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Corporate Finance 4th Edition David Hillier - Solutions
A solar panel production firm, Soleil SA, is considering an investment in new solar production technology.The new investment would require initial funding of €4 million today and further expenditure on manufacture of €1 million in each of the years 6 and 7. The net cash inflow for the years 1
Construct a spreadsheet to calculate the payback period, internal rate of return, modified internal rate of return and net present value of the proposed mine.You have set up a new firm in Copenhagen to produce mobile face recognition technology for all new smartphones. An opportunity has arisen
Based on your analysis, should the company open the mine?You have set up a new firm in Copenhagen to produce mobile face recognition technology for all new smartphones. An opportunity has arisen that would result in a new contract with a major mobile phone manufacturer that would massively
Bonus question: Most spreadsheets do not have a built-in formula to calculate the payback period. Write a macro that calculates the payback period for a project.You have set up a new firm in Copenhagen to produce mobile face recognition technology for all new smartphones. An opportunity has arisen
Use NPV and other capital budgeting theories to explain the reasoning behind its restructuring.
Is it possible for the value of distressed firms’ shares to go up even though their sales revenues are extremely likely to fall as a result of their decisions? Explain your answer.
What do you think would be the effect of your firm’s business decisions on its risk? How would this factor into the value of your company’s operations?
Can you think of any other business decisions your company could have made to protect itself against future economic conditions? Give some reasons why you think it did not choose these.
Look up the share price of your firm and search the internet (FT.com, Yahoo! Finance, Reuters, Google News are examples) for information on your company over the last three years. What was the main reason for the financial distress your company is currently in? Do you think its restructuring
Returns What is meant by the term ‘return’? What is the difference between monetary returns and percentage returns? Do monetary or percentage returns matter more to investors? Provide an example to explain your answer.
Holding Period Returns In what situations would you use a holding period return or a percentage return? Are the two measures the same?
Return Statistics Why would you wish to present return distributions? How do you think the distributions would change when you incorporated inflation into the return statistics?
Risk Statistics What do we mean by risk? In long-term investments, equities tend to give higher returns than bonds. Why, then, do all investors not invest in equities? Are such investors irrational?
Other Return Measures What is the difference between arithmetic and geometric returns? Suppose you have invested in a company’s shares for the last 10 years. Which number is more important to you, the arithmetic or geometric return?REGULAR
Investment Selection Given that the Ukraine Stock Exchange was up by over 80 per cent in 2018, why didn’t all investors put their money in Ukraine?
Investment Selection Given that the Venezuela stock exchange was down 94.9 per cent in 2018, why did investors continue to hold shares in Venezuela? Why didn’t they sell out before the market declined so sharply?
Equities versus Gambling Critically evaluate the following statement: ‘Investing in the stock market is just like gambling. It has no social value and investors do it purely to give them a thrill.’
Returns Two years ago, General Materials’ and Standard Fixtures’ share prices were the same. During the first year, General Materials’ share price increased by 10 per cent while Standard Fixtures’ share price decreased by 10 per cent. During the second year, General Materials’ share price
Historical Returns The historical returns presented in the chapter are not adjusted for inflation. What would happen to the estimated risk premium if we did account for inflation? The returns are also not adjusted for taxes. What would happen to the returns if we accounted for taxes? What would
Calculating Returns and Variability The returns of Lockhart Group plc and TJC plc are given below.Using the following returns, calculate the average returns, the variances and the standard deviations for Lockhart Group and TJC:Year Lockhart Group (%) TJC (%)2018 −60.7 −3.6 2017 24.1 37.5 2016
Risk Premiums Refer to Table 9.1 and look at the period 2008–2018.(a) Calculate the arithmetic average returns for each country’s stock market over this period.(b) Calculate the standard deviation of the returns for each country over this period.
Calculating Returns and Variability You have observed the following prices for British Auto, the luxury car maker, for a number of years. Jan 2011: €26.87; Jan 2012: €35.19; Jan 2013: €32.17; Jan 2014: €37.23;Jan 2015: €46.84; Jan 2016: €36.80; Jan 2017: €18.61; Jan 2018: €30.96;
Calculating Real Returns and Risk Premiums In Problem 15, suppose the average inflation rate over this period was 4.2 per cent and the average T-bill rate over the period was 5.1 per cent.(a) What was the average real return on British Auto’s shares?(b) What was the average nominal risk premium
Holding Period Return A firm had the following share prices: Jan 2015: £1.12; Jan 2016: £1.34; Jan 2017:£1.68; Jan 2018: £1.8825; Jan 2019: £2.18; Jan 2020: £2.07. The equity paid no dividends. What was the holding period return?
