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C540 Assignment 4

Financial
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Assignment 4
90 points

1.
The returns on a stock for the last 5
years have been 25%, 6%, -11%, 2%, and -20%.

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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

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Stock A return

Stock B return

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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 - Affordable Custom Essay Writing Service | Write My Essay from Pro Writers 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 - Affordable Custom Essay Writing Service | Write My Essay from Pro Writers and holding it through the end of December 2013. In your
calculations assume that any dividends are reinvested immediately in the stock

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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 - Affordable Custom Essay Writing Service | Write My Essay from Pro Writers 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)

http://finance.yahoo.com/q/ks?s=PII
http://finance.yahoo.com/q/ks?s=EMMS
http://finance.yahoo.com/q/ks?s=JNJ

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)

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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)

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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 ßP = 1.0, ßE = 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)

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