FINANCIAL MANAGEMENT (MGT201) ASSIGNMENT NO. 02 DUE DATE: 10TH JANUARY 2013

SEMESTER FALL 2012

FINANCIAL MANAGEMENT (MGT201)

ASSIGNMENT NO. 02

DUE DATE: 10TH JANUARY 2013 MARKS: 20

“Risk and Return – Stock Valuation”

Objectives:

_ To understand the analysis of risk and return for single stock investment.

_ To recognize the evaluation and application of common stock pricing and dividend growth models

Learning Outcomes:

After attempting this assignment, the students would be able to:

_ Understand the analysis of risk and return for single stock investment.

_ Recognize the evaluation and application of common stock pricing and dividend growth models

The Case:

Recently after graduating from Local Business College (LBC), you have started your own investment consultancy firm – Prudent Consultants (PC’s) to earn your livelihood. Mr. Zain, a regular investor approaches you to get some financial advice on different intended stocks. On the basis of his preliminary research, Zain is curious in reaping the risk and returns associated with these stocks. For your convenience, he has also brought necessary information regarding these stocks along with him:

_ MAQ Motors’ possible returns on investment of Rs.10,000 in common stock,

over the coming year is as follows:

Economic conditions Probability (p) Returns (r ) in Rupees

Recession 0.20 - 1, 000

Normal 0.60 1, 500

Boom 0.20 2, 500

_ Wahid Consultant Company, on its stock, is currently paying Rs. 2 per share as dividend, which is expected to grow at a constant rate of 7 percent per year.

_ Zahoor Company’s stock Y is expected to pay a dividend of Rs. 57; while, stock Z is expected to pay a dividend of Rs. 54 in the upcoming year. The expected growth rate of dividends for both stocks is 7%.

_ Ideal Contractors’ common stock (a very long term investment) is also

available. Mr. Zain’s required return on this investment (based on risk) is 25% (rCE). The present dividend offered by the Company is Rs 10; while, the par value of each stock is Rs 100.

Based on provided information:

a) You need to calculate the expected return, standard deviation of returns and coefficient of variations for MAQ Motors’ investment opportunity. [7 marks]

b) You are expected to analyze the price of Wahid Consultant Company’s stock in case Mr. Zain requires a rate of return of 16 percent to invest in this stock with this degree of riskiness. [4 marks]

c) You need to identify which stock of Zahoor Company has higher intrinsic value; in case, Mr. Zain wishes to earn a return of 9% on each stock.

[5 marks]

d) You are supposed to determine the dividend yield pricing for common stock of Ideal Contractors using both: ‘Zero Growth Pricing’ plus ‘Constant Growth Pricing’ Models (where: g=10%). Also compare & interpret the result. [4 marks]

(Show complete formulas, calculation and working as they carry marks)

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information for better understanding or visit

http://linguistics.byu.edu/faculty/henrichsenl/apa/APA01.html

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IDEA SOLUTION AVAILABLE SOON

Hints For  Solution

Solution:

expected return = rp* = xA rA + xB rB

coefficient of variations = S.D / Expected return

Now, how can we put these values in the above given fomulas………

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a) You need to calculate the expected return, standard deviation of returns and
coefficient of variations for MAQ Motors’ investment opportunity. [7 marks]

expected return = rp* = xA rA + xB rB

coefficient of variations = S.D / Expected return

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Now, how can we put these values in the above given fomulas.........

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              a) You need to calculate the expected return, standard deviation of returns and 

coefficient of variations for MAQ Motors’ investment opportunity.
Solution of Part a
Expected ROR =<r>= ∑ Piri=12%,
Std Dev=σ = (∑(ri - < ri> ) 2 * Pi)0.5 = 11.66%
CV = σ / <r>= 0.97

b) You are expected to analyze the price of Wahid Consultant Company’s stock
in case Mr. Zain requires a rate of return of 16 percent to invest in this stock
with this degree of riskiness.

Solution of Part b

PV = Po* = DIV1 / (rce – g) = 22.22

c) You need to identify which stock of Zahoor Company has higher intrinsic
value; in case, Mr. Zain wishes to earn a return of 9% on each stock.

