4. You bought a stock one year ago for $50 per share and sold it today for $55 p
ID: 2757325 • Letter: 4
Question
4. You bought a stock one year ago for $50 per share and sold it today for $55 per share. It paid a $1 per share dividend today.
a. What was your realized return?
b. How much of the return came from dividend yield and how much came from capital gain?
20. Consider two local banks. Bank A has 100 loans outstanding, each for $1 million, that it expects will be repaid today. Each loan has a 5% probability of default, in which case the bank is not repaid anything. The chance of default is independent across all the loans. Bank B has only one loan of $100 million outstanding, which it also expects will be repaid today. It also has a 5% probability of not being repaid. Explain the difference between the type of risk each bank faces. Which bank faces less risk? Why?
22. Consider the following two, completely separate, economies. The expected return and volatility of all stocks in both economies is the same. In the first economy, all stocks move together—in good times all prices rise together and in bad times they all fall together. In the second economy, stock returns are independent—one stock increasing in price has no effect on the prices of other stocks. Assuming you are risk-averse and you could choose one of the two economies in which to invest, which one would you choose? Explain.
30. What does the beta of a stock measure?
Betas with Respect to the S&P 500 for Individual Stocks (based on monthly data for 2007–2012)
Company
Ticker
Industry
Equity Beta
General Mills
GIS
Packaged Foods
0.20
Consolidated Edison
ED
Utilities
0.28
The Hershey Company
HSY
Packaged Foods
0.28
Abbott Laboratories
ABT
Pharmaceuticals
0.31
Newmont Mining
NEM
Gold
0.32
Wal-Mart Stores
WMT
Superstores
0.35
Clorox
CLX
Household Products
0.39
Kroger
KR
Food Retail
0.42
Altria Group
MO
Tobacco
0.43
Amgen
AMGN
Biotechnology
0.44
McDonald’s
MCD
Procter & Gamble
PG
Household Products
0.47
Pepsico
PEP
Soft Drinks
0.51
Coca-Cola
KO
Soft Drinks
0.54
Johnson & Johnson
JNJ
Pharmaceuticals
0.59
PetSmart
PETM
Specialty Stores
0.75
Molson Coors Brewing
TAP
Brewers
0.78
Nike
NKE
Footwear
0.91
Microsoft
MSFT
Systems Software
1.01
Southwest Airlines
LUV
Airlines
1.09
Intel
INTC
Semiconductors
1.09
Whole Foods Market
WFM
Food Retail
1.10
Foot Locker
FL
Apparel Retail
1.11
Oracle
ORCL
Systems Software
1.12
Amazon.com
AMZN
Internet Retail
1.13
GOOG
Internet Software and Services
1.14
Starbucks
SBUX
Restaurants
1.20
Walt Disney
DIS
Movies and Entertainment
1.21
Cisco Systems
CSCO
Communications Equipment
1.23
Apple
AAPL
Computer Hardware
1.26
PulteGroup
PHM
Homebuilding
1.28
Dell
DELL
Computer Hardware
1.41
salesforce.com
CRM
Application Software
1.47
Marriott International
MAR
Hotels and Resorts
1.48
eBay
EBAY
Internet Software and Services
1.48
Coach
COH
Apparel and Luxury Goods
1.60
Macy’s
M
Juniper Networks
JNPR
Communications Equipment
1.71
Williams-Sonoma
WSM
Home Furnishing Retail
1.72
Tiffany & Co.
TIF
Apparel and Luxury Goods
1.80
Caterpillar
CAT
Construction Machinery
1.85
Ethan Allen Interiors
ETH
Home Furnishings
1.95
Autodesk
ADSK
Application Software
2.14
Harley-Davidson
HOG
Motorcycle Manufacturers
2.23
Advanced Micro Devices
AMD
Semiconductors
2.24
Ford Motor
F
Automobile Manufacturers
2.38
Sotheby’s
BID
Auction Services
2.39
Wynn Resorts Ltd.
WYNN
Casinos and Gaming
2.41
United States Steel
X
Steel
2.52
Saks
SKS
Department Stores
2.57
Source: CapitalIQ
35. Suppose the market risk premium is 5% and the risk-free interest rate is 4%. Using the data in Table 10.6 (also shown above), calculate the expected return of investing in
a. Starbucks’ stock.
b. Hershey’s stock.
c. Autodesk’s stock.
