Coates Decision On January 1, 2017 Dave Coates A 23 Year Old

Coatess Decisionon January 1 2017 Dave Coates A 23 Year Old Mathem

Evaluate the acceptability of two investment options for Dave Coates, applying present value techniques with specified discount rates. Reassess the investments considering different risk premiums, estimate internal rates of return (IRR), and provide a recommendation based on risk and return analysis. Additionally, determine the future value of the additional $50 invested in a savings account over 10 years.

Analyze Molly O’Rourke’s past stock performance to calculate historical returns and risks for stocks X and Y. Compare their return and risk measures to evaluate which stock is preferable and advise potential investment decisions.

Compare traditional portfolio management approaches, emphasizing the role of diversification and risk measurement, with modern portfolio theory, including concepts of Beta, systematic vs. unsystematic risk, and the benefits of diversification. Discuss how these approaches can be integrated into a comprehensive investment strategy for individual investors.

Assess Susan Lussier’s inherited portfolio to determine its suitability for her financial goals. Evaluate asset allocation, risk, return, and tax implications. Recommend adjustments to tailor the portfolio to her income and tax situation, and outline steps for portfolio rebalancing.

Evaluate the performance of the Stalcheck’s investment portfolio by calculating prior-year returns, adjusting for taxes, and analyzing risk-adjusted performance using Jensen’s alpha. Offer recommendations for portfolio revision based on the findings.

Sample Paper For Above instruction

Assessment of Investment Decisions and Portfolio Management Strategies

Understanding the intricacies of investment assessment and portfolio management is essential for making sound financial decisions. This paper systematically evaluates various investment scenarios and strategies to illustrate the practical application of financial theories such as present value analysis, internal rate of return, risk measurement through beta, and portfolio performance assessment using Jensen’s alpha. By analyzing Dave Coates's investment options, Molly O’Rourke’s stock performance, traditional versus modern portfolio theories, Susan Lussier’s inherited portfolio, and the Stalcheck’s portfolio evaluation, we can derive insights into prudent investment management aligned with individual financial goals.

Decision Analysis for Dave Coates’s Investment Options

Initially, we consider the two investment options available to Dave Coates, each costing $1,050 and expected to generate income over ten years. Investment A offers a relatively certain stream of income, while Investment B's income certainty is less assured, with a risk premium of 4% added due to its higher risk profile. The discount rate for a relatively safe investment is 4%. Using present value (PV) calculations, the acceptability and preference for each investment can be assessed.

For Investment A, cash flows consist of a $50 annual return, with the initial investment at $1,050. The PV of an annuity of $50 over ten years at 4% is calculated as:

PV = \$50 [(1 - (1 + r)^-n) / r] = \$50 [(1 - (1 + 0.04)^-10) / 0.04] ≈ \$50 * 8.1109 ≈ \$405.55

Adding the present value of the principal (which is $1,050 discounted over 10 years): PV = \$1,050 / (1 + 0.04)^10 ≈ \$1,050 / 1.4802 ≈ \$709.78

The total PV of the cash flows and principal is approximately \$405.55 + \$709.78 ≈ \$1,115.33, indicating that the investment is acceptable since the PV exceeds the initial cost.

Repeat the PV calculation for Investment B with a higher discount rate of 8% (adding the 4% risk premium):

PV of annuity: \$50 [(1 - (1 + 0.08)^-10) / 0.08] ≈ \$50 6.7101 ≈ \$335.50

Present value of principal: \$1,050 / (1 + 0.08)^10 ≈ \$1,050 / 2.1589 ≈ \$486.72

Total PV ≈ \$335.50 + \$486.72 ≈ \$822.22, which is less than the initial investment of \$1,050, suggesting that Investment B is less acceptable under these assumptions.

Risk Premium Adjustment and Reassessment

Recognizing that Investment B is riskier, adding an 8% discount rate (4% + 4% risk premium) significantly diminishes its present value compared to the initial assessment. This underscores the importance of risk-adjusted discount rates. When compared to Investment A, which remains acceptable at the 4% rate, Investment B's lower present value indicates a less favorable investment if the risk-adjusted return is considered.

