Understanding and Computing Stocks

Problems (10 points each) – Show your Work unless otherwise indicated
Problem 1:
The Delano Hydrogen Vehicle Company has projected the following data:
Demand for Scooters

Probability of This Demand Occurring

Rate of Return if Demand Occurs

Weak

0.10

-30%

Below Average

0.20

-10%

Average

0.40

15%

Above average

0.25

30%

Strong

0.05

40%

a.Calculate the expected return for Delano stock:
E. R. R= (0.10*-30%)+(0.20*-10%)+(0.40*15%)+(0.25*30%)+(0.05*40%)
E.R.R= -3+-2+6+7.5+2
E.R.R= 10.5%
b.Calculate the variance for Delano stock:
VAR= √ (Initial Return-Expected Return)2*Probability.
=(-30-10.5)2*0.1+(-10-10.5)2*0.20+(15-10.5)2*0.40+(30-10.5)2*0.25+(40-10.5)2*0.05
=164.02+84.05+8.1+95.06+43.51
=394.74%
c. Calculate the standard deviation for Delano stock:
SD for Delano= √VAR OF DELANO
SD= √394.74
SD= 19.87%
Problem 2:
* The common stock of Gummy Treats, Inc. has a beta of 1.35 while the stock of Peppermint Fantasy, Inc. has a beta of 0.7. The expected rate of return on an average stock is 11% and the risk-free rate is 5%. By how much does the return on the riskier stock exceed that on the less risky stock?
Gummy treats= 1.35(0.11-0.05)
= 1.35(0.06)
= 0.081*100%
=8.1%
Peppermint fantasy= 0.7(0.11-0.05)
= 0.7(0.06)
= 0.042*100%
= 4.2%
Return on the riskier stock exceeds the less risky stock by= 8.1%-4.2%
=3.9%
* You have two stocks in your portfolio. $100,000 is invested in a stock with a beta of 0.4 and $150,000 is invested in a stock with a beta of 1.6. What is the portfolio’s beta?
βp= (100000*0.4) + (150000*1.6)
βp= 40000+240000
βp= $280000
* Blue Horizon stock has beta = 0.7. The risk-free rate is 3% and the expected return on the market is 12%. What is the required rate of return on Blue Horizon’s stock?
RR= 0.7(R-12) =3
= 0.7R-8.4=3
= 0.7R=3+8.4
R=11.4÷0.7
R=16.29%
Problem 3:
In-Shape Fitness (ISF) expects to have sales of $18 million. Costs other than depreciation is expected to be 65% of sales, and depreciation is expected to be $3.0 million. All sales revenues will be collected in cash, and costs other than depreciation must be paid for during the year. ISF’s federal and state tax rate combined is 27%. ISF has no debt.
a. Create an income statement for ISF (include Earnings before Tax as one of the line items).
IN SHAPE FITNESS

INCOME STATEMENT


SALES




$18million


Cost (65% of sale)


$11.7million










Gross Margin



$6.3million










Operating Expenses





Depreciation


$3million











Operating income



$3.3million










income before tax



$3.3million



ISF Federal & state tax (27%)


$0.891million






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