2. You own three stocks: 600 shares of Apple Computer, 10,000 shares of Cisco Systems, and 5,000 shares of Colgate-Palmolive. The current share prices and expected returns of Apple, Cisco, and Colgate-Palmolive are, respectively, $500, $20, $100 and 12%, 10%, 8%.
a. What are the portfolio weights of the three stocks in your portfolio?
b. What is the expected return of your portfolio?
c. Suppose the price of Apple stock goes up by $25, Cisco rises by $5, and Colgate-Palmolive falls by $13. What are the new portfolio weights?
d. Assuming the stocks’ expected returns remain the same, what is the expected return of the portfolio at the new prices?
50. Suppose Autodesk stock has a beta of 2.16, whereas Costco stock has a beta of 0.69. If the risk-free interest rate is 4% and the expected return of the market portfolio is 10%, what is the expected return of a portfolio that consists of 60% Autodesk stock and 40% Costco stock, according to the CAPM?
26. Unida Systems has 40 million shares outstanding trading for $10 per share. In addition, Unida has $100 million in outstanding debt. Suppose Unida’s equity cost of capital is 15%, its debt cost of capital is 8%, and the corporate tax rate is 40%. •
a. What is Unida’s unlevered cost of capital?
b. What is Unida’s after-tax debt cost of capital?
c. What is Unida’s weighted average cost of capital?
27. You would like to estimate the weighted average cost of capital for a new airline business. Based on its industry asset beta, you have already estimated an unlevered cost of capital for the firm of 9%. However, the new business will be 25% debt financed, and you anticipate its debt cost of capital will be 6%. If its corporate tax rate is 40%, what is your estimate of its WACC?
Company
Ticker
Industry
Equity Beta
General Mills
GIS
Packaged Foods
0.20
Consolidated Edison
ED
Utilities
0.28
The Hershey Company
HSY
Packaged Foods
0.28
Abbott Laboratories
ABT
Pharmaceuticals
0.31
Newmont Mining
NEM
Gold
0.32
Wal-Mart Stores
WMT
Superstores
0.35
Clorox
CLX
Household Products
0.39
Kroger
KR
Food Retail
0.42
Altria Group
MO
Tobacco
0.43
Amgen
AMGN
Biotechnology
0.44
McDonald’s
MCD
Procter & Gamble
PG
Household Products
0.47
Pepsico
PEP
Soft Drinks
0.51
Coca-Cola
KO
Soft Drinks
0.54
Johnson & Johnson
JNJ
Pharmaceuticals
0.59
PetSmart
PETM
Specialty Stores
0.75
Molson Coors Brewing
TAP
Brewers
0.78
Nike
NKE
Footwear
0.91
Microsoft
MSFT
Systems Software
1.01
Southwest Airlines
LUV
Airlines
1.09
Intel
INTC
Semiconductors
1.09
Whole Foods Market
WFM
Food Retail
1.10
Foot Locker
FL
Apparel Retail
1.11
Oracle
ORCL
Systems Software
1.12
Amazon.com
AMZN
Internet Retail
1.13
GOOG
Internet Software and Services
1.14
Starbucks
SBUX
Restaurants
1.20
Walt Disney
DIS
Movies and Entertainment
1.21
Cisco Systems
CSCO
Communications Equipment
1.23
Apple
AAPL
Computer Hardware
1.26
PulteGroup
PHM
Homebuilding
1.28
Dell
DELL
Computer Hardware
1.41
salesforce.com
CRM
Application Software
1.47
Marriott International
MAR
Hotels and Resorts
1.48
eBay
EBAY
Internet Software and Services
1.48
Coach
COH
Apparel and Luxury Goods
1.60
Macy’s
M
Juniper Networks
JNPR
Communications Equipment
1.71
Williams-Sonoma
WSM
Home Furnishing Retail
1.72
Tiffany & Co.
TIF
Apparel and Luxury Goods
1.80
Caterpillar
CAT
Construction Machinery
1.85
Ethan Allen Interiors
ETH
Home Furnishings
1.95
Autodesk
ADSK
Application Software
2.14
Harley-Davidson
HOG
Motorcycle Manufacturers
2.23
Advanced Micro Devices
AMD
Semiconductors
2.24
Ford Motor
F
Automobile Manufacturers
2.38
Sotheby’s
BID
Auction Services
2.39
Wynn Resorts Ltd.
WYNN
Casinos and Gaming
2.41
United States Steel
X
Steel
2.52
Saks
SKS
Department Stores
2.57
Explanation / Answer
4.)
Realized return:
= ($55+$1-$50)/$50
= 12%
Dividend yield = $1/$50 = 2%
Capital gains yield = 12%-2% = 10%
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