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##### FNCE 370 Assignment 4

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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);a. What is the historical average return over the;last four years?;b. What is the variance of the returns over the last;four years?;c. What is the standard deviation of the returns;over the last four years?;Page 1 of 5;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;Variance of;Correlation;Return;Returns;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;Determine the expected return and variance;for a portfolio composed of 25% of security A and 75% of security 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?;Calculate the expected return and variance;of a portfolio that contains 60% security C and 40% security 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?;Page 2 of 5;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;Probability of;Stock A;Stock B;Stock C;economy;state of;economy;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?;Page 3 of 5;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);Page 4 of 5;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.;Page 5 of 5

Paper#49046 | Written in 18-Jul-2015

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