You have collected returns on AnaDone Corporation (AD Corp.), a large diversified manufacturing firm, and the NYSE index for five years:
Year AD Corp NYSE
1981 10% 5%
1982 5% 15%
1983 -5% 8%
1984 20% 12%
1985 -5% -5%
a. Estimate the intercept (alpha) and slope (beta) of the regression.
b. If you bought stock in AD Corp. today, how much would you expect to make as a return over the next year? [The six-month T.Bill rate is 6%]
c. Looking back over the last five years, how would you evaluate AD's performance relative to the market?
d. Assume now that you are an undiversified investor and that you have all of your money invested in AD Corporation. What would be a good measure of the risk that you are taking on? How much of this risk would you be able to eliminate if you diversify?
e. AD is planning to sell off one of its divisions. The division under consideration has assets which comprise half of the book value of AD Corporation and 20% of the market value. Its beta is twice the average beta for AD Corp (before divestment). What will the beta of AD Corporation be after divesting this division?