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Midterm Exam
Module 4 Assignment 2
Lydia Ross
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Managerial Finance B6022
Midterm Exam
Lydia Ross
Problems:
=2 (-5%) +.4(10%)+.5(30%)
= .18
4. Required Rate of Return = risk free rate + (market rate of return - risk free rate)*
Beta of the stock
rRF = 5%, rM = 12%, ß = 1.5
= .155
5. Required Rate of Return = risk free rate + (market rate of return - risk free rate)*
Beta of the stock
rRF = 4%, rM = 5%, ß = 2.0
=.06
6. Stock E has the greater relevant risk of 60% as opposed to Stock D relevant risk
of 18%.
7. Required Rate of Return = risk free rate + (market rate of return - risk free rate)*
Beta of the stock
. 16 = n + (.10 – n) * 1.8
= (.03)
8.
rRF = 3%, rM = 10%
Weight =
r = rRF + Stock/Total
Stock ß (rM -rRF)b Stock
$
400,000.00 1.5 0.135 0.4
$
500,000.00 2.0 0.17 0.5
$ 4.0 0.31 0.1
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100,000.00
10.
Weight =
Stock/Total
Stock r Stock
$
10,000.00 30% 0.1
$
50,000.00 16% 0.5
$
40,000.00 20% 0.4
8-24
a. “Like other low-risk investments, such as savings accounts and certificates of
deposit (CDs), T-Bills often earn relatively low interest; unlike with those
other options, however, interest earned by a T-Bill is not subject to state or
local taxes, although it is subject to federal income tax. Also, they are issued
in denominations of $100 and up to a maximum of $5 million in government
securities which may be purchased at a single auction. They are fully backed
by the credit of the U.S. government and thus are considered essentially risk-
free (Practical Money, 2011)”. “High tech’s returns move with, hence are
positively correlated with, the economy, because the firm’s sales, and hence
profits, will generally experience the same type of ups and downs as the
economy. If the economy is booming, so will high tech. On the other hand,
collections is considered by many investors to be a hedge against both bad
times and high inflation, so if the stock market crashes, investors in this stock
should do relatively well. Stocks such as collections are thus negatively
correlated with (move counter to) the economy (Umdrive Memphis, 2011)”.
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Managerial Finance B6022
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+ (8 - 8)2(0.2) + (8 - 8)2(0.1)]½
σ T-bills =0%
=√280.761
σ Collections =13.36%
σ USRubber =18.82%
σ M = 15.3%
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Managerial Finance B6022
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Lydia Ross
average return, the more volatile the stock (David M. Lane)”. High tech is
the most risky investment.
f. The portfolio of the two stand alone stocks is significantly better than the
stand alone stock by itself. These two stocks are negatively correlated and
will offset each other in the event one is not doing well. This is a good
example of diversification.
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Portfolio
Single Stock
R=
Risk are reduced by adding stock to the portfolio. Therefore a portfolio of
16 %
stock is less risky than a single stock.
h. “The measure of an asset's risk in relation to the market (for example, the
S&P500) or to an alternative benchmark or factors. Roughly speaking, a
security with a beta of 1.5, will have move, on average, 1.5 times the market
return. [More precisely, that stock's excess return (over and above a short-
term money market rate) is expected to move 1.5 times the market excess
return).] According to asset pricing theory, beta represents the type of risk,
systematic risk, that cannot be diversified away. When using beta, there are
a number of issues that you need to be aware of: (1) betas may change
through time; (2) betas may be different depending on the direction of the
market (i.e. betas may be greater for down moves in the market rather than
up moves); (3) the estimated beta will be biased if the security does not
frequently trade; (4) the beta is not necessarily a complete measure of risk
(you may need multiple betas). Also, note that the beta is a measure of
comovement, not volatility.
Return It is possible for a security to have a zero beta
on Stock
and higher volatility than the market. The expected returns are related to
High Tech
(%)
each alternative’s market
40 risk--that is, the higher the alternative’s rate of
(slope = beta = 1.30)Market
return the higher its beta. Also, note that t-bills have zero risk. We do not
(slope = beta
yet have enough information to choose among the= various
1.0) alternatives
(Farlex, 2011)”.
20
T-Bills
(slope = beta = 0)
Return on the
-20 20 40
Market
(%) 6
-20
Managerial Finance B6022
Midterm Exam
Lydia Ross
i. Merrill finch has estimated the risk-free rate to be krf = 8%. Further, our
estimate of rm = rm is 15 percent. The required rates of return for the
alternatives are as follows:
EXPECTED REQUIRED
RETURN RETURN
SECURITY (r^) (r) CONDITION
HIGH TECH 17.4% 17.1% UNDERVALUED: r^> r
MARKET 15.0 15.0 FAIRLY VALUED (MARKET EQUILIBRIUM)
U.S. RUBBER 13.8 14.2 OVERVALUED: r > r>
T-BILLS 8.0 8.0 FAIRLY VALUED
COLLECTIONS 1.7 1.9 OVERVALUED: r > r^
The t-bills and the market portfolio promise a fair return, high tech is a
good deal because its expected return is above its required return, and
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= 0.215
9-1 NPV is a way to decide whether or not to invest in a project by looking at the
projected cash inflows and outflows. Based on the analysis below, the
project is a go.
n : Number of years = 6
6-1
= 20,000*[(1 +10%) ]/[10% * (1 +10%)6
=3221.02/.1771561
=$18,181.82
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9-4 The projects should be accepted if they deliver a 14% rate of return. (Excel
Spreadsheet used)
= 14%
9-6 =IRR(B30:B37) = 11%, Exit should not purchase the project. Exit’s rate of
return is 12%.
9-7 PB = 5 + (450000/120000)
PB = 8.75 yrs.
= 4.67 yrs
PBNT = 4 + (10000/12100)
=4.83 yrs
= 46%
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Managerial Finance B6022
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P Q
-15000 -37500
4500 11100
4500 11100
4500 11100
4500 11100
4500 11100
NPV=($3,375.37) ($8,050.14) ($3,377.43)
IRR= 15% 15%
MIRR= 16.6 12.46
9-14
References
Calculate Net Present Value. (n.d.). Retrieved 3 28, 2011, from EHow:
http://www.ehow.com/how_2187130_calculate-net-present-value-
npv.html#ixzz1Hwa6OHIL
Econ 101. (n.d.). Retrieved 4 28, 2011, from Practical Money Skills:
http://www.practicalmoneyskills.com/foreducators/econ101/20090904_tbills.php
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