Download Quiz 4 with Answers | Financial Management | FIN 316 and more Quizzes Financial Management in PDF only on Docsity! Finance 316 Name___________________________________________________ Winter 2000 - 12:00 p.m. Fourth Quiz (25 points) Student Number__________________________________________ Question 1 (7 points) Your company is considering three investment projects with characteristics shown in the table below. Your supervisor has asked you to identify the project or projects that have positive NPV. The risk-free rate is 6% and the market risk premium is 8%. Explain your answer to your supervisor. Expected Return Standard Deviation Beta Project K 13% 25% 1.00 Project L 20% 30% 1.50 Project M 10% 35% 0.25 Required return: rK = rf + (rm-rf) x βK = 6% + 8% x 1.00 = 14% rL = rf + (rm-rf) x βL = 6% + 8% x 1.50 = 18% rM = rf + (rm-rf) x βM = 6% + 8% x 0.25 = 8% K has expected return less than its required return, so it has a negative NPV. L has expected return greater than its required return, so it has a positive NPV. M has expected return greater than its required return, so it has a positive NPV. Expected return greater than required (minimum acceptable) return means the project adds value (has Positive NPV). This could also be answered by comparing reward to risk ratios to the market risk premium, e.g., for Project L the reward to risk ratio is (20% - 6%)/1.50 = 9.33%, which is greater than the market risk premium of 8%, and so L has a positive NPV. Question 2 (6 points) The table below shows the return earned by the stock of DDD Co. and the return earned by the S&P 500 Index over the past 5 years. Year -5 Year -4 Year -3 Year -2 Year -1 DDD Co. 8% 4% 8% 9% 6% S&P 500 2% 14% 12% 5% 17% a. Calculate the mean return on each of these investments. Show your calculations. DDD: (8% + 4% + 8% + 9% + 6%)/5 = 7% S&P: (2% + 14% + 12% + 5% + 17%)/5 = 10% b. Which investment had the higher variance over this period. Explain your answer without using any computations. The S&P had the higher variance over this period. Its deviations of the yearly returns around the mean are noticeably higher than DDD's deviations from its mean return. c. From the data in the table, does the beta of DDD Co. stock seem likely to be > 0 or < 0? Explain your answer without using computations. The beta of DDD seems likely to be negative (< 0) over this sample time period. In four of the five years the deviations of the returns from their respective means are of opposite sign, suggesting they co-vary negatively.
