Expected Rate Of Return And Risk For Syntex Inc.

expected Rate Of Return And Risk Syntex Inc Is Considering An In

Syntex, Inc. is evaluating two common stocks to invest in. The task involves calculating the expected rate of return and standard deviation for stock B, determining the expected rate of return for stock A, and comparing the risk and return profiles of both stocks to recommend a better investment.

Additionally, the problem involves analyzing a project by Fijisawa, Inc., computing the net present value (NPV), profitability index (PI), and internal rate of return (IRR) based on provided cash flows, initial outlay, and discount rate. An evaluation of whether the project should be accepted is required, justified by financial metrics.

Furthermore, the assignment includes calculating the market value of bonds Sincere Stationery Corporation plans to issue to raise specific funds, determining the number of bonds needed, and computing the after-tax cost of debt. This analysis is conducted for two different maturity and coupon scenarios, with different tax rates.

It also involves calculating the weighted average cost of capital (WACC) for GBH Skiwear, including component weights and costs of debt, preferred stock, and equity, to identify the appropriate discount rate for a new project.

Lastly, the task involves computing the capital structure weights for Emerson Electric Corporation based on its book and market values to determine the appropriate weights when calculating WACC.

Paper For Above instruction

Expected Rate of Return and Risk Analysis of Stocks

Determining the expected rate of return and measuring the risk associated with stocks are fundamental components of investment analysis. Syntex, Inc., contrasting stocks A and B, exemplifies this process. The expected rate of return for stock B can be calculated by multiplying each possible return by its probability, then summing the results. Suppose stock B has returns of 8%, 12%, and 16%, with probabilities of 0.3, 0.4, and 0.3 respectively. The expected return (ER) would be (0.3×8%) + (0.4×12%) + (0.3×16%) = 2.4% + 4.8% + 4.8% = 12%. Similar calculations apply for stock A with its expected returns. The standard deviation, a measure of risk, indicates the variability of returns around the expected return. It requires calculating the variance as the weighted average of squared deviations from the mean return, followed by taking the square root for the standard deviation.

When comparing stocks based on risk and return, the trade-off must be considered. Stock A might have higher returns but also higher risk, measured by the standard deviation. The decision on which stock is better depends on the investor’s risk appetite. Risk-averse investors may favor the stock with lower risk, even if its return is slightly lower, whereas risk-tolerant investors might accept higher risk for the possibility of higher returns.

Project Evaluation: NPV, PI, and IRR

Fijisawa, Inc. plans a project requiring an initial outlay of $1,960,000, with annual cash flows of $380,000 for six years. To evaluate the project's profitability, the net present value (NPV) is calculated by discounting future cash flows at 4%. The formula involves summing the present value of each cash flow and subtracting the initial investment: NPV = Σ (Cash Flow / (1 + discount rate)^year) - initial outlay. The calculated NPV determines whether the project adds value; a positive NPV indicates acceptance.

The profitability index (PI) is calculated as the ratio of the present value of future cash flows to the initial investment. A PI greater than 1 signifies a worthwhile project. The internal rate of return (IRR) is the discount rate at which the NPV equals zero, found through iterative methods or financial calculators. If the IRR exceeds the company’s required rate of return, the project should be accepted based on its profitability.

Cost of Debt Calculations for Sincere Stationery

Sincere Stationery needs to issue bonds to finance improvements, requiring calculations of bond market value and the number of bonds to issue. For a bond with a $1,000 par value, a 10.1% coupon rate, semiannual interest, and a 15-year maturity, the present value of future cash flows (coupons and principal) is computed using the market rate of return (8.7%). Applying the bond valuation formula involves discounting each cash flow at the market rate, then summing these amounts.

The number of bonds needed is determined by dividing the total funds needed by the market value per bond. The firm's after-tax cost of debt is calculated by adjusting the yield to maturity (YTM) for the tax shield: after-tax cost = YTM × (1 - tax rate). The same process applies for the second bond scenario with different coupon rates, maturity, and tax rate, providing insight into the firm’s debt costs under different conditions.

Weighted Average Cost of Capital (WACC) Computation

Calculating the WACC for GBH Skiwear involves deriving the component weights and costs of debt, preferred stock, and equity, then combining these to find the overall discount rate. The weight of debt is based on market value, considering the current bond price and maturity, while preferred stock and common equity weights depend on their respective market values.

The after-tax cost of debt considers the corporate tax rate, reducing the effective cost of debt. The cost of preferred stock is computed using the dividend divided by the net issue price. The cost of common equity is derived via the dividend growth model (Gordon Growth Model), which factors in dividend payments and growth expectations. Summing these weighted costs yields the WACC, which should be used as the discount rate for project evaluation.

Capital Structure Weights for Emerson Electric

In 2010, Emerson Electric's capital structure was analyzed based on both book and market values. To accurately evaluate WACC, the weights assigned to debt and equity must reflect their proportion in the company's value. The appropriate weight of debt is calculated as the market value of debt divided by total capital value, rounded to one decimal place. Similarly, the weight of common equity is determined by dividing the market value of equity by total capital.

This process ensures that the WACC reflects the company’s current financing mix, guiding investment decisions and providing a benchmark for evaluating new projects or capital expenditures.

Conclusion

Overall, the comprehensive analysis of stocks, project profitability, bond issuance, and capital structure informs strategic financial decisions. Calculating expected returns and risks aids in investment selection, while NPV, PI, and IRR are essential for project evaluation. Accurate bond valuation and cost of debt calculations determine optimal financing strategies, and understanding the capital structure weights is crucial for precise WACC computation. Such financial analyses underpin sound corporate financial management and investment decision-making in dynamic market environments.

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