. Is this portfolio;superior to that one in (a) above?;c. Calculate the expected return and variance of a;portfolio that contains 60% security C and 40% security D.;d. If an investor were to select among the following;three portfolios, which one would he or she prefer?;o;An;equally-weighted portfolio of securities A, B, and C.;o;An;equally-weighted portfolio of A, B, and D.;o;An;equally-weighted portfolio of B, C, and D.;e. If a risk-adverse investor desires to hold a;portfolio of only two securities and expects a return of 11%, what would you;advise the investor to do?;7.;Use;the following information to answer the questions below. (10 marks);Security;Return;Standard Deviation;Beta;A;15%;8%;1.2;B;12%;14%;0.9;a.;Which;of A and B has the least total risk? The least systematic risk?;b.;What;is the value of systematic risk for a portfolio with 75% of the funds invested;in A and 25% of the funds invested in B?;c.;Calculate;the risk free rate of return and the market risk premium;(i.e., Rf and RM ? Rf).;d.;What;is the portfolio expected return and the portfolio beta if you invest 30% in A;30% in B, and 40% in the risk-free asset?;(For questions (d) and (e), assume the risk free rate of return is 5%.);e.;What;is the portfolio expected return with 125% invested in A and the remainder in;the risk-free asset via borrowing at the risk-free interest rate?;f.;What;is the beta of the portfolio created in part (e)?;8.;Consider the following information on three;stocks. (10 marks);Rate of Return if State Occurs;State of economy;Probability of;state of economy;Stock A;Stock B;Stock C;Boom;0.5;0.2;0.35;0.6;Normal;0.3;0.15;0.12;0.05;Bust;0.2;0.01;-0.25;-0.5;a.;If your portfolio is;invested 40% each in A and C, and 20% in B, what is the portfolio expected;return?;b.;What is the variance of;this portfolio?;c.;What is the standard;deviation of this portfolio?;d.;If the expected T-Bill;rate is 5%, what is the expected risk premium on the portfolio?;e.;If the expected;inflation rate is 2.50%, what are the approximate and exact expected real;returns on the portfolio?;f.;If the expected T-Bill;rate is 5% and the expected inflation rate is 2.50%, what are the approximate;and exact expected real risk premiums on the portfolio?;9.;Briefly discuss the;advantages and disadvantages of using the dividend growth model to estimate the;cost of equity. (5 marks);10.Mustard;Patch Doll Company needs to purchase new plastic moulding machines to meet the demand;for its product. The cost of the equipment is $100,000. It is estimated that;the firm will generate, after tax, operating cash flow (OCF) of $22,000 per year;for the next seven years. The firm is financed with 40% debt and 60% equity;both based on market values. The firm?s cost of equity is 16% and its pre-tax;cost of debt is 8%. The flotation costs of debt and equity are 2% and 8%;respectively. Assume the firm?s tax rate is 34% and ignore the effects of CCA;depreciation. (10 marks);a. What is;the firm?s tax adjusted WACC?;b. Ignoring;flotation costs, what is the NPV of the proposed project?;c. What is;the weighted average flotation cost, fA, for the firm?;d. What is;the dollar flotation cost of the proposed financing?;e. After;considering flotation costs, what is the NPV of the proposed project?;11.Photosynthesis;Inc. is considering a project that will result in initial after-tax cash savings;of $2 million at the end of the first year, and these savings will grow at a;rate of 6% per year indefinitely. The firm has a target debt-equity ratio of;1.5, a cost of equity of 20%, and an after-tax cost of debt of 7%. The;cost-saving proposal is somewhat riskier than the usual projects the firm;undertakes, management uses the subjective approach and applies an adjustment;factor of +10% to the cost of capital for such risky projects.;Under;what circumstances should Photosynthesis take on the project? (10;marks);12.ABC Co.;has the following dividend payment history: (10 marks);Year;Dividend;2003;$1.00;2004;1.15;2005;1.25;2006;1.35;2007;1.45;a. How many periods of growth are;there in the information given?;b. What is the compound growth rate;of dividends?;c. Calculate the year-to-year;growth rates in dividends.;d. What is the average year-to-year;dividend growth rate?;e. Assume a retention ratio of 0.45;and a historical return on equity (ROE) of 0.18. Using these two additional;pieces of information, calculate an alternative estimate of dividend growth;rate, g.


Paper#48453 | Written in 18-Jul-2015

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