Corporate Finance Study Notes

1863 WordsNov 1, 20118 Pages
Solutions to Chapter 10 Introduction to Risk, Return, and the Opportunity Cost of Capital capital gain + dividend ($44 − $40) + $2 = = 0.15 = 15.0% initial share price $40 1. Rate of return = Dividend yield = dividend/initial share price = $2/$40 = 0.05 = 5% Capital gains yield = capital gain/initial share price = $4/$40 = 0.10 = 10% 2. Dividend yield = $2/$40 = 0.05 = 5% The dividend yield is unaffected; it is based on the initial price, not the final price. Capital gain = $36 – $40 = −$4 Capital gains yield = –$4/$40 = –0.10 = –10% capital gain + dividend ($38 − $40) + $2 = = 0% initial share price $40 1 + nominal rate of return 1+ 0 −1 = − 1 = −0.0385 = −3.85% 1 + inflation rate 1 + 0.04 3. a. Rate of return =…show more content…
When the economy does well and the lawyer’s bankruptcy business suffers, the stock return is excellent, thereby stabilizing total income. 10-4 16. Boom: $0 + ($18 − $25) = −28.00% $25 $1 + ($26 − $25) = 8.00% $25 $3 + ($34 − $25) = 48.00% $25 Normal: Recession: r= (−28) + 8 + 48 = 9.33% 3 1 1 1 × (−28 − 9.33) 2 + × (8 − 9.33) 2 + × (48 − 9.33) 2 = 963.56 3 3 3 Variance = Standard deviation = variance = 31.04% Portfolio Rate of Return Boom: (−28 + 150)/2 = 61.00% Normal: (8 + 27.5)/2 = 17.75% Recession: (48 –100)/2 = –26.0% Expected return = 17.58% Standard deviation = 35.52% 17. a. Interest rates tend to fall at the outset of a recession and rise during boom periods. Because bond prices move inversely with interest rates, bonds provide higher returns during recessions when interest rates fall. rstock = [0.2 × (−5%)] + (0.6 × 15%) + (0.2 × 25%) = 13.0% rbonds = (0.2 × 14%) + (0.6 × 8%) + (0.2 × 4%) = 8.4% Variance(stocks) = [0.2 × (−5−13)2] + [0.6 × (15−13)2] + [0.2 × (25 – 13)2] = 96 Standard deviation = 96 = 9.80% Variance(bonds) = [0.2 × (14−8.4)2] + [0.6 × (8−8.4)2] + [0.2 × (4−8.4)2] = 10.24 Standard deviation = 10.24 = 3.20% b. c. Stocks have both higher expected return and higher volatility. More risk averse investors will choose bonds, while those who are less risk averse might choose stocks. 10-5 18. a. Recession Normal economy Boom (−5% × 0.6) + (14% × 0.4)

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