Question 1. You own a portfolio that consists of three stocks. Here is the information on each:
|
Name of Stock
|
Walmart |
Coke |
Shell |
|
Shares Owned
|
100 |
200 |
100
|
|
Price per Share
|
$55 |
$50 |
$35
|
|
P/E Ratio
|
17 |
27 |
33 |
|
Expected Return
|
10% |
12% |
15%
|
|
Standard Deviation
|
5% |
8% |
10%
|
|
Correlation with Walmart
|
1.0
|
0.3
|
0.1
|
|
Correlation with Coke
|
0.3
|
1.0
|
0.7
|
| Correlation with Shell |
0.1
|
0.7
|
1.0
|
What is the expected return of your portfolio?
What is the standard deviation of your portfolio?
Question 2. Procter and Gamble paid a dividend of $3.00 per share to its common stockholders yesterday. You expect its dividend to increase by 10 percent per year for the next two years. From that point, you expect the dividend to increase by 8 percent per year for the following three years, before settling into a constant growth of 5 percent per year forever. You believe that P&G stockholders require a 12 percent rate of return and its bondholders require a 7 percent rate of return. If the market value of Procter and Gamble's bonds is $100 million and the company has one billion shares of common stock outstanding, what should the price of P&G stock be based on the dividend
discount model?
Price of Procter and Gamble Stock
Question 3 Reese's Peanut Butter Cups Inc. has a series of 8 percent (coupon rate) bonds outstanding with a total face value of $20 million. The bonds are currently priced at 100.87 and are due to mature in exactly 15 years. The company's stock is currently trading at a price of $46.96. On average, if the stock market goes up 1%, Reese's stock goes up 1.3%. If the stock market goes down 1%, Reese's stock goes down 1.3%. There are 1.7 million shares of common stock outstanding. The risk-free rate of interest is 3.0%. Over the past 100 years, the stock market has averaged 5.7% better than the risk-free rate and you feel that this is likely to continue in the future. Reese's marginal tax rate is 35%.
Reese's is planning to introduce a coconut peanut butter cup which it will produce for five years. The initial cost of equipment will be $15,000, which can be depreciated on a straight-line basis over the life of the project. You will need $2,000 of working capital immediately and that level of working capital will be maintained throughout the life of the project (no increases or decreases). The working capital will be recovered when the project ends. Based on the results of a recently concluded test market, sales are expected to be $10,000 per year.
Reese's spent $2,000 conducting the test market. Variable costs for this new flavor are expected to be equal to 20 percent of sales, just as they are for the traditional flavor. There are no fixed costs. The new flavor is expected to cause a $1,000 drop in sales of the traditional flavor during the first year only. All cash flows should be discounted at the same rate.
Determine the appropriate free cash flows to use for an NPV analysis and show the net FCF for each year on the time line below. Next, determine the WACC that Reese's should use, and then calculate the NPV of this project.