2-1 Estimating Returns Assessment
Preparation
For this assessment, you will use a hypothetical situation in order to demonstrate the use of a probability analysis in estimating returns. Imagine the following scenario:
A company is faced with a 20 percent chance of a poor economy, a 40 percent chance of an average economy, and a 40 percent chance of an above-average economy. The company would expect only a 10 percent return in a poor economy, an 18 percent return in an average economy, and a 30 percent return in an above-average economy.
Instructions
Use this hypothetical situation above to answer these questions:
· What would the expected return be for this company?
· What would the standard deviation be for this company?
Then, explain how the standard deviation helps you better understand what to expect in terms of a return. Use at least two resources to support your ideas.
You have the option of either completing the calculations in a spreadsheet or just describing the steps in the process.
Other Requirements
· Length: Your paper should be 1–2 typed, double-spaced pages. In addition, include a title page and references.
2-2 Refinancing Decision Assessment
Instructions
Changing interest rates create opportunities for home owners to gain advantage by refinancing their homes.
Imagine you have a $100,000 mortgage. Your current loan is at 7 percent with 14 years left, negotiated one year ago and involving $2,000 in closing costs. You are considering refinancing at 5.5 percent for 15 years. The closing costs would be $1,500.
For this assessment, use the scenario above to write a paper in which you address the following:
· Would you decide to refinance? Why or why not?
· What qualitative considerations would you consider in your decision to refinance or not refinance?
Provide examples of calculations you would use to help you make your decision. In addition, use at least two resources to support your ideas.
Other Requirements
· Length: Your paper should be 1–2 typed, double-spaced pages. In addition, include a title page and references page.
2-3 Unit 2 Problems Assessment
Overview
For this assessment, you will apply the necessary knowledge to assess ways to maximize shareholder wealth.
Instructions
For this assessment, complete Problems 1–6. You may need an HP 10B II Business Calculator to complete the following problems. You may use Word or Excel to complete the assessments throughout this course, but you will find Excel to be most helpful for creating spreadsheets.
Problem 2-1: Portfolio Required Return
You are the money manager of a $10 million investment fund, which consists of four stocks. This fund has the following investments and betas:
|
Stock
|
Investment
|
Beta
|
|
A
|
$3,000,000
|
1.50
|
|
B
|
$1,000,000
|
(0.50)
|
|
C
|
$2,000,000
|
1.25
|
|
D
|
$4,000,000
|
0.75
|
If the market’s required rate of return is 12 percent, and the risk-free rate is 4 percent, what is the fund’s required rate of return?
Problem 2-2: Required Rate of Return
· Stock R’s beta = 1.5
· Stock S’s beta = 0.75
Consider that the required return on an average stock is 14 percent. The risk-free rate of return is 6 percent. If this is so, the required return on the riskier stock exceeds the required return on the less risky stock by how much?
Problem 2-3: CAPM and Required Return
Calculate the required rate of return for XYZ Inc using the following information:
· The investors expect a 3.0 percent rate of inflation.
· The real risk-free rate is 2.0 percent.
· The market risk premium is 6.0 percent.
· XYZ Inc. has a beta of 1.7.
· Over the past 5 years, the realized rate of return has averaged 13.0 percent.
Problem 2-4. Present Value of an Annuity
Find the present values of the following ordinary annuities if discounting occurs once a year:
1. $300 per year for 10 years at 10 percent.
2. $150 per year for 5 years at 5 percent.
3. $350 per year for 5 years at 0 percent.
Problem 2-5: Uneven Cash Flow Stream
Use the table below to answer the following:
1. What are the present values of the following cash flow streams if they are compounded at 5 percent annually?
2. What are the PVs of the streams at 0 percent compounded annually?
|
0
|
1
|
2
|
3
|
4
|
5
|
|
Stream A
|
$0
|
$100
|
$400
|
$400
|
$400
|
$300
|
|
Stream B
|
$0
|
$300
|
$400
|
$400
|
$400
|
$100
|
Problem 2-6: Capital Budgeting Criteria
XYZ Inc. is considering two projects. Its WACC is 12 percent, and the projects’ after-tax cash flows (in millions of dollars) would be as follows:
|
0
|
1
|
2
|
3
|
4
|
|
Project A
|
-$30
|
$5
|
$10
|
$15
|
$20
|
|
Project B
|
-$30
|
$20
|
$10
|
$8
|
$6
|
1. Calculate the projects’ NPVs, IRRs, MIRRs, regular paybacks, and discounted paybacks.
2. How might conflicts exist between the NPV and the IRR when independent projects are evaluated? Explain your answer.