Return Distributions Refer back to Table 9.3. What range of risk premiums would you expect to see 68 per cent of the time for Europe? What about 95 per cent of the time?
Blume’s Formula Over a 30-year period an asset had an arithmetic return of 12 per cent and a geometric return of 10 per cent. Using Blume’s formula, what is your best estimate of the future annual returns over five years? 10 years? 20 years?
Arithmetic and Geometric Returns An equity has had returns of 10 per cent, 15 per cent, 20 per cent,–12 per cent, 2 per cent, and –5 per cent over the last six years. What are its arithmetic and geometric returns?
Using Return Distributions Assume that the returns from holding French shares are normally distributed. From Table 9.2, what is the approximate normal distribution probability that your money will double in value in a single year? Triple in value?
Using Return Distributions Suppose the mean returns on long-term government bonds are 5.8 per cent, and are normally distributed with a standard deviation of 9.3 per cent. Based on the historical record, what is the approximate probability that your return on these bonds will be less than –3.5
Distributions Your investment portfolio has earned returns of 400 per cent once in the last 10 years, zero per cent in 8 years out of the last 10 years and lost 90 per cent one year. What was the average arithmetic return and standard deviation of returns for this portfolio?
Inflation The inflation rates for the UK have been as follows, 2018: 2.5 per cent; 2017: 2.7 per cent; 2016:0.7 per cent; 2015: 0 per cent; and in 2014: 1.5 per cent. Calculate the average real return of Lockhart Group and TJC from Question 13.CHALLENGE
Calculating Returns Go to the Yahoo! Finance website and look up any FTSE 100 company of your choice. Click on the Historical Prices link. Find its closing price yesterday and its closing price exactly one year earlier. From the historical prices in Yahoo! Finance you will see the total dividend
Value at Risk The monthly prices for Banco Ruida are as follows:Date Adj Close 01/03/2020 514.2 01/02/2020 518 03/01/2020 493.35 01/12/2019 492.75 01/11/2019 473 03/10/2019 533 01/09/2019 539 01/08/2019 564 01/07/2019 640 01/06/2019 715 03/05/2019 720 01/04/2019 763 01/03/2019 714 01/02/2019 758
Calculate the average arithmetic returns, the variances and the standard deviations for Mauritius. (30 marks)You have invested in the Mauritian stock market. Details on the performance of the market are given below:Date Mauritius Jan-13 100 Jan-14 117.36 Jan-15 131.46 Jan-16 122.47 Jan-17 86.136
Calculate the geometric return on the Mauritius Stock Market and compare it to the arithmetic return.Comment on and explain the differences between the Mauritius arithmetic and geometric return. (20 marks)You have invested in the Mauritian stock market. Details on the performance of the market are
What was the holding period return on Mauritius equities over the period? (10 marks)You have invested in the Mauritian stock market. Details on the performance of the market are given below:Date Mauritius Jan-13 100 Jan-14 117.36 Jan-15 131.46 Jan-16 122.47 Jan-17 86.136 Jan-18 110.06 Jan-19 126.16
Suppose the returns on Mauritius equities are normally distributed. Based on the data above, what is the approximate probability that your return on these will be less than –2 per cent in a given year? What range of returns would you expect to see 95 per cent of the time? What range would you
Review the difficulties in using historical data to measure expected returns on an investment. (20 marks)You have invested in the Mauritian stock market. Details on the performance of the market are given below:Date Mauritius Jan-13 100 Jan-14 117.36 Jan-15 131.46 Jan-16 122.47 Jan-17 86.136 Jan-18
Calculating Yields Download the historical monthly share prices for a company of your choice from Yahoo! Finance. Find the closing share price for yesterday and for exactly two years ago. The dividends should also be listed in the monthly price series. What was the capital gains yield and dividend
Calculating Average Returns Download the Monthly Adjusted Share Prices for a company of your choice. What is the return on the equity over the past 12 months? Now use the 1 Month Total Return and calculate the average monthly return. Is this one-twelfth of the annual return you calculated? Why or
What advantages do the mutual funds offer compared to the company equity?You recently graduated from university, and your job search led you to West Coast Yachts at Kip Marina.Because you felt the company’s business was seaworthy, you accepted a job offer. The first day on the job, while you are
Assume that you invest 5 per cent of your salary and receive the full 5 per cent match from West Coast Yachts. What APR do you earn from the match? What conclusions do you draw about matching plans?You recently graduated from university, and your job search led you to West Coast Yachts at Kip
Assume you decide you should invest at least part of your money in large-capitalization companies based in the United Kingdom. What are the advantages and disadvantages of choosing the Skandla Large-Company Equity Fund compared to the Skandla Market Index Fund?You recently graduated from
The returns on the Skandla Small-Cap Fund are the most volatile of all the mutual funds offered in the retirement plan. Why would you ever want to invest in this fund? When you examine the expenses of the mutual funds, you will notice that this fund also has the highest expenses. Does this affect
A measure of risk-adjusted performance that is often used is the Sharpe ratio. The Sharpe ratio is calculated as the risk premium of an asset divided by its standard deviation. The standard deviation and return of the funds over the past 10 years are listed here. Calculate the Sharpe ratio for each
What portfolio allocation would you choose? Why? Explain your thinking carefully.You recently graduated from university, and your job search led you to West Coast Yachts at Kip Marina.Because you felt the company’s business was seaworthy, you accepted a job offer. The first day on the job, while
Individual Securities What are the main characteristics of individual security returns? Provide a definition of each characteristic and say why it is important.
