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Lecture 12

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

4 pages78 viewsFall 2015

Department
Course Code
Professor
Dr.Anne E.Mac Donnell
Lecture
12

Page:
of 4
ADM 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:
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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