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Question
IMPORTANT NOTES
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Failure to submit the assignment for this topic is deemed to constitute failure to meet the assessment requirements for the purposes of eligibility for supplementary assessment on academic grounds.
Provide workings and/or explanations for all calculations.
CHAPTER 5. RISK AND RETURN (35 MARKS)
You have been given the following data on 3 assets – A, B, and C
Year Expected Return (%)
Asset A Asset B Asset C
2011 7 9 5
2012 8 7 6
2013 10 8 7
2014 11 7 9
The allocation of the investment money is as follows:
Asset A: $660,000
Asset B: $530,000
Asset C: $420,000
- Calculate the expected return for the portfolio in each year and for the period 2011-14.
- Calculate the standard deviation for the portfolio for the period 2011-14.
- Calculate the coefficient of variation for the portfolio for the period 2011-14.
- What are your remarks in regards to the expected return versus the risk of the portfolio? Compare your result with the current official interest rate and share/property market performance (open question)?
CHAPTER 4. TIME VALUE OF MONEY (10 MARKS)
A pension company is trying to sell you a retirement annuity, which for a single amount paid today will provide you with $12,000 at the end of each year for the next 25 years. You currently earn 9% on low risk investments comparable to the retirement annuity. Ignoring taxes, what is the most you would pay for this annuity?
CHAPTER 6. INTEREST RATE AND BOND VALUATION (20 MARKS)
What is the appropriate yield to maturity for a $1000 par value bond selling for $1120 that matures in 6 years and pays 12% interest annually?
Hint: Use your critical analysis and trial-error method to estimate the yield to maturity. Provide all workings.
CHAPTER 7. SHARE VALUATION (35 MARKS)
1) Value an ordinary share of PBG Ltd using the free cash flow model. Assume current date is 2017.
Given information:
Weighted average cost of capital: 11%
Value of debts: $1,500,000
Value of preference shares: $400,000
Forecast free cash flows:
2018 $200,000
2019 $250,000
2020 $310,000
2021 $350,000
2022 $390,000
Number of ordinary shares: 200,000
Assume a zero growth rate beyond 2022.
2) Open discussion question: Examine the advantages and disadvantages of different share valuation models (150-200 words).
Solution
Risk and return
Computation of portfolio return for each year
| Computation of portfolio return for 2011 | ||||
| Expected return (r ) | Allocation of investment | Weights (w) | Weighted return (w*r) | |
| Asset A | 7% | $660,000 | 41% | 2.87% |
| Asset B | 9% | $530,000 | 33% | 2.96% |
| Asset C | 5% | $420,000 | 26% | 1.30% |
| Portfolio return | $1,610,000 | 100% | 7.14% | |
| Computation of portfolio return for 2012 | ||||
| Expected return (r ) | Allocation of investment | Weights (w) | Weighted return (w*r) | |
| Asset A | 8% | $660,000 | 41% | 3.28% |
| Asset B | 7% | $530,000 | 33% | 2.30% |
| Asset C | 6% | $420,000 | 26% | 1.57% |
| Portfolio return | $1,610,000 | 100% | 7.15% | |
| Computation of portfolio return for 2013 | ||||
| Expected return (r ) | Allocation of investment | Weights (w) | Weighted return (w*r) | |
| Asset A | 10% | $660,000 | 41% | 4.10% |
| Asset B | 8% | $530,000 | 33% | 2.63% |
| Asset C | 7% | $420,000 | 26% | 1.83% |
| Portfolio return | $1,610,000 | 100% | 8.56% | |
| Computation of portfolio return for 2014 | ||||
| Expected return (r ) | Allocation of investment | Weights (w) | Weighted return (w*r) | |
| Asset A | 11% | $660,000 | 41% | 4.51% |
| Asset B | 7% | $530,000 | 33% | 2.30% |
| Asset C | 9% | $420,000 | 26% | 2.35% |
| Portfolio return | $1,610,000 | 100% | 9.16% | |
Average portfolio return during the period 2011-14
| Year | Portfolio return |
| 2011 | 7.14% |
| 2012 | 7.15% |
| 2013 | 8.56% |
| 2014 | 9.16% |
| Average return | 8.00% |
Working notes:
1. The weights represent the proportion of investment which a security bears to the total investment. It has been computed as follows
W= investment in an asset/total investment *100 (Weaver & Weston, 2001)
2. Weighted return represents the multiplication of weights and return.
Weighted return = weights* returns (Weaver & Weston, 2001)
3. Portfolio return is the summation of weighted return (Weaver & Weston, 2001).
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