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Running Head: MODULE 1 CASE ASSIGNMENT 0

Tecia Thomas-Jones

Present Value and the Risk/Return Trade-Off

FIN501 Strategic Corporate Finance

Dr. Edward Kaplan

Trident International University

May 31, 2018

In this first Module, I am solving all four questions by getting information from different sources to calculate Future value, Present Value, Risk and Return of the investments or `amounts. Among four questions two questions are fully solved below while question 2 and 3 would be solved in the attached excel file.

Q1. Calculate the following:

1. First question is based on the perpetuity concept or a series of the payment of same cash flows.

In this situation we have an NGO for which we wish to raise funds. This NGO needs of $50,000 per year for their smooth operations. I really want this NGO to be in running condition in indefinite year. For this purpose I have to make `an initial deposit to make sure that they are getting their required amount of $50,000.

In this investment I will receive 5% interest rate annually.

I will use simple formula for this I will take the required cash of $50,000 and then divided by the 5% annual rate of interest.

Annual Payment =$50,000

Amount needed per year/interest rate = 50,000/.05= $1,000,000.00

1. Part B for this question we have planned to deposit $1,000 in new account and let the interest compound over 10 years. The bank does a series of compounding on this amount with the 1% interest rate

Following is the calculation to find out the value of this deposit after 10 years:

This part is requiring the future value calculations for the cash flow. Future value is defined as the value of the cash or equivalent at a future particular date is equal to the cash or value sum for today.

Following is the formula to calculate the future value of the deposit:

Present Value (PV) = $1000

Number of periods =10 years and r (rate of interest) =1%

Future Value (FV) =1000x (1+0.1) ^10 = $ 2,593.74 (Present Value)

Q4. In the next question it is assumed that Rm is 8%, Rf is 1% and the beta for the stock is 1.2.

1. What is the required return for this stock?

To calculate the rate of return I will use CAPM formula which is given below:

Rate of Return = Rf + B * (Rm – Rf)

Rf = Risk free rate

Rm = Market rate of return

B = Beta of the specific stock

By putting the value in the formula:

E = 0.01 + 1.2 * (0.08-0.01)

E = 0.01 + 1.2 *(0.07)

E = 0.01 + 0.084

E = 0.094

E = 9.40%

1. If the beta increases by 50% (but risk free rate remains at 1%), what will be the new required return for the stock?

Revised Beta is 1.2 * 1.5

B (revised) = 1.8

E = 0.01 + 1.8 * (0.08 – 0.01)

E = 13.60%

What is the percentage-wise change in required return compared to your answer to A) above?

The percentage difference is 13.60% - 9.40% = 4.20%

1. If the market return increases by 50% (but beta remains at 1.2), what will be the new required return for the stock?

Revised Market return is

Rm = 8% *1.5 = 12%

Putting the value in the CAPM formula

=0.01 + 1.2 * (0.12 - 0.01)

Required rate of return= 14.20%

What is the percentage-wise change in required return compared to your answer to A) above?

The percentage difference is 14.20% - 9.40% = 4.80%

Beta is the value to evaluate the fluctuation of the particular stock changes within the specific market. The base beta is the 1 known as the market beta. For these companies having less than 1 beta is less volatile and risky as compare to the companies having more than 1 beta which is more volatile and risky in the competitive market place.

The Conglomerated Conglomerate, is part of a market that has the different line of engagements so have the highest Beta, this clearly indicates that based on the market trend they have more fluctuations in their stock price as compared to the market.

The Oily Oil Company stock price is only fluctuated by the oil price so it would have the beta less than 1. I think that the remaining company, Trendy Tech would have a beta nearest to 1 truly based on the assumption that its stock price fluctuate with the market trend (Does Beta Define Real Stocks’ Risk?)

Bibliography

CAPM. (n.d.). Retrieved from https://corporatefinanceinstitute.com/resources/knowledge/finance/what-is-capm-formula/

Does Beta Define Real Stocks’ Risk? (n.d.). Retrieved from http://www.investinganswers.com/financial-dictionary/stock-valuation/beta-1079

Present Value. (n.d.). Retrieved from https://www.business-case-analysis.com/discounted-cash-flow.html