1. 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?
2. 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?
3. 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.
4. What does the beta of a stock measure?
TABLE 1: 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
|
|
Google
|
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
5. Suppose the market risk premium is 5% and the risk-free interest rate is 4%. Using the data in Table 1 (also shown above), calculate the expected return of investing in
a. Starbucks’ stock.
b. Hershey’s stock.
c. Autodesk’s stock.
6. 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?
7. 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?
8. 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?
9. 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?