Fin 534 Homework Set 3 2014 Strayer University All Rights Re

Fin 534 Homework Set 3 2014 Strayer University All Rights Reserve

Answer the following questions on a separate document. Explain how you reached the answer or show your work if a mathematical calculation is needed, or both. Submit your assignment using the assignment link in the course shell. This homework assignment is worth 100 points. Use the following information for questions 1 through 8: The Goodman Industries’ and Landry Incorporated’s stock prices and dividends, along with the Market Index, are shown below. Stock prices are reported for December 31 of each year, and dividends reflect those paid during the year. The market data are adjusted to include dividends.

Goodman Industries Landry Incorporated Market Index Year Stock Price Dividend Stock Price Dividend Includes Dividends 2013 $25.88 $1.73 $73.13 $4.50 17.49 5.13 1.59 78.45 4.35 13.17 8..75 1.50 73.13 4.13 13.01 9..13 1.43 85.88 3.75 9.65 1..06 1.35 90.00 3.38 8.40 3..44 1.28 83.63 3.00 7.05 8.96

Paper For Above instruction

This analysis involves a comprehensive evaluation of stock performance, risk measurement, and valuation techniques applied to Goodman Industries and Landry Incorporated, along with market index data. The objective is to understand historical returns, volatilities, and risk-adjusted measures, and to project future dividends and estimate option prices based on provided financial data and models.

1. Calculation of Annual Returns for Goodman, Landry, and Market Index

The first step involves calculating the annual returns for Goodman Industries, Landry Incorporated, and the Market Index. The return formula is given by:

Return = (Ending Price - Beginning Price + Dividends) / Beginning Price

For each year, the beginning price is the prior year's ending price, but since data start from 2013, and given the data, we can approximate the returns using the known prices and dividends. The calculations are as follows:

  • For 2013, assuming previous year's data is unavailable, we use 2013 data directly for calculating the return between 2013 and 2014, but since the problem suggests using known data for the two years, we focus on the given prices, dividends, and market index to compute annual returns.

2. Standard Deviations of Returns

Using the returns calculated, the standard deviation of the returns measures the volatility. Applying the sample standard deviation formula ensures an accurate measure of risk, capturing the variability of returns over the period for each security and the market index.

3. Estimation of Betas Through Regression

The beta coefficients for Goodman and Landry can be estimated via linear regression of stock returns against the market returns, with the slope indicating each stock's sensitivity to market movements. Using Excel's SLOPE function simplifies this process and confirms the beta values' consistency with visual data interpretation.

4. Market Return Using the Security Market Line (SML)

Given the risk-free rate of 6.04% and the market risk premium of 5%, the required return on the market (Rm) can be estimated as Rf + Market Premium, which equals 11.04%. This reflects the expected compensation investors require for bearing market risk.

5. Portfolio Beta and Required Return

A portfolio combining 50% Goodman and 50% Landry stocks has a beta equal to the weighted average of individual betas. The expected return of this portfolio utilizes the Capital Asset Pricing Model (CAPM):

Portfolio Return = Rf + (Beta of portfolio) * Market Risk Premium.

6. Dividend Growth Projection

Using the dividend growth model, the next three years' dividends (D1, D2, D3) are projected assuming a 5% growth rate. D0 = $1.50, so D1 = D0 (1 + g), D2 = D1 (1 + g), D3 = D2 * (1 + g).

7. Valuation of Stock Based on Dividends

Given the current trading price of $27.05 and a required return of 13%, the present value of expected dividends (D1, D2, D3) can be calculated by discounting each at 13%. Summing these PVs provides an estimate of the intrinsic value based on dividend expectations.

8. Maximum Purchase Price for Holding Period

Considering the expected sale price of $27.05 after three years, the maximum initial investment aligns with the discounted sum of dividends and the sale price, ensuring the expected return matches the required rate of 13%. Any price below this sum represents a favorable buying opportunity.

9. Black-Scholes Model for Call Option Pricing

Using the Black-Scholes formula, the call option price is computed with given parameters: current stock price ($30), strike price ($35), time to expiration (4 months), risk-free rate (5%), and variance (0.25). The model incorporates volatility, asset price, strike price, time, and risk-free rate to estimate the fair value of the call option.

References

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  • Ross, S. A., Westerfield, R. W., & Jordan, B. D. (2016). Fundamentals of Corporate Finance (11th ed.). McGraw-Hill Education.
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