EXERCISE 5 (RISK AND RETURN)
1. Perry purchased 100 shares of Ferro, Inc. common stock for $25 per share one year ago. During the year, Ferro, Inc. paid cash dividends of $2 per share. The stock is currently selling for $30 per share. If Perry sells all of his shares of Ferro, Inc. today, what rate of return would he realize? Answer: Realized return = = 28%

2. Tim purchased a bounce house one year ago for $6,500. During the year it generated $4,000 in cash flow. If Time sells the bounce house today, he could receive $6,100 for it. What would be his rate of return under these conditions? Answer: Realized return = = 55%

3. Asset A was purchased six months ago for $25,000 and has generated $1,500 cash flow during that period. What is the asset's rate of return if it can be sold for $26,750 today? Answer: Realized return = = 13% (semi annual). For annual 13% x 2 = 26% 4. Assuming the following returns and corresponding probabilities for asset A, compute its standard deviation and coefficient of variation.

Answer:

SD = 3.87%
CV = SD/K = 3.87/15 = 0.26
Champion Breweries must choose between two asset purchases. The annual rate of return and related probabilities given below summarize the firm's analysis. 5. For each asset, compute
(a)the expected rate of return.
(b)the standard deviation of the expected return.
(c)the coefficient of variation of the return.
(d)Which asset should Champion select?
Answer:
(a)

Expected Return = 15% Expected Return = 15%
(b) Asset A
(10% – 15%)^2 × 0.30 = 7.5%
(15% - 15%)^2 × 0.40 = 0%
(20% - 15%)^2 × 0.30 = 7.5%
15%
Standard Deviation of A = 3.87%
Asset B
(5% - 15%)^2 × 0.40 = 40%
(15% - 15%)^2 × 0.20 = 0%
(25% - 15%)^2 × 0.40 = 40%
80%
Standard Deviation of B = 8.94%
(c) CVA = 3.87/15 = 0.26 CVB = 8.94/15 = 0.60
(d) Asset A; for 15% rate of return and lesser risk.

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