Expected Return, Variance and Covariance Explain what is meant by correlation and how it is used to measure the relationship between the returns on two securities. How is correlation related to variance and covariance? Use mathematical formulae to illustrate your answer. If a portfolio has a
Portfolio Risk and Return Why does naive diversification reduce the risk of a portfolio? What benefits does naive diversification bring to international investment strategies?
The Efficient Set for Two Assets What is a minimum variance portfolio? In a world with only two assets, is it possible to have two portfolios with the same risk but different expected return? Explain your answer using a practical example. What is the two-fund spanning property of the efficient
The Efficient Set for Many Securities In a portfolio of many securities, all having positive correlation with one another, is it possible for the minimum variance portfolio to have zero risk? What happens to the efficient frontier when a risk-free asset exists?
Diversification Assume that every asset has the same expected return and variance. Furthermore, all assets have the same covariance with one another. As the number of assets in the portfolio grows, which becomes more important: variance or covariance? Clarify your answer using words, diagrams,
Riskless Borrowing and Lending Explain what is meant by an optimal portfolio. What are the conditions that must exist for there to be only one optimal portfolio? Do you think these conditions are likely to persist in the real world? Explain.
Market Equilibrium Your company is following two stocks, ABC plc and XYZ plc, and your manager tells you the following:‘The shares of ABC plc have traded close to £15 for most of the past four years, and because of this lack of price movement the stock has a very low beta. XYZ plc, on the other
Relationship between Risk and Expected Return Is it possible that a risky asset could have a beta of zero? Explain. Based on the CAPM, what is the expected return on such an asset? Is it possible that a risky asset could have a negative beta? What does the CAPM predict about the expected return on
Criticisms of the CAPM Define the market portfolio and provide a brief overview of Roll’s (1977)critique. Do you agree or disagree with it? Why?
Variations of the CAPM Explain what is meant by the CCAPM, HCAPM and X-CAPM. Why do you think these models are not popular with practitioners? Give an overview of the empirical evidence concerning these models and their performance relative to the CAPM.REGULAR
Systematic Versus Unsystematic Risk Classify the following events as mostly systematic or mostly unsystematic:(a) The Bank of England’s base rate increases unexpectedly.(b) A company renegotiates its bank debt after breaching a covenant agreement.(c) Oil prices unexpectedly decline.(d) No clear
Short Selling Explain what is meant by short selling. When is short selling profitable?
Risk A broker has advised you not to invest in technology stocks because they have high standard deviations. Is the broker’s advice sound for a risk-averse investor like yourself? Why, or why not?
