Homework: Finance & Financial Management
Each coursework group is required to choose two real-life companies (Company A & Company B) that are publicly traded on the main market of the London stock exchange. The two companies can be selected from the FTSE 100 Index.
Part A
To complete this part, you will require data on your two companies' monthly (or weekly) common-stock returns from January 2009 to December 2018. Or weekly common-stock returns for the period January 2014 to December 2018. If weekly returns are used then the answers to the questions below should be based on weekly data.
Required:
I. Suppose you are advising an investor who is considering investing all his/her wealth in the stock of just one of the two companies chosen by your coursework group (Company A or Company B).
i. Provide brief descriptions of Company A and of Company B.
ii. Next, compare and contrast the stock return performance of the two companies' common stocks over the calendar period using monthly (or weekly) return data from January 2009 to December 2018. Specifically, calculate the mean, variance and standard deviation of the monthly returns of the two stocks separately.
iii. Briefly comment on your results and make a stock recommendation.
II. Now suppose you are advising an investor who is considering investing all his/her wealth in a portfolio consisting of the two companies' common stock held together.
i. Calculate the mean, variance and standard deviation of the returns of portfolio comprising the two stocks with equal weights (i.e. 50:50). Next repeat the calculations for alternative portfolio weights, including 10:90, 20:80, 40:60, 60:40, 80:20, and 90:10. You may choose to construct other additional portfolios (but remember the portfolio weights need to add to 100%). Report your results in a table. Compare and contrast your findings with those of the single-stock portfolios in 1(b).
ii. Illustrate your results in 2(a), along with the single-stock results in 1(b), in a graph plotting the trade-off between the mean return and standard deviation of the portfolio returns.
iii. In the trade-off graph in 2(b), indicate the efficient frontier (assuming the stocks of Company A and B are the only available assets).
iv. Finally, try to identify the minimum variance portfolio in the trade-off graph. To do so, you can use trial and error, or the method outlined in the notes that you can find in MyPlace. Report the portfolio weights of the minimum-variance portfolio, and the mean, variance and standard deviation of returns of the minimum-variance portfolio.
v. Based on your findings in the previous parts, briefly explain to the investor how to choose his/her optimal portfolio assuming the two stocks are the only assets available to him/her. Also briefly indicate how your advice would change if other assets (e.g., risk-free asset) became available to the investor.
Part B
The senior management of Company A have asked you to advise them on the cost of capital the company should use to calculate the net present value and decide whether or not to undertake a new investment project. You may assume that the new project is comparable to the average of the company's existing projects in all respects.
It is worth stressing that that Company A cannot be from the financial sector and also cannot be an investment fund.
Required:
I. Calculate investors' required rate of return on Company A's equity.
Remember, there are many ways of estimating investors' required returns. You should use two alternative methods of calculating the required returns to check how sensitive your result is to using different methods; i.e. to check the robustness of your result. For example, you could use the Capital Asset Pricing Model (CAPM) which uses a single factor (beta) and the Dividend Constant Growth Model.
II. Calculate Company A's debt cost of capital.
The bond yield (cost of debt) can be calculated as Yield = risk-free rate + credit spread. If you cannot find data on the approximate credit spread for a given credit rating of your chosen company then you can simply use the latest rate that your company is paying on its newly issued debt (you can use the latest published financial Statements of your chosen company to find the latest rate the company is paying on its debt). For simplicity, you may assume that the only securities outstanding of your chosen company are common stock (equity) and long-term debt. Note that the after-tax cost of debt is lower than the pre-tax cost of debt if there is a tax advantage of debt relative to equity (interest tax shield).
III. Calculate the cost of capital (that is, the appropriate discount rate to calculate the net present value) of Company A's new investment project.
IV. Clearly explain your calculations and methods used in (I) to (III). Among other things, note explicitly whether your results are in terms of monthly, weekly or yearly returns (either is acceptable as long as clearly stated). Briefly describe and justify the data and (proxy) measures you are using. State and discuss any assumptions you are making (including assumptions about the financing of the project).
V. Briefly discuss any limitations of your analysis and how (given more time and information) you might improve your analysis in the future.
Format your homework according to the give formatting requirements:
a. The answer must be double spaced, typed, using Times New Roman font (size 12), with one-inch margins on all sides.
b. The response also includes a cover page containing the title of the homework, the course title, the student's name, and the date. The cover page is not included in the required page length.
c. Also include a reference page. The references and Citations should follow APA format. The reference page is not included in the required page length.
Attachment:- Collecting-Data.rar