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C540 Assignment 4




Question;Financial;Management;Spring 2014;Assignment 4;90 points;1.;The returns on a stock for the last 5;years have been 25%, 6%, -11%, 2%, and -20%.;a. Assuming;that you purchased the stock for $31.50 five years ago and that all returns;have come in the form of either capital gains or losses (i.e., there have been;no dividends), what is the price of the stock today? (3 points);b.;Compute the average (arithmetic) return.;(3 points);c.;Compute the geometric average return. (3;points);d.;What is the yearly return standard;deviation? (3 points);2.;The following describes the probability;distribution of future returns for 2 stocks;State;of the Economy;Probability;Stock A return;Stock B return;High growth;.15;30%;10%;Low;growth;.20;13%;8%;No;growth;.40;6%;4%;Recession;.25;-5%;-2%;The beta of;stock A is 1.3 and the beta of stock B is 0.4.;Compute the;expected return and standard deviation for both stocks. (3 points)Compute;the expected return, standard deviation, and beta of a portfolio;consisting of 50% in stock A and 50% in stock B. (6 points)Which risk measure is more;appropriate for determining a stock?s contribution to the riskiness of a;well-diversified portfolio, its return standard deviation, or its beta? Clearly;explain your reasoning (3 points);To answer Question 3,you;need to download the spreadsheet with stock price data fromthe;?assignment? section of lesson 7 in Angel. This file contains monthly stock;prices, dividends, and stock split information for Advanced Micro Devices;Green Mountain Coffee Roasters, and UnitedHealth Group for the period spanning;from December 2008 through December 2013. For each company, there are 61;monthly closing prices, from which you will be able to calculate 60 months of;stock returns.;3.;Calculate the monthly returns for each;of the stocks;a.;Calculate the arithmetic average monthly;return for each stock. (3 points);b.;Calculate the geometric average monthly;return for each stock. (3 points);c.;Calculate the monthly return standard;deviation for each stock. (3 points);d. Calculate;the total percentage return (this would be what is referred to in the text as;the holding period return) for each stock based on purchasing a share at the;end of December 2008 and holding it through the end of December 2013. In your;calculations assume that any dividends are reinvested immediately in the stock;C540;? Spring 2014 1;rather;than being stuffed under a mattress where they would earn no further returns.;(3 points);If;you constructed a portfolio at the end of December 2008 consisting of 50;shares of each of the stocks and held this portfolio through the end of;December 2013 (once again, reinvesting all dividends), what would be the;total percentage return (holding period return) on the portfolio? What;would the portfolio?s geometric average monthly return be? (3 points);To;answer questions 4 through 6,you will to;access the tab labeled ?stock return datafor Q4-6? in the previously;downloaded spreadsheet. The tab contains monthly stock returns for;Polaris Industries (PII), Emmis Communications (EMMS), and Johnson;Johnson (JNJ), for the months from January 2009 through December 2013, along;with monthly stock returns for the S&P Composite Index over the same;period.;4. a.;Using the returns on the S&P 500 Composite Index as the proxy for the;overall stock market return, estimate a beta for each stock listed above in;Excel. Report the betas and comment on your level of confidence in each of the;beta estimates given the significance level (p-values) of the t-statistics for;the beta estimates in the regression models. Clearly demonstrate your;understanding of beta calculations and statistical estimates. (15 points);b.;What beta estimates do you find at Yahoo Finance (the links below)? Why might;the beta estimates from Yahoo Finance differ from the beta estimates that you;calculated? (3 points);;;;5. Which;of the three stocks (PII, EMMS, and JNJ) has the most total risk if held in;isolation? Clearly convey what measure you used to identify the amount of risk;of a stock held in isolation. (3 points);6. Which;of the three stocks (PII, EMMS, and JNJ) has the most systematic risk? Clearly;convey what measure you used to identify the amount of systematic risk. (3;points);C540;? Spring 2014 2;7. a.;Based on the following beta estimates, what would be the portfolio beta for a;portfolio invested as follows? (3 points);Portfolio;Beta;Weights;2nd;National Bank;20%;0.5;Chesapeake;Energy;15%;0.6;Pentair;30%;0.9;Pegasus;15%;0.5;Sodastream;20%;1.6;100%;b. Based;on the Beta estimates in part a, a Treasury bond rate of 2.97% and an expected;market risk premium of 7%, what would be the expected return on the portfolio;described in part a (assuming the stocks are fairly priced based on the CAPM)?;(3 points);8. Vaughn;Manufacturing (VM) has 720 bonds outstanding with a 5.75 percent coupon rate;(semi-annual coupon payments) and 15 years left to maturity. The bonds sell for;$927.50. VM?s common stock has a beta of 1.24. The 10-year Treasury-Bond rate;is currently 2.75 percent, and historically, the market has earned 7% more per;year than the 10-year Treasury rate. The firm has 147,000 shares of common;stock outstanding at a market price of $21.50 a share (book value of $9 per;share). There are 40,000 shares of preferred stock outstanding at a market;price of $30 a share (book value of $40 per share). The preferred stock pays a;$2.50 annual dividend. The company?s marginal tax rate is 38 percent.;a.;What is the after-tax cost of debt? (3;points);b.;What is the cost of preferred stock? (3;points);c.;What is the cost of common stock? (3;points);d.;What is the weighted;average cost of capital for Vaughn Manufacturing? (3 points);C540;? Spring 2014 3;9. SL;Jones Corporation, an all equity-financed company, has traditionally employed a;firm wide discount rate for capital budgeting purposes. However, its two;divisions ? publishing and entertainment, have different degrees of risk given;by ?P = 1.0, ?E = 2.0, and the beta for the overall firm is 1.3. Use 6% as the;risk-free rate and 12% as the expected return on the market. The firm is;considering the following capital expenditures;Proposed Project;Initial Investment;IRR;P 1;$1M;.130;Publishing;P 2;$3M;.121;P 3;$2M;.090;E 1;$4M;.160;Entertainment;E 2;$6M;.170;E 3;$5M;.140;a.;Which projects would the firm accept if it uses the opportunity cost of capital;for the entire company? (3 points);b. Which;projects would it accept if it estimates cost of capital separately for each;division? (3 points);c. If;SL Jones Corporation only uses the cost of capital for the entire firm, what;will happen to the riskiness of the firm, compared to using the appropriate;divisional cost of capital? (3 points);C540;? Spring 2014 4


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