deviation of the market returns

Sheet1

Problem 7-2
The following table shows the nominal returns on U.S. Stocks and the rate of inflation:
Year Nominal Return (%) Inflation (%)
2004 12.5 3.3
2005 6.4 3.4
2006 15.8 2.5
2007 5.6 4.1
2008 -37.2 0.1
a)     What was the standard deviation of the market returns?
b)     Calculate the average real return.
Answers:
a)     What was the standard deviation of the market returns?
Find the standard deviation by completing the table with the appropriate formulas
Year Nominal Return (%) Difference from Average Squared Difference TIP: Click on the cell for directions
2004 12.5 C C
2005 6.4 C C
2006 15.8 C C
2007 5.6 C C
2008 -37.2 C C
Total 2004-2008 C C
Average C C
Std. Deviation C Use SQRT function for this answer only
b)     Calculate the average real return.
Find the average real return by completing the table with the appropriate formulas
Year Nominal Return (%) Inflation (%) Real Return (%) TIP: Click on the cell for directions
2004 12.5 3.3 C
2005 6.4 3.4 C
2006 15.8 2.5 C
2007 5.6 4.1 C
2008 -37.2 0.1 C
Average C

Sheet2

Problem 8-6
Suppose that the Treasury bill rate were 6% rather than 4%. Assume that the expected return on the market stays at 10%. Use the betas in Table 8.2 (p. 193) – also provided below.
a. Calculate the expected return from Dell. b. Find the highest expected return that is offered by one of these stocks. c. Find the lowest expected return that is offered by one of these stocks. d. Would Ford offer a higher or lower expected return if the interest rate were 6% rather than 4%? Assume that the expected market return stays at 10%. e. Would Exxon Mobil offer a higher or lower expected return if the interest rate were 8%?
Answers:
Formula Calculation
A. Dell’s expected return Rf + (Beta (Rm – Rf)) C
B./C.
Stock Beta (B) Revised T Bill Risk-Free Rate Market Return Expected return
Amazon 2.16 F F C
Ford 1.75 F F C
Dell 1.41 F F C
Starbucks 1.16 F F C
Boeing 1.14 F F C
Disney 0.96 F F C
Newmont 0.63 F F C
Exxon Mobil 0.55 F F C
Johnson & Johnson 0.5 F F C
Campbell Soup 0.3 F F C
B. Highest T
C. Lowest T
D. FORD will offer a ________ expected return at 6%. Higher or lower?
Interest rate 4% 6%
Rate of return C C
E. Exxon will offer a _______ expected return at 8%. Higher or lower?
Interest rate 4% 8%
Rate of return C C

Sheet3

Problem 9-2
A company is 40% financed by risk-free debt. The interest rate is 10%, the expected market risk premium is 8%, and the beta of the company’s common stock is .5.
Risk Free Debt Interest Rate Market Risk Premium Beta Taxes
40% 10% 8% 0.5 35%
a.      What is the company cost of capital?
b.      What is the after-tax WACC, assuming that the company pays tax at a 35% rate?
Answers:
Step 1:
r(d)= F
r(e)= C
D/V C TIP: D + E = V
E/V C
Step 2:
a. Formula (in words) Calculation
Cost of Capital T C
b. WACC T C

Sheet4

Problem 10-14
Suppose that the expected variable costs of Otobai’s project are ¥33 billion a year and that fixed costs are zero. a. How does this change the degree of operating leverage (DOL)? b. Now recompute the operating leverage assuming that the entire ¥33 billion of costs are fixed.
Answers:
See page 243, Table 10.1, of textbook for additional information. Copy is also provided below.
DOL Formula Fixed Costs Calculation
a. 1+(Fixed cost + depreciation)/ operating profit F C
b. 1+(Fixed cost + depreciation)/ operating profit F C