Using CAPM An equity has a beta of 0.9 and an expected return of 9 per cent. A risk-free asset currently earns 2 per cent.(a) What is the expected return on a portfolio that is equally invested in the two assets?(b) If a portfolio of the two assets has a beta of 0.6, what are the portfolio
Portfolio Risk Assume the risk-free rate is 3 per cent and the expected return on the FTSE 100 index is 9 per cent. The standard deviation of the market index is 23 per cent. You are managing the pension fund of your company and would like to achieve an expected return of 5 per cent. How should
Using the SML W has an expected return of 12 per cent and a beta of 1.2. If the risk-free rate is 3 per cent, complete the following table for portfolios of W and a risk-free asset. Illustrate the relationship between portfolio expected return and portfolio beta by plotting the expected returns
Reward-to-risk Ratios Y has a beta of 1.50 and an expected return of 17 per cent. Z has a beta of 0.80 and an expected return of 10.5 per cent. If the risk-free rate is 5.5 per cent and the market risk premium is 7.5 per cent, are these equities correctly priced? What would the risk-free rate have
Portfolio Returns and Deviations Shares in Hellenic Telecom have an expected return of 15 per cent and the standard deviation of these returns is 30 per cent. National Bank of Greece’s shares are expected to produce a return of 16 per cent with a standard deviation of 40 per cent. What would be
Analysing a Portfolio You want to create a portfolio equally as risky as the market, and you have€1,000,000 to invest. Given this information, fill in the rest of the following table:Asset Investment (€) Beta Equity A 200,000 0.80 Equity B 250,000 1.30 Equity C 1.50 Risk-free asset
Analysing a Portfolio You have £24,000 to invest in a portfolio containing X, Y and a risk-free asset. You must invest all of your money. Your goal is to create a portfolio that has an expected return of 8.5 per cent and that has only 70 per cent of the risk of the overall market. If X has an
Covariance and Correlation Based on the following information, calculate the expected return and standard deviation of each of the following equities. Assume each state of the economy is equally likely to happen. What are the covariance and correlation between the returns of the two equities?State
Covariance and Correlation Based on the following information, calculate the expected return and standard deviation for each of the following equities. What are the covariance and correlation between the returns of the two equities?State of Economy Probability of State of Economy Return on J Return
Portfolio Standard Deviation Suppose the expected returns and standard deviations of A and B are E(RA) = 0.15, E(RB) = 0.25, σA= 0.40, and σB = 0.65, respectively.(a) Calculate the expected return and standard deviation of a portfolio that is composed of 40 per cent A and 60 per cent B when the
Correlation and Beta You have been provided the following data about the equities of three firms, the market portfolio and the risk-free asset:Expected Return Standard Deviation Correlation* Beta Firm A 0.13 0.38 (i) 0.9 Firm B 0.16 (ii) 0.40 1.1 Firm C 0.25 0.65 0.35 (iii)Expected Return Standard
CAPM The expected rates of return on the French firms, Publicis and Renault, the market portfolio(CAC 40) and the risk-free asset are given below, along with the standard deviations of these returns.Asset Expected Return (%) Standard Deviation (%)Publicis 17 40 Renault 10 20 CAC 40 14 17 Risk-free
Portfolios Below is given the standard deviation and correlation information on three South African companies, Afgri, Harmony Gold and SABMiller.Afgri Harmony Gold SABMiller Standard Deviation (%)Afgri 1 −0.2 0.5 29 Harmony Gold 1 0.4 21 SABMiller 1 23(a) If a portfolio is made up of 30 per cent
Systematic versus Unsystematic Risk Consider the following information about I and II:Rate of Return if State Occurs State of Economy Probability of State of Economy I II Recession 0.15 0.09 −0.30 Normal 0.70 0.42 0.12 Irrational exuberance 0.15 0.26 0.44 The market risk premium is 10 per cent,
CML and SML Explain in detail, using diagrams to illustrate your answer, what is meant by the terms‘capital market line’ and ‘security market line’.
SML Suppose you observe the following situation:Security Beta Expected Return Renewable Energy Corp 1.3 0.23 Statoil 0.6 0.13 Assume these securities are correctly priced. Based on the CAPM, what is the expected return on the market? What is the risk-free rate?
Portfolio Theory This question is designed to test your understanding of the mean standard deviation diagram.(a) Draw a mean-standard deviation diagram to illustrate combinations of a risky asset and the risk-free asset.(b) Extend this concept to a diagram of the risk-free asset and all possible
Covariance and Portfolio Standard Deviation There are three securities in the market. The following chart shows their possible payoffs:State Probability of Outcome Return on Security 1 Return on Security 2 Return on Security 3 1 0.10 0.25 0.25 0.10 2 0.40 0.20 0.15 0.15 3 0.40 0.15 0.20 0.20 4 0.10
SML Suppose you observe the following situation:Return if State Occurs State of Economy Probability of State A B Bust 0.25 −0.10 −0.30 Normal 0.50 0.10 0.05 Boom 0.25 0.20 0.40(a) Calculate the expected return on each equity.(b) Assuming the capital asset pricing model holds and A’s beta is
Standard Deviation and Beta There are two securities in the market, A and B. The price of A today is€50. The price of A next year will be €40 if the economy is in a recession, €55 if the economy is normal and€60 if the economy is expanding. The probabilities of recession, normal times and
Company Beta Charles Ray plc has three main divisions: Oil & Gas, Minerals and Power & Industrial. Oil &Gas accounts for 40 per cent of the company’s assets and Minerals accounts for 35 per cent of the assets.It has been estimated that the asset betas for these divisions are 1.2, 0.8 and 0.6,
Minimum Variance Portfolio Assume A and B have the following characteristics:Equity Expected Return (%) Standard Deviation (%)A 5 10 B 10 20 The covariance between the returns on the two equities is 0.001.(a) Suppose an investor holds a portfolio consisting of only A and B. Find the portfolio
CAPM An investor holds a portfolio of three securities. She invests 30 per cent in A, 30 per cent in B and 40 per cent in C. The betas on A, B and C are 1.5, 0.6 and 1.1, respectively. If E(RM) = 12% and RF = 4%, calculate the expected return and beta of the portfolio.
