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As a financial advisor at ABC Corporation, the CEO asked you to analyze the following
information pertaining to two common stock investments, TI and SG. You are told that a oneyear Treasury Bill will have a
an investment advising service lists the current beta for TI as 1.68 and for SG as 0.52. You are
provided a series of questions to guide your analysis.
|
Economy |
Probability |
TI |
SG |
market |
|
Recession |
30% |
-20% |
5% |
-4% |
|
Average |
20% |
15% |
6% |
11% |
|
Expansion |
35% |
30% |
8% |
17% |
|
Boom |
15% |
50% |
10% |
27% |
4. Based on the beta provided, what is the expected rate of return for TI and SG for the next
year?
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- Investment advisors estimated the stock market returns for four market segments: computers, financial, manufacturing, and pharmaceuticals. Annual return projections vary depending on whether the general economic conditions are improving, stable, or declining. The anticipated annual return percentages for each market segment under each economic condition are as follows: Assume that an individual investor wants to select one market segment for a new investment. A forecast shows improving to declining economic conditions with the following probabilities: improving (0.2), stable (0.5), and declining (0.3). What is the preferred market segment for the investor, and what is the expected return percentage? At a later date, a revised forecast shows a potential for an improvement in economic conditions. New probabilities are as follows: improving (0.4), stable (0.4), and declining (0.2). What is the preferred market segment for the investor based on these new probabilities? What is the expected return percentage?What makes for a good investment? Use the approximate yield formula or a financial calculator to rank the following investments according to their expected returns. Buy a stock for $30 a share, hold it for three years, and then sell it for $60 a share (the stock pays annual dividends of $2 a share). Buy a security for $40, hold it for two years, and then sell it for $100 (current income on this security is zero). Buy a one-year, 5 percent note for $1,000 (assume that the note has a $1,000 par value and that it will be held to maturity).An investor is thinking about buying some shares of Health Diagnostics, Inc., at $75 a share. She expects the price of the stock to rise to $115 a share over the next three years. During that time, she also expects to receive annual dividends of $4 per share. Assuming that the investor’s expectations (about the future price of the stock and the dividends that it pays) hold up, what rate of return can the investor expect to earn on this investment? (Hint: Use either the approximate yield formula or a financial calculator to solve this problem.)
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- As an analyst at Chitalu & Daka Securities, you are responsible for making recommendations to your firm’s clients regarding common stocks. After gathering data, you have found that their dividends have been growing at a rate of 10% per year to the current (D0) rate of K0.60 per share. The stock is currently selling for K12 per share, and you believe that an appropriate rate of return for this stock is 15% per year.i. If you expect that the dividend will continue to grow at a 10% rate into the foreseeable future, what is the highest price at which you would recommend purchasing this stock to your clients?ii. Suppose now that you determine that the company’s new product line will cause much higher growth in the near future. Your revised estimate is for a three-year period of 20% annual growth which will be followed by a return to the historical 10% growth rate. Under these new assumptions, what is the current value of the stock using the two-stage dividend growth model?iii. After…As a finance intern at Pork Products, Jennifer Wainwright’s assignment is to come up with fresh insights concerning the firm’s cost of capital. She decides that this would be a good opportunity to try out the new material on the APT that she learned last semester. She decides that three promising factors would be (a) the return on a broad-based index such as the S&P 500; (b) the level of interest rates, as represented by the yield to maturity on 10-year Treasury bonds; and (c) the price of hogs, which is particularly important to her firm. Her plan is to find the beta of Pork Products against each of these factors by using a multiple regression and to estimate the risk premium associated with each exposure factor. Comment on Jennifer’s choice of factors. Which are most promising with respect to the likely impact on her firm’s cost of capital? Can you suggest improvements to her specification?Amy is looking into investing a portion of her recent bonus into the stock market. While researching different companies, she discovers the following standard deviations of one year of daily stock closing prices. Masterful Pocketwatches: Standard deviation of stock prices =$1.23 Eye Remember Enterprises: Standard deviation of stock prices =$9.72 Based on the data and assuming these trends continue, which company would give Amy a stable long-term investment?
