Week 3 Answers

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Solution 3.

1
Let amount to be invested in company Vienna and Graz be x and
(60000-x)
Since portfolio should have a return of 15%, the return in amount
will be ($60000*0.15)
Now,
X*0.14 + (60000-X)*0.18 = 60000*0.15
0.14x + 10800 0.18x = 9000
0.04x = 1800
Therefore, X= 1800/0.04 = 45000
Hence, the amount to be invested in company Vienna is $45000
and in company Graz is $15000
Since the price per share of Vienna is $30, the number of shares
to be bought = 45000/30 = 1500
Since the price per share of Graz is $40, the number of shares to
be bought = 15000/40 = 375
Thus the number of shares to be bought of Vienna = 1500
shares and of Graz = 375 shares
Weight of each share relative to the entire portfolio:
WV = 45000/60000 = 0.75
WG = 15000/60000 = 0.25
Now the standard deviation of portfolios returns,
= [0.752*35%2 + 0.252*45%2 + 2*0.75*0.4*35%*0.25*45%]1/2
= [689.0625 + 126.5625 + 236.25]1/2 = [1051.875]1/2 = 32.43%

Solution 3.2
Total investments in a portfolio = $20000 + $35000 + $45000 =
$100000
Weight of each security relative to the entire portfolio:
WTB = 20000/100000 = 0.20
WSC = 35000/100000 = 0.35
WIC = 45000/100000 = 0.45
Now, Return of portfolio = 0.20*4% + 0.35*16% + 0.45*17% =
14.05%
Now the standard deviation of portfolios returns,
= [0.202 *0 + 0.352 *35%2 + 0.452 *40%2 +
2*0.35*0.45*0.3*35%*40%]1/2
= [150.0625 + 324 + 132.3]1/2
= [606.3625]1/2 = 24.62%
Since returns are normally distributed, the probability
that the return of the portfolio is more than 18% is given
by,
P(x>18%) = 1- P(x<18%)
= 1- p( 18-14.05/24.62) = 1-(0.1604) = 1- 0.5637 = 0.4363 =
43.63%

Solution 3.3
Expected return of stock = Riskless return + (Market return
riskless return)
= 4% + 1.75(12% - 4%) = 18%
Expected growth rate = 3.5%
Next year dividend to be paid = $2.25

Now, the value of its common stock = 2.25/(0.18 0.035)


= $15.52

Solution 3.4
Current price of stock = $65
Annual dividend = $3.50
Therefore, return on stock = 3.50/65 = 5.3846%
Now, 5.3846 = Riskless rate + 1.7*(Market rate Riskless rate)
5.3846 = 3% + 1.7*(Market rate 3%)
Market rate = 4.4027%
Now, due to jump in price by $1.5, the new price = $65 + $1.5 =
$66.5
New return on stock = 3.5/66.5 = 5.2632%
Now,
5.2632% = 3% + *(4.4027% - 3%)
= 1.613

Solution 3.5
Expected market return = 11%
Riskless return = 5%
= 1.25
Therefore, Expected return on stock = 5% + 1.25*(11% - 5%) =
12.5%

Solution 3.6
Price of Sankt Polten Corp stock = $140
Dividend next year = $3
= 1.15
Riskless rate = 4%
Expected market return = 11%
Hence, Expected return on Sankt Polten Corp Stock = 4% +
1.15*(11%-4%)
= 12.05%
Now, 140 = 3/(0.1205 growth rate)
Growth rate = 0.09907 = 9.907%
Current price of Dornbirn stock = $65
Growth rate of Dornbirn = 9.907%
Therefore,
65 = 1.5*(1.09907)/ (ke 0.09907)
Ke = 12.44%
Again, 12.44% = 4% + *(11% - 4%)
Hence, = 1.206

Solution 3.7
After acquisition, = 1.1
Expected market return = 12%
Riskless rate = 6%
Now, Expected return of Steyr Corporation =6% + 1.1*(12% - 6%)
= 12.6%

Buying cost of Feldkirch Corporation = $600000


Therefore, minimum growth rate of earnings to make it a
profitable acquisition can be calculated as under$50000/(0.126 growth rate) = 600000
Hence, growth rate = 4.267%

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