**
**

In tab P8-14 my formulas are not working to calculate the
Standard Deviation, hence CV are also incorrect.Â Can you
suggest a solution to what I am doing wrong?

LG 1. Rate of return pg 317

Market

Expected Rate

Investment

Value

Cash flowCurrent market values

of Return

1 year ago

X

$20,000

$1,500

$21,000

13%

Y

$55,000

$6,800

$55,000

0% A Calcuate the expected rate of return on investments X
and Y usising the most recent years data. B Assuming that the two
investments are equally risky, which one should Douglas recommend?
Why?

Douglas should recommend investment X because the rate of
return is higher. Although there was cash fl

options, investment Y did not change in value over the year,
on the open market. Total Rate of

Ct+Pt-Pt-1/Pt-1

Return =

The total rate of return = the total gain or loss experienced
on an invetment over a given period. ent years data. commend? Why?

hough there was cash flow in both investment ment over a
given period. LG 2 Risk analysis

Expanded product line estimates Range = a measure of an
assets risk. The

= Return of an associated optimistic Expansion A Expansion B

Initial investment

$12,000

$12,000

Annual rate of return

Pessimistic

16%

10%

Most likely

20%

20%

Optimistic

24%

30%

Range

8%

20%

A Determine the range of the rates of return for each of the
2 projects.

B Which project is less risky?

Expansion A because it has a lower range. C If you were
making the investment decision, which one would you choose? What
does this decision imp

I would choose expansion A for two reasons. The range is
lower, and the most likely annual rate of retur

that I am more risk adverse than risk neutral or risk
seeking. D Assume

that expansion

B's most

likely

outcome is

perfor

year

that all

other fact

remain

the indica

same

No. Because

I am risk adverse

and

accountable

to21%

others

theand

financial

decisions,

the

data still

many reasons pertaining to management, industry, market,
economyâ€¦ the scenario analysis still proves

and comparable annual rate of return to be expansion A. e of
an assets risk. The greater the range, the greater the risk.

an associated optimistic investment outcome - pessimistic
investment outcome t does this decision imply about your feelings
toward risk?

kely annual rate of return is the same as expansion B. This
reveals er

fact

remain

the indicates

same. Does

to part c This

nowcould

change?

ons,

the

data still

the your

rangeanswer

to be greater.

be for

nario analysis still proves the investment with the least
amount of risk Coefficient of variation

Need for increased production capacity..

Alternative

A

B

C

D Expected

return

20%

22%

19%

16% Standard

deviation

of return

7%

10%

6%

5.5% Standard deviation = the most common stat

dispersion related to t

risk.

Coefficient of variatio greater

standardthe

deviation/exp

Coefficient

of variation

35.00%

43.18%

31.58%

34.38% A Calculate the coefficient of variation for each
alternative. B If the firm wishes to minimize risk, which
alternative do you recommend?

Upon a cursory look either option A or D have the lower
coefficients which indicate that they are less volat

lowest coefficient variation, alternative A offers a 4%
higher expected total return with a 1.5% greater stan

variation. With these considerably marginal variations,
alternative A offers the greatest potential for return the most
common statistical method to evaluate risk. Measure the

dispersion related to the expected value. The higher the
value, the

greater

risk.

standardthe

deviation/expected

return. Useful when looking at risks of assets with differing
returns. hat they are less volatile than C and D. Although
alternative D is the

ith a 1.5% greater standard deviation and .62% higher
coefficient

test potential for returns to finance the need for increased
production. LG 3 Portfolio analysis

Expected return

Year

2016

2017

2018

2019 Asset F Asset G

16%

17%

17%

16%

18%

15%

19%

14% Alternativ

e

Asset H Investmen

t

14%

1

15%

2

16%

3

17% Investment

Blend

100% asset F

50% asset F and

50% asset F and

Total D On the basis of the findings, which of the three
investment alternatives do I recommend? Why? Expected Return

Alternativ Alternativ Alternativ

e

e

e

1

2

3

16.00%

16.50%

15.00%

17.00%

16.50%

16.00%

18.00%

16.50%

17.00%

19.00%

16.50%

18.00%

70.00%

66.00%

66.00% ves do I recommend? Why? Expected

Standard

Coefficient

Portfolio

deviation

of Variation

Return

17.50% 0.00016667 0.000952381

16.50%

###

###

16.50% 0.00016667 0.001010101 Expected return = Ct + Pt-1 /
Pt-1

the total gain or loss over a given period of time.

Standard deviation =the dispersion around the expected value.

the higher the SD the greater the risk.

the return x the probability of the occurrence of the outcome
/ the number of out

Coefficient of Variati standard deviation / return

the higher the CV the greater the volitiliy. tcome / the
number of outcomes considered. LG 5 Interpreting Beta

10% market decrease

Asset

Beta10% market increase

A

0.5

B

1.6

C

-0.2

D

0.9

A What impact would a 10% increase in the market return be
expected to have on each asset's ret B What impact would a 10%
decrease in the market return be expected to have on each asset's
re C If you believed that the market return would increase in the
near future, which asset would you p D If you believed that the
market return would decrease in the near future, which asset would
you o have on each asset's return? o have on each asset's return?
e, which asset would you prefer? Why? e, which asset would you
prefer? Why? LG 5 Personal Finance Problem

Portfolio betas

Evaluate two possible portfolios.

Portfolio Weights

Beta

Asset Asset betaPortfolio APortfolio BPortfolio APortfolio B

1

1.3

10%

30%

2

0.7

30%

10%

3

1.25

10%

20%

4

1.1

10%

20%

5

0.9

40%

20%

Totals

100%

100%

B Compare the risks of these portfolios to the market as well
as to each other. Which portfolios h other. Which portfolios is
more risky? LG 6 Capital asset pricing model (CAPM) For each of the
cases shown in the following table use the capital asset pricing
model to find the re

Case

A

B

C

D

E Risk-free

rate,

Rf

5%

8%

9%

10%

6% Market return, Beta,

Required Return

rm

B

8%

1.3

13%

0.9

12%

-0.2

15%

1

10%

0.6 cing model to find the required return. LG 1, concept of
cost of capital

Analyzing investment decision making procedures.

investment involves building new facilities in different
regions, North and South.

Basic variables North

South

Cost

$6,000,000

$5,000,000

Life (years)

15

15

Expected return

8%

15%

Least-cost financing

Source

Debt

Equity

Cost (after-tax)

7%

16%

Decision

Action

Invest

Don't invest

Reason

8% > 7% cost 15% < 16% cost

A An analyst evaluating the North facility expects that the
project will be financed by debt that B Another analyst assigned to
study the South facility believes that funding for that project
will C Explain why the decisions in parts a and b may not be in the
best interests if the firm's invest D If the firm maintains a
capital structure containing 40% debt and 60% equity find its
weighte E If both analysts had used the weighted average cost
calculated in part d, what recommendat F Compare and contrast the
analysts initial recommendations with your findings in part e. Whi
be financed by debt that costs the firm 7%. What recommendation do
you think this analyst will make rega nding for that project will
come form the firm's retained earnings at a cost of 16%. What
recommendation d terests if the firm's investors. % equity find its
weighted average cost using the data in the table. art d, what
recommendations would they have made regarding the North and South
facilities? ur findings in part e. Which decision method seems more
appropriate? Why? his analyst will make regarding the investment
opportunity? What recommendation do you expect the this analyst to
make regarding the investments? h facilities? LG 3 Cost of debt
using both methods.

Warren Industries can sell 15 - year $1,00 par value bonds
paying annual interest at 12$ coupon ra

Warren Industries

Bond Value

$1,000

Maturity, years

15

Annual interest

12%

Market value

$1,010

Flotation

$30

Tax bracket

40%

A Find the net proceeds from sale of the bond, Nd. rest at
12$ coupon rate. As a result of current interest rates, the bonds
can be sold for $1,010 each. Flotatio for $1,010 each. Flotation
costs of $30.00 per bond will be incurred in this process. The firm
is in the 40% s. The firm is in the 40% tax bracket. LG 5. Cost of
common stock equity: CAPM

J&M Corporation

Comon stock

beta

1.2

Risk-free ra

6%

Market return

11%

A Determine the risk premium on J&M common stock. B
Determine the required return that J&M common stock should
provide. C Determine J&Ms cost of common stock equity using
the CAPM. LG 6. WACC: Book wights and market weights.

Webster Company

Source of capital

Book valueMarket valueAfter-tax cost

Long-term debt

$4,000,000

$3,840,000

6%

Preferred stock

$40,000

$60,000

13%

Common stock equit $1,060,000

$3,000,000

17%

Totals $5,100,000

$6,900,000

A Calculate the weighted average cost of capital using book
value weights. B Calculate the weighted average cost of capital
using market value weights. C Compare the answers obtained in parts
a and b. Explain the differences. LG 3, 4, 5, 6. Calculation of
Individual costs and WACC

Measure the cost of each specific type of capital as well as
the weighted average cost of capital.

Weighted average

Long-term debt

40%

Preferred stock

10%

Common stock equit

50%

Tax rate

40% verage cost of capital. Forecasted Returns, Expected
Values, and Standard Deviations for

Assets A, B, and C and Portfolios AB, AC, and BC Year

2015

2016

2017

2018

2019

2020

2021 Statistics:

Expected valu

Standard devi A

10%

13%

15%

14%

16%

14%

12% Assets

B

10%

11%

8%

12%

10%

15%

15% C

12%

14%

10%

11%

9%

9%

10% AB

10.0%

12.0%

11.5%

13.0%

13.0%

14.5%

13.5% Portfolios

AC

11.0%

13.5%

12.5%

12.5%

12.5%

11.5%

11.0% 13%

2% 12%

3% 11%

2% 13%

1% 12%

1% Note: In each two stock portfolio, the weights of each s

50%

50%

50% eviations for

BC rtfolios

BC

11.0%

12.5%

9.0%

11.5%

9.5%

12.0%

12.5% 11%

1% Chapter 9 The Cost of Capit

Nova Corporation

Debt

Net Proceeds

maturity

coupon rate

par

$

coupon payme $ 10

6.50%

1,000

65 Required bond price

Flotation percent

Flotation cost

Net Proceeds

Trial and error YTM End of Year(s) Cash Flow

0

$

960

1 - 10

$

(65)

10

$

(1,000) $

$

7.0714% $ $ PV

960.00

(455.03)

(504.97)

0.00 (The YTM of 7.0714% equates the NPV to z Before-tax Cost
of Debt

Tax rate

After-tax Cost of Debt Par value

$

Annual percen

Annual divide $ 100.00

6%

6.00 980

2.00%

20

960 Preferred Stock

Expected sale price

Flotation cost

Net Proceeds

Cost of Preferred Stock 7.0714%

40.00%

4.24% (a) $

$

$ 102.00

4.00

98.00

6.12% (b) Common Stock

Gordon Model

Expected divi $

Expected grow

Current price $

Flotation cost $

Adjusted Pric $ 3.25

5%

35.00

2.00

33.00 Cost of Common Stock 14.85% (c) Weighted Average Cost
of Capital

Weight in debt

Weight in pref

Weight in com

Sum of weight 0.35

0.12

0.53

1.00 WACC 10.09% (d) 4% equates the NPV to zero)

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