Solution of Part c
Stock Y: PV=Po* = DIV1 / (rce – g)= 2850
Stock Z: PV=Po* = DIV1 / (rce – g)= 2700

d)
You are supposed to determine the dividend yield pricing for common stock

of Ideal Contractors using both: ‘Zero Growth Pricing’ plus ‘Constant Growth
Pricing’ Models
(where: g=10%). Also compare & interpret the result.

Solution of Part d
Zero Growth Pricing: Po* = DIV1/rCE= 40
Constant Growth Pricing: Po* = DIV1/ (rCE – g)= 66.66

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Formulas are :

1.The rate of return on an investment can be

calculated as follows:

 Return = (Amount received – amount invested ) / amount invested

2. standard deviation is the square root of variance. 

3. 

Coefficient of Variation:

= S.D. / Return;  or Risk / Return

Note: for students convenience virtualians team has prepared a presentation on the said topic, this presentation will be helpful in understanding the main theme of this assignment. plz study the attached file. 

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a) You need to calculate the expected return, standard deviation of returns and 
coefficient of variations for MAQ Motors’ investment opportunity. 
Solution of Part a
Expected ROR =<r>= ∑ Piri=12%,
Std Dev=σ = (∑(ri - < ri> ) 2 * Pi)0.5 = 11.66%
CV = σ / <r>= 0.97

b) You are expected to analyze the price of Wahid Consultant Company’s stock 
in case Mr. Zain requires a rate of return of 16 percent to invest in this stock 
with this degree of riskiness.
Solution of Part b
PV = Po* = DIV1 / (rce – g) = 22.22

c) You need to identify which stock of Zahoor Company has higher intrinsic 
value; in case, Mr. Zain wishes to earn a return of 9% on each stock.
Solution of Part c
Stock Y: PV=Po* = DIV1 / (rce – g)= 2850
Stock Z: PV=Po* = DIV1 / (rce – g)= 2700

d)
You are supposed to determine the dividend yield pricing for common stock
of Ideal Contractors using both: ‘Zero Growth Pricing’ plus ‘Constant Growth 
Pricing’ Models
(where: g=10%). Also compare & interpret the result.
Solution of Part d
Zero Growth Pricing: Po* = DIV1/rCE= 40 
Constant Growth Pricing: Po* = DIV1/ (rCE – g)= 66.66

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     Solution of Part a

=-1000/10000 =-10

=1500/10000 = 15

=2500/10000 = 25

Expected Return = p1r1 * p2r2 + p3r3

= 0.20 * -0.10 + 0.50 * 0.35 + 0.29 * 1.25

= (0.02) +0.09 - 0.05

= 0.15 * 100 = 15%

Expected Return = <r> = ∑ piri

Expected Return = P1 (r1) + P2 (r2) + P3 (r3)

Expected Return = 0.20(-1000) +0.60(1500) +0.20(2500)

                          = 12% ans.

Std Dev = δ = √ Σ (r i - < r i >) 2 p i.

= square root of {[(-10-12) power 2 (0.20)] + [(15-12) power 2 (0.60)] + [(25-12) power 2 (0.20)]}.

= square root of {96.8 + 5.4 + 33.8}

= square root of {136} = 11.66% ans.

Coefficient of variations for MAQ Motors’ investment opportunity:

CV = σ / <r>= 0.97
CV = Standard Deviation / Expected Return.

       = 11.66% /12 %

       = 0.97 ans.

Solution of Part b

PV = P0* = DIVI / (rCE –g)

Here,

 DIVI = 2, g = 7 %, rCE = 16%

  PV = P0* = 2/16% -7%

                   =2/0.09

                   =22.22 ans.
.

Solution of Part c

rCE = 9%

Y = Rs. 57 Div1

Z = Rs. 54 Div1

G = 7%

Stock Y: PV=Po* = DIV1 / (rce – g)

Y = 57 / 9% – 7%

  = 57 /2%

  = 57 / 0.02

  = 2850 ans.

Stock Z: PV=Po* = DIV1 / (rce – g)

Z = 54 / 9% - 7%

  = 54 / 2%

  = 54 / 0.02

  = 2700 ans.

 Solution of Part d

      Zero Growth Pricing: Po* = DIV1/rCE

                                            = 10 / 0.25

                                            = 40 ans.

Constant Growth Pricing: Po* = DIV1/ (rCE – g)

                                            = 10 / 0.25 – 10%

                                            = 10 / 0.15

                                              = 66.66 ans.

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