Minimum Variance Portfolio Consider the table below. Using either the historical return or expected return and Solver, compute the minimum variance portfolio for the universe of three Norwegian shares, Crew Gold, GGS and Marine Harvest, described below. Assume the risk-free return is 6 per cent.
Beta The following prices are for Rollway plc and the market index.Date Rollway plc Market Index Mar-20 1,187.00 5,768.50 Feb-20 1,077.00 5,871.50 Jan-20 941.00 5,681.60 Dec-19 852.00 5,572.30 Nov-19 922.50 5,505.40 Oct-19 1,179.00 5,544.20 Sep-19 1,263.00 5,128.50 Aug-19 1,365.00 5,394.50 Jul-19
Assuming that the returns are explained by the capital asset pricing model, calculate the betas of L’Oréal and Daimler, and the risk of a portfolio holding L’Oréal and Daimler with an expected return the same as the Euro Stoxx 50 Index return. (20 marks)Below, you are given the expected
Construct a portfolio consisting of the Euro Stoxx 50 Index and the risk-free asset that will produce an expected return of 12 per cent. Contrast the risk on this portfolio with the risk of Daimler. (20 marks)Below, you are given the expected returns and standard deviations of L’Oréal and
Assuming that the expected return on an average security is 13 per cent with a standard deviation of 26 per cent, and the average covariance of returns between securities is +100, determine the expected risk of a portfolio with 28 securities and a portfolio with 1,000 securities. Comment briefly on
Now assume that the returns on securities are independent. Continuing to assume that the expected return on an average security is 13 per cent with a standard deviation of 26 per cent, determine the risk of a portfolio with 28 securities and 1,000 securities. Comment on your results. (20
Explain what is meant by the separation principle. (20 marks)Below, you are given the expected returns and standard deviations of L’Oréal and Daimler AG, the Euro Stoxx 50 Index of largest Eurozone firms, and the risk-free asset.Asset Expected Return (%) Standard Deviation (%)L’Oréal 16 30
Considering the effects of diversification, how should Sarah respond to the suggestion that you invest 100 per cent of your retirement account in West Coast Yachts?You are discussing your retirement plan with Dan Ervin when he mentions that Sarah Brown, a representative from Skandla Financial
Sarah’s response to investing your retirement account entirely in West Coast Yachts has convinced you that this may not be the best alternative. You now consider that a 100 per cent investment in the bond fund may be the best alternative. Is it?You are discussing your retirement plan with Dan
Using the returns for the Skandla Large-Cap Equity Fund and the Skandla Bond Fund, graph the opportunity set of feasible portfolios.You are discussing your retirement plan with Dan Ervin when he mentions that Sarah Brown, a representative from Skandla Financial Services, is visiting West Coast
After examining the opportunity set, you notice that you can invest in a portfolio consisting of the bond fund and the large-cap equity fund that will have exactly the same standard deviation as the bond fund.This portfolio will also have a greater expected return. What are the portfolio weights
Examining the opportunity set, notice there is a portfolio that has the lowest standard deviation. This is the minimum variance portfolio. What are the portfolio weights, expected return and standard deviation of this portfolio? Why is the minimum variance portfolio important?You are discussing
A measure of risk-adjusted performance that is often used is the Sharpe ratio. The Sharpe ratio is calculated as the risk premium of an asset divided by its standard deviation. The portfolio with the highest possible Sharpe ratio on the opportunity set is called the Sharpe optimal portfolio. What
The Accounting Equation Explain why the total value of the assets of a company should equal the sum of liabilities and equity.
Book Values versus Market Values Explain the difference between book value and market value.Under standard accounting rules, it is possible for a company’s liabilities to exceed its assets. When this occurs, the owners’ equity is negative. Can this happen with market values? Why, or why not?
Operating Cash Flow Identify two circumstances where negative operating cash flow might not necessarily be a sign of deteriorating financial health. When can negative operating cash flow become problematic for a company?
Financial Ratio Analysis A financial ratio by itself tells us little about a company because financial ratios vary a great deal across industries. There are two basic methods for analysing financial ratios for a company: time trend analysis and peer group analysis. Why might each of these analysis
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