# ADM3415 Lecture Notes - Lecture 12: Risk Premium, Cash Flow, Msci

4 pages78 viewsFall 2015

Department

Administration - UNBFCourse Code

ADM3415Professor

Dr.Anne E.Mac DonnellLecture

12ADM 3415 – 1A Assignment 1

Question 1

You are involved in a project that requires an immediate investment in Net Working

Capital (NWC) of $10,000. At the end of the year the level of NWC is expected to be

$12,000. At the end of year two it is expected to be $5,000. How much is the

inflow/outflow due to NWC in time 0, 1, and 2. Clearly identify the amount and state

whether it is an inflow or an outflow.

Year 0 1 2

NWC 10,000 12,000 5,000

Change in NWC 10,000 2,000 -7,000

Cash flow for

change in NWC

(-10,000)

outflow

(-2,000)

outflow

7,000

inflow

Question 2

Stock A has an expected return of 17%, its beta is 1.5, and the risk-free rate is 5%.

What must be the market risk premium?

E(R) = Rf + ß( Rmarket - Rf )

17% = 5% + 1.5(Rmarket - 5%)

1.5Rmarket = 17% - 5% + 1.5(5%)

1.5Rmarket = 19.5%

Rmarket = 13%

Market Risk Premium = Expected Market Return – Risk Free rate

= 13% - 5%

= 8%

Question 3

Project “git ‘er done” has the following cash flows over its lifetime:

Year 0 -$15,000

Years 1, 2, 3, 4, and

5

$4,700 Each

Assuming a discount rate of 12%, find:

a) The payback period

Year 0 1 2 3 4 5

Cash flow (15,000) 4,700 4,700 4,700 4,700 4,700

Cumulative

Cash Flow

(15,000) (10,300) (5,600) (900) 3,800 8,500

3 < Payback period < 4

900

4,700 ≈0.19

∴

Payback period = 3.19

b) The discounted payback period

Year Cash flow Discounted Cash Flow

at 12%

Cumulative

Discounted Cash Flow

0 (15,000) (15,000) (15,000)

1 4,700 4196 (10,804)

2 4,700 3747 (7,057)

3 4,700 3345 (3,712)

4 4,700 2987 (725)

5 4,700 2667 1,942

Discounted payback period = 4 +

725

2667 ≈

4.27years

c) The Net Present Value

NPV = 1,942

d) The approximate IRR

NPV = -15,000 +

4,700

1+IRR +4,700

(1+IRR)2+4,700

(1+IRR)3+4,700

(1+IRR)4+4,700

(1+IRR)5

= 0

NPV = -15,000 +

4,700

1+0.2 +4,700

(1+0.2)2+4,700

(1+0.2)3+4,700

(1+0.2)4+4,700

(1+0.2)5

= -944

NPV = -15,000 +

4,700

1+0.17 +4,700

(1+0.17)2+4,700

(1+0.17)3+4,700

(1+0.17)4+4,700

(1+0.17)5

= 36.92

NPV = -15,000 +

4,700

1+0.171 +4,700

(1+0.171)2+4,700

(1+0.171)3+4,700

(1+0.171)4+4,700

(1+0.171)5

= 2.4

The approximate IRR will be 17.1%

e) The Profitability Index.

The Profitability Index =

NPV

initial investment

=

1,942

15,000

= 0.129

Question 4

You decide to hold a portfolio with 80% invested in the S&P 500 stock index and 20%

invested in the MSCI Emerging Markets index. The expected return is 9.93% for the

S&P 500 and 18.20% for the Emerging Markets index. The risk (i.e. standard deviation)

is 16.21% for the S&P 500 and 33.11% for the Emerging Markets index. What will be

the portfolio’s expected return and risk given that the covariance between the two

indexes is 0.5% (i.e. 0.005)?

Given:

WA=80

WB=20

R

E(¿¿ A)=9.93

¿

R

E(¿¿ B)=18.2

¿

σA=16.21

σB=33.11

σAB =0.5

Find:

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