Assignment Questions

Part A: Risk and Return

Use yahoo finance to find historical prices of the Australia market index All Ordinaries (^AORD) and the following three companies traded in the Australian market: Wesfarmers Ltd. (WES.AX), BHP Billiton Ltd. (BHP.AX) and AGL Energy Ltd. (AGL.AX):

- Go to yahoo finance
- Type in the company ticker in the Look Up window
- Click on Historical Prices on the left panel of the page
- Set date range from 01/01/2012 to 31/12/2016 and choose Daily Frequency. Also set the same date range as above and choose Monthly Frequency. Note that you will be downloading the data for the above stocks twice (Monthly and Daily). However, you can download your own if you like.
- Download the data from Download to Spreadsheet button at the end of the page.

Note: We assume that the performance of All Ordinaries represents the average performance of the Australian market.

Questions

1. Using monthly data, compute continuously compounded monthly return of the above stocks and index using adjusted Close Price (Adj Close).

Hint: R_t = ln(Price_t) - ln(Price_t-1). Where ln means natural logrithim.

2. Compute Expected return, E(R), for the above stocks and index.

Hint: Use Excel function AVERAGE() to compute expected return of a series.

3. Compute the standard deviation of the above stocks and index using monthly continuous return.

Hint: Use Excel function STDEV.S() to compute standard deviation of a series.

4. Compute the (monthly) return correlation coefficient between any two of the above stocks and index. You can use two stocks or one stock and the index.

Hint: Use Excel function CORREL() to compute the correlation coefficient between two data series.

5. Using the correlation coefficient, comment on the return movement of these stocks and index in the specified date range.

6. If you were to form a portfolio of 2 stocks (using monthly data), which ones are your choice to maximise diversification benefit? Explain the rationale behind your investment choice.

7. If you were to invest in the two stocks (it can be one stock and the index) in question 6 equally, what is the standard deviation of your portfolio?

8. Using monthly return data, calculate β for any of the stocks?

9. Using the CAPM model calculate the expected return for any of the stock and compare it with (2). Explain why the expected return from the CAPM is different from answers in (2)? If so, why do you see the difference? Assume R_f to be 1.5% and E(R_m - R_f) to be 6.25%. Is the stock undervalued or overvalued? Explain.

10. Using daily return data calculate β for any of the stocks and compare it with (8). Note that you should choose same stock to answer (8) and (10). Explain why do you see any difference? Comment.

Part B: Capital Budgeting

You have been given the following information on a project.

The project has a five-year life time. The initial investment in the project will be $25 million, and the investment will be depreciated straight-line, down to salvage value of $10 million at the end of the fifth year.

The revenues are expected to be $20 million next year and to grow 10% a year after that for the remaining four years. The cost of goods sold, excluding depreciation, is expected to be 50% of revenues.

The tax rate is 30%. The firm faced cost of capital of 14%.

Questions:

1. Compute:
- Calculate Free Cash flow over the project's life.
- Calculate terminal year cash flow for the project.
- Should the project be accepted using NPV analysis.

Now assume that the facts in problem 1 remain unchanged except for the depreciation method which is now according to the following table. In this case the salvage value will be whatever is left at the end of year 5.

2. If the firm has a cost of capital of 14%
a. should it take the project using NPV analysis.
b. Compare NPV calculated in Question 1 with NPV calculated in Question 2. In which case the NPV is higher? Why do you see this difference?

3. Perform a sensitivity analysis on NPV of the project for (1) on the following scenarios:
a. Sales decreases by 10%.
b. Cost of capital decreases by 10%.
c. Both (a) and (b).