Finance Problem Set: Earnings & Returns Analysis
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SpencerFinance Problem Set: Earnings & Returns Analysis
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SpencerCommon questions
Powered by AIThe expected HPR of the insurance policy is calculated via E(HPR) = (Probability of Loss * (Payout - Premium) + Probability of No Loss * (-Premium)) / Premium. Here, Payout = $150,000 and Premium = $200, with a fire probability of 0.0001. E(HPR) = (0.0001 * ($150,000 - $200) + 0.9999 * (-$200)) / $200 = 7.4% .
CAPM consistency is verified via comparing expected returns to CAPM expected returns: E(R) = Risk-free rate + Beta * Market risk premium. With the risk-free rate at 10% and market premium at 8%, for security A with Beta 1.5, CAPM E(R) = 0.10 + 1.5*0.08 = 22%. If actual E(R) equals CAPM E(R), it's consistent. Given security A E(R) is 22%, it is consistent with CAPM .
The discount rate can be found using the formula: r = (D/P) + g, where D/P is the dividend yield and g is the growth rate. MZ Corp retains 75% of $20 million earnings, so dividends are $5 million. The current stock price is $60, with 1.25 million shares outstanding, so D/P = ($5 million / 1.25 million) / $60 = $62.5 million / $60 per share. The growth rate g = 75% * 12% = 9%. Thus, r = 3.33% + 9% = 12.33% .
To calculate the expected return on a portfolio with 80% investment in Stock A and 20% in Stock B, you use the formula E(Portfolio Return) = w_A * E(R_A) + w_B * E(R_B). Here, w_A = 0.8, E(R_A) = 5%, w_B = 0.2, E(R_B) = 10%. Therefore, E(Portfolio Return) = (0.8 * 5%) + (0.2 * 10%) = 6% .
For Star Corp, with no growth, the discount rate can be calculated using the dividend discount model for a perpetuity: r = D/P, where D is the annual dividend and P is the stock price. Star Corp paid $6 per share dividends with a market value indicating a stock price of $62.5 million / 5 million shares = $12.50 per share. Thus, r = $6 / $12.50 = 48% .
The standard deviation of a portfolio is given by sqrt((w_A^2 * σ_A^2) + (w_B^2 * σ_B^2) + (2 * w_A * w_B * σ_A * σ_B * ρ_AB)). With w_A = 80%, σ_A=10%, w_B=20%, σ_B=20%, ρ_AB = +0.5: Portfolio σ = sqrt((0.8^2 * 0.1^2) + (0.2^2 * 0.2^2) + (2 * 0.8 * 0.2 * 0.1 * 0.2 * 0.5)) = 8.62% .
The growth rate of earnings for Spatial Navigation Inc. can be calculated using the formula g = retention ratio * return on equity (ROE). The company plans on retaining 25% of its earnings, so the retention ratio is 0.25. Given the ROE is 12%, the growth rate g = 0.25 * 0.12 = 0.03 or 3% .
NPVGO is calculated as P - (E_1 / r), where P is the current stock price, E_1 is the earnings per share expected next year, and r is the required return. MZ Corp's E_1 = $20 million / 1.25 million shares = $16 per share. With a 12.33% discount rate and stock price of $60, NPVGO = $60 - ($16 / 12.33% ) = $60 - $129.73 = -$69.73. This negative NPVGO indicates that new investment opportunities at the historical ROE do not justify the current stock price .
Covariance is calculated as ∑ (Probability of State * (Return_A - E(Return_A)) * (Return_B - E(Return_B))). Correlation is Covariance / (Standard Deviation_A * Standard Deviation_B). With State probabilities and returns provided: E(Return_A) = 6.84% and E(Return_B) = 8.04%. Covariance = 0.0115. Assuming Standard Deviation_A = 6.9% and Standard Deviation_B = 5.1%, Correlation = Covariance / (0.069 * 0.051) = 3.232 .
The stock price of Spatial Navigation Inc. can be calculated using the Gordon Growth Model: P = D_1 / (r - g), where D_1 is the expected dividend next year. With the firm retaining 25% of $2 million earnings, the dividends are $2 million * 75% = $1.5 million. With 500,000 shares, D_1 = $1.5 million / 500,000 = $3 per share. The discount rate r is 10% and the growth rate g is 3%. Thus, P = $3 / (0.10 - 0.03) = $42.86 .