Estimating Returns Assessment
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.