Question 1: Monthly Returns.

Month Heavy Ltd Return Light Ltd Return Market Index Return
Share price (P1/P0)-1 Share price (P1/P0)-1 (ASX index) (P1/P0)-1
($) ($)
Jan 16 13.05 0.00% 20.55 0.00% 4650 0.00%
Feb 16 13.40 2.68% 21.15 2.92% 4770 2.58%
Mar 16 13.87 3.51% 20.95 -0.95% 4840 1.47%
Apr 16 13.12 -5.41% 18.75 -10.50% 4940 2.07%
May 16 13.37 1.91% 17.10 -8.80% 4815 -2.53%
Jun 16 13.00 -2.77% 19.35 13.16% 4788 -0.56%
Jul 16 13.50 3.85% 20.10 3.88% 5055 5.58%
Aug 16 13.90 2.96% 21.05 4.73% 5125 1.38%
Sep 16 14.12 1.58% 22.15 5.23% 5035 -1.76%
Oct 16 14.87 5.31% 23.85 7.67% 5115 1.59%
Nov 16 15.25 2.56% 22.90 -3.98% 5200 1.66%
Dec 16 16