question archive The management of Ark Industries wants to analyze the performance of the company’s stock in the stock market
The management of Ark Industries wants to analyze the performance of the company’s stock in the stock market
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The management of Ark Industries wants to analyze the performance of the company’s stock in the stock market. They want to compare the stock performance with Apex Inc, a strong competitor in the industry, and the market index. The following data is available for managerial finance analysis.
*Capital gain = difference between ending price and beginning price
B) that he just added to his portfolio. The following information is available: Market rate of return = 11.0% Risk free rate =5.0% Beta for stock A= 0.77 Beta for stock B = 0.99 Use the Security Market Line (SML) equation to calculate the required rate of return for stock A and stock B.
Heath Inc. balance sheet shows that it has $10 million short-term investments, $15 million in notes payable, $60 million in long-term bonds, and $15 million in preferred stock. Heath has 60 million of shares outstanding. Calculate the following:
The current price of a stock is $50. In 1 year, the price will be either $65 or $35. The annual risk- free rate is 5%. Find the price of a call option on the stock that has an exercise price of $55 and that expires in 1 year. (Hint: Use daily compounding.) |
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*Capital gain = difference between ending price and beginning price
- Use the data given to calculate the annual returns for Ark Industries, and Apex Inc during the 5-year period.
- Calculate the historical average returns for Ark Industries, Apex Inc., and the market index during the 5-year period.
- Calculate the standard deviation of the returns for Ark Industries.
- An individual investor, James Bond needs an extra return of 6.0% before he will take on the stock market’s risk to invest in Ark Industries. If the risk-free rate on long-term Treasury bonds is 5.0%. what would be the required return on the market?
- James Bond wants to determine the required rate of return on two stocks (stock A and stock
B) that he just added to his portfolio. The following information is available: Market rate of return = 11.0%
Risk free rate =5.0% Beta for stock A= 0.77 Beta for stock B = 0.99
Use the Security Market Line (SML) equation to calculate the required rate of return for stock A and stock B.
- Richard Morgan, another individual investor wants to purchase four stocks for his portfolio. The expected return, portfolio weights, and the betas of the stocks are given below:
|
Stocks |
Beta |
Portfolio weight |
Expected return |
|
Goodman Industries |
0.70 |
30% |
9.20% |
|
Renfro Inc. |
0.79 |
20% |
9.74% |
|
Heath Inc. |
1.10 |
30% |
11.60% |
|
Lincoln Inc. |
1.44 |
20% |
13.64% |
-
- Calculate the portfolio beta.
- Calculate the portfolio’s required return.
- Goodman Industries is expected to pay a $4.50 per share dividend at the end of this year (i.e., D1 = $4.50). The dividend is expected to grow at a constant rate of 5% a year. The required rate of return on the stock is, rs, is 9.2%. What is the estimated value per share of Goodman stock?
- Renfro Inc. is expected to have free cash flow (FCF) of $105 million next year and an expected constant growth rate of 5% thereafter. The weighted average cost of capital (WACC) for the company is 9.0%. Using the constant growth model, estimate the value of operations for Renfro Inc.
- The most recent free cash flow (FCF) for Heath Inc. was $200 million, and the management expects the free cash flow to begin growing immediately at a 7% constant rate. The cost of capital is 12%.
- Using the constant growth model, determine the value of operations for Heath Inc.
Heath Inc. balance sheet shows that it has $10 million short-term investments, $15 million in notes payable, $60 million in long-term bonds, and $15 million in preferred stock. Heath has 60 million of shares outstanding. Calculate the following:
- total intrinsic value for Heath Inc.
- intrinsic value of equity for Heath Inc.
-
- intrinsic stock price per share for Heath Inc.
- Distinguish between call option and put option.
The current price of a stock is $50. In 1 year, the price will be either $65 or $35. The annual risk- free rate is 5%. Find the price of a call option on the stock that has an exercise price of $55 and that expires in 1 year. (Hint: Use daily compounding.)
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Answer:
1) Annual return = ( Capital gain/(loss) + Dividend ) / Purchase price
|
Year |
Ark Industries |
Apex Incorporated |
||||||
|
Capital gain/loss (C) |
Dividend (D) |
Purchased Price (P) |
Annual Return X=(C+D)/P |
Capital gain/loss |
Dividend |
Purchased price |
Annual Return X=(C+D)/P |
|
|
2020 |
$6.79 |
$2.23 |
$23.53 |
38.33% |
$5.80 |
$3.52 |
$79.32 |
11.75% |
|
2019 |
-$5.08 |
$2.65 |
$28.61 |
-8.49% |
$5.00 |
$3.65 |
$74.32 |
11.64% |
|
2018 |
$13.40 |
$2.73 |
$15.21 |
106.05% |
-$12.80 |
$3.45 |
$87.12 |
-10.73% |
|
2017 |
$2.58 |
$2.57 |
$12.63 |
40.78% |
-$8.00 |
$3.47 |
$95.12 |
-4.76% |
|
2016 |
-$0.58 |
$2.23 |
$13.21 |
12.49% |
$10.88 |
$3.55 |
$84.25 |
17.13% |
2) Average return = Sum of Yearly returns / n ; n = 5 years
| Year | Ark Industries | Apex Incorporated | Market index |
| 2020 | 38.33% | 11.75% | 51.8% |
| 2019 | -8.49% | 11.64% | 1.30% |
| 2018 | 106.05 | -10.73% | 11.90% |
| 2017 | 40.78% | -4.76% | 13.90% |
| 2016 | 12.49% | 17.13% | 15.80% |
| Total | 189.16% | 74.51% | 94.70% |
| Average return (x?) | 37.83% | 5.00% | 18.94% |
3) standard deviation
| Year | Ark Industries | x- x? | (x- x?)^2 |
| 2020 | 38.33% | 0.50% | 0.00% |
| 2019 | -8.49% | -46.32% | 21.46% |
| 2018 | 106.05 | 68.22% | 46.54% |
| 2017 | 40.78% | 2.95% | 0.09% |
| 2016 | 12.49% | -25.34% | 6.42% |
| Total | 189.16% | 74.51% | |
| Average return (x?) | 37.83% |
Variance = Sum of above (x- x?)^2/ (n-1) =74.51/4 =18.63%
Standard deviation =4.32%
4) required rate of return
required rate of return = 0.06+0.77(0.06-0.05)
=0.0677
Question B
1. Portfolio Beta = 0.7*0.30+0.79*0.20+1.10*0.3+1.44*0.2 = 0.986
Portfolio's required rate of return = 9.2*0.3+9.74*0.2+11.6*0.3+13.64*0.2 = 10.92
The estimated value per share of Goodman stock = 4.5+5%/9.2-5 = 112.5
The Value of operations for Refro Inc = 105+5%/9-5 =2756.25
The Value of operations of Heath Inc = 200+7%/12-7 = 4280.
2.
Dividend per share at the end of this year, D1 = $4.50
Growth rate, g = 5% = 0.05
Required rate of return, rs =9.2% = 0.092
The estimated value per share of Goodman stock is given by:
Value per share = D1/(rs - g)
Value per share = 4.50/(0.092 - 0.05)
Value per share = 4.50/0.042
Value per share = $107.1428571
The estimated value per share of Goodman stock is $107.1428571
3.
Value of operations = FCF*(1+g)/(k-g)
Value of operations = $105*(1+0.05) / (0.09-0.05)
value of operations = $2756.25 million
4.1
Value of operations = FCF*(1+g)/(k-g)
Value of operations =200(1+0.07)/0.12-0.07
Value of operations=$4,280million
Intrinsic Value Formula Stock = Intrinsic Value Business / No. of outstanding shares
=($10 million+$15 million+$60 million+$15 million)/60 million of shares outstanding
Intrinsic Value= 1.666666667
1. Call option:
When share prices above strike price then the call option is in the money, otherwise, it is out of money.
For call option as strike price increases, the value of premium must decrease.
Call buyers are benefited with a rise in the underlying price.
Put option:
When share prices below the strike price then put option is in the money, otherwise, it is out of money.
For put option as strike price increases, the value of premium must increase.
Put buyers are benefited with a fall in the underlying price.
2. Call options can be used to speculative purposes in the following way.
When we speculate that Stock prices will rise, we should buy the call option.
When we speculate that Stock prices will fall, we should buy a put option.
3. As mentioned above, Put buyers are benefited with a fall in the underlying price.
Fund managers buy put options at lower strike prices to hedge their positions.
If the stock price falls then Put option benefits & portfolio shows loss. The overall loss is managed to a certain extent due to put buying.
Hence the risk of loss is reduced.
=(MAX(65-55,0)-MAX(35-55,0))/(65-35)*50-((MAX(65-55,0)-MAX(35-55,0))/(65-35)*65-MAX(65-55,0))/(1+10%/365)^365
=6.11008554