Estimating IRR and Investment Preference

The internal rate of return (IRR) for each investment can be estimated by finding the discount rate that sets the PV of cash flows equal to the initial investment. For Investment A, the IRR appears to be slightly above the 4% discount rate, confirming its acceptability. For Investment B, the IRR falls below 8%, consistent with the previous PV analysis and indicating higher riskiness.

Future Value of the Extra $50

The additional $50 invested for ten years at 3% compounded annually grows as:

FV = PV (1 + r)^n = \$50 (1 + 0.03)^10 ≈ \$50 * 1.3439 ≈ \$67.20

Thus, by the end of 2026, the extra funds will have grown to approximately \$67.20, providing an additional measure of the return on the uninvested portion of the initial refund.

Evaluation of Molly O’Rourke’s Stock Choices

Molly’s analysis involves calculating each stock’s historical holding period return (HPR) over ten years and deriving expected returns and risks. For instance, the HPR for Stock X annually is calculated by:

HPR = [(Ending Price + Dividends) / Beginning Price] - 1

Applying this over ten years yields average annual returns, with the standard deviation measuring volatility.

Suppose Stock X’s average annual return is approximately 8%, with a standard deviation of 2.5%, reflecting moderate risk. Stock Y’s average return might be around 7%, with a higher standard deviation of 3%, indicating slightly higher risk but similar return profiles. Based on the risk-return tradeoff, Stock X appears preferable for its marginally higher return and lower volatility.

Portfolio Theory Comparison

The traditional approach emphasizes diversification through mutual funds, reducing unsystematic risk, while modern portfolio theory (MPT) advocates analyzing systematic risk via beta. Shane’s focus on beta as a risk measure assumes market-based risk equivalency, but as Walt’s traditional view supports, diversification minimizes total risk, especially unsystematic components.

Blending approaches involves selecting a diversified portfolio that considers systematic risks (using beta) but also aims to mitigate unsystematic risks through diversification, aligning with MPT principles. This combined strategy allows individual investors to balance risk exposure with return goals efficiently.

Susan Lussier’s Portfolio Review and Recommendations

Assessing Susan’s inherited portfolio, it comprises bonds, stocks, and mutual funds with a conservative, income-oriented profile. The portfolio’s allocation suggests a primary focus on stability and income, consistent with her moderate growth expectation. However, her tax situation requiring high income tax will impact after-tax returns, particularly from dividend and interest income.

Given her objective for high capital gain potential, she should consider shifting toward growth-oriented stocks with lower yield but higher appreciation potential, while reducing holdings that generate taxable income. Rebalancing her portfolio toward tax-efficient investments like index funds or ETFs with minimal dividend distributions is advisable. Moreover, utilizing tax-advantaged accounts or municipal bonds may further optimize after-tax returns.

Portfolio Performance and Potential Adjustments for Mary and Nick Stalcheck

The Stalchecks’ portfolio’s return over the past year, adjusted for beta and market conditions, can be estimated using Jensen’s alpha, which measures excess return above what is predicted by market risk. With a beta of 1.2, their portfolio’s expected return based on the market is 10.1% * 1.2 = 12.12%. The actual return can then be compared to this, adjusting for the risk-free rate and beta. If their actual return exceeds the expected, their alpha is positive; otherwise, it signals underperformance.

Based on calculations, if their actual return was approximately 11%, their Jensen's alpha would be negative, indicating underperformance relative to the systematic risk undertaken. Recommendations include rebalancing to reduce exposure to overly risky assets or diversifying further to improve risk-adjusted returns, aligning with modern portfolio principles.

Conclusion

Effective investment decisions depend on integrating valuation techniques, understanding risk metrics, and employing comprehensive portfolio strategies that balance risk and return. Whether evaluating individual projects, stocks, or entire portfolios, applying these foundational principles ensures more informed and resilient financial planning. Continuous assessment and adaptation are vital as market conditions evolve, emphasizing the importance of a disciplined, strategic approach to investment management.

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