Documente Academic
Documente Profesional
Documente Cultură
(FIN215)
Fall 2017-2018
Assignment
Submitted to
Dr.Suchi Dubey
Submitted to
201620059
Ques. 1 Using the data in the following table, estimate
Answer
a)
−10 + 20 + 5 − 5 + 2 + 9
̅A =
R = 3.5%
6
21 + 7 + 30 − 3 − 8 + 25
̅B =
R = 12%
6
1
Variance of A = [(−0.1 − 0.035)2 + (0.2 − 0.08)2 + (0.05 − 0.035)2 + (−0.05 − 0.035)2
5
+ (0.02 − 0.035)2 + (0.09 − 0.035)2 ] = 0.01123
1
Variance of B = [(0.21 − 0.12)2 + (0.3 − 0.12)2 + (0.07 − 0.12)2 + (0.03 − 0.12)2
5
+ (−0.08 − 0.12)2 + (0.25 − 0.12)2 ] = 0.02448
b)
1
Covariance = [(−0.1 − 0.035)(0.21 − 0.12) + (0.2 − 0.035)(0.3 − 0.12)
5
+ (0.05 − 0.035)(0.07 − 0.12) + (−0.05 − 0.035)(−0.03 − 0.12)
+ (0.02 − 0.035)(−0.08 − 0.12) + (0.09 − 0.035)(0.25 − 0.12)] = 0.104%
c)
Covariance
Correlation = = 6.27%
6SD(R A )SD(R B )
Ques. 2 Suppose you have $100,000 in cash, and you decide to borrow another $15,000 at a
4% interest rate to invest in the stock market. You invest the entire $115,000 in a portfolio
J with a 15% expected return and a 25% volatility.
a. What is the expected return and volatility (standard deviation) of your investment?
b. What is your realized return if J goes up 25% over the year?
c. What return do you realize if J falls by 20% over the year?
Answer
a)
115,000
X= = 1.15
100,000
b)
115,000(1.25) − 15,000(1.04)
R= − 1 = 28.15%
100,000
c)
115,000(0.80) − 15,000(1.04)
R= − 1 = −23.6%
100,000
Ques. 3 Harrison Holdings, Inc. (HHI) is publicly traded, with a current share price of $32
per share. HHI has 20 million shares outstanding, as well as $64 million in debt. The
founder of HHI, Harry Harrison, made his fortune in the fast food business. He sold off
part of his fast-food empire, and purchased a professional hockey team. HHI’s only assets
are the hockey team, together with 50% of the outstanding shares of Harry’s Hotdogs
restaurant chain. Harry’s Hotdogs (HDG) has a market capitalization of $850 million, and
an enterprise value of $1.05 billion. After a little research, you find that the average asset
beta of other fast-food restaurant chains is 0.75. You also find that the debt of HHI and
HDG is highly rated, and so you decide to estimate the beta of both firms’ debt as zero.
Finally, you do a regression analysis on HHI’s historical stock returns in comparison to the
S&P 500, and estimate an equity beta of 1.33. Given this information, estimate the beta of
HHI’s investment in the hockey team.
Answer
So, if β = hockey team beta, (425/(425+279)) 0.93 + (279/(425+279)) β = 1.21 β = 1.64 Beta
of hockey team = 1.64
Ques. 4 You own a firm with a single new product that is about to be introduced to the
public for the first time. Your marketing analysis suggests that the demand for this product
could be anywhere between 500,000 units and 5,000,000 units. Given such a wide range,
discuss the safest cost structure alternative for your firm
Answer
Since there is a great deal of variability concerning the demand for the product, then the safest
alternative would be to create a cost structure that limits the variability of the firm’s EBIT. This
means that you would create a cost structure that is composed of high unit variable costs with
low fixed costs. Although this would not enable the firm to maximize earnings if the 5,000,000
unit forecast occurs, it limits the downside profitability for the firm in the event that the 500,000
Answer
Because the current machine has a book value of $110,000 - 10,000 (one year of depreciation) =
$100,000, selling it for $50,000 generates a capital gain of 50,000 - 100,000 = -50,000.
This loss produces tax savings of 0.45 × 50,000 = $22,500, so that the after-tax proceeds from
the sales including this tax savings is $72,500.
There is a small profit from replacing the machine. Even though the decision has no impact on
revenues, it still matters for cash flows because it reduces costs. Further, both selling the old
machine and buying the new machine involve cash flows with tax implication
Ques. 6 Chip’s Home Brew Whiskey forecasts that if the firm sells each bottle of Snake-
Bite for $20, then the demand for the product will be 15,000 bottles per year, whereas sales
will be 90 percent as high if the price is raised 10 percent. Chip’s variable cost per bottle is
$10, and the total fixed cash cost for the year is $100,000. Depreciation and amortization
charges are $20,000, and the firm has a 30 percent marginal tax rate. Management
anticipates an increased working capital need of $3,000 for the year. What will be the effect
of a price increase on the firm’s FCF for the year?
Answer
Answer
The after-tax version of the formula for the weighted-average cost of capital is:
The financial analyst should use market values rather than book values to calculate
WACC.
Financial theory tells us that the rate that should be used to discount these incremental
This means that the WACC is going to be the appropriate discount rate for evaluating a
project only when the project has cash flows with systematic risks that are exactly the
o When a single rate, such as the WACC, is used to discount cash flows for
projects with varying levels of risk, the discount rate will be too low in some
o When the discount rate is too low, the firm runs the risk of accepting a negative-
NPV project.
The estimated NPV will be positive even though the true NPV is
negative.
o When the discount rate is too high, the firm runs the risk of rejecting a positive-
NPV project.
The estimated NPV will be negative even though the true NPV is
positive.
The key point is that it is correct to use a firm’s WACC to discount the cash flows for a
o Condition 1: A firm’s WACC should be used to evaluate the cash flows for a
new project only if the level of systematic risk for that project is the same as that
project uses the same financing mix—the same proportions of debt, preferred
If the discount rate for a project cannot be estimated directly, a financial analyst might try
o This approach is generally not feasible due to the difficulty of finding a public
Financial managers sometimes classify projects into categories based on their systematic
risks.
o They then specify a discount rate that is to be used to discount the cash flows for