Question 1a) Use the following information to calculate your company\'s expected

Question

Question 1a) Use the following information to calculate your company's expected return.

State

Probability

Return

Boom

20%

40%

Normal

60%

15%

Recession

20%

(20%)

11%

13%

15%

17%

Question 2b) The expected rate of return for 3COM is 18 percent, with a standard deviation of 10.98 percent. The expected rate of return for Just the Fax is 26 percent with a standard deviation of 15.86%. Which firm would be considered the riskier from a total risk perspective?

3COM

Just the Fax

Neither, both have the same risk in a relative sense

cannot be determined

Question 1c) Use the following information to calculate Overland's expected return.

Economy

Probability

Return

Boom

30%

30%

Normal

70%

10%

16%

14%

12%

10%

Question 1d) Estimate the required return on Baniff Corp under the following conditions:
The average stock is returning 11%
Short term treasury bills yield 5%
Baniff's beta is 1.25

11.00%

17.25%

12.50%

6.00%

Question 1e) If the required return on a stock is 15% and the future price of the stock one year from today is projected to be $32.00, what should be the current price for the stock assuming no dividends are paid?

$27.83

$36.80

$22.50

$29.50

State

Probability

Return

Boom

20%

40%

Normal

60%

15%

Recession

20%

(20%)

Explanation / Answer

Answer:

1a) Expected Return is 13%

Working:

Expected Return = Sum of (Return x Probabilities)

Expected Return = (40 x 0.2) + (15 x 0.6) + (-20 x 0.2) = 8 + 9 – 4 = 13%

1b)

We need to calculate co efficient of variation. Coefficient of Variation is used when there is confusion in selection of some securities from many. Coefficient of Variation measures risk per unit of return

Coefficient of Variation = Standard Deviation / Expected Return

3COM’s Coefficient of Variation = 10.98 / 18 = 0.61

Just the Fax’s Coefficient of Variation = 15.86 / 26 = 0.61

Therefore, Neither, both have the same risk in a relative sense.

1c)

Expected Return = Sum of Return x Probabilities

Expected Return = (30 x 0.3) + (10 x 0.7) = 9 + 7 = 16%

1d)

Required Return on Baniff Corp (CAPM Model) = Risk Free return + Beta (Market Return – Risk Free Return)

Here, Risk Free Return = Treasury bills yield = 5%

Beta given = 1.25

Market Return = 11%

Hence, Required Return = 5% + 1.25 (11% - 5%) = 5% + 7.5% = 12.5%

1e)

Current Price for the Stock = Stock Price at the end of one year x 1/(1+0.15) = $32 x 1/1.15 = $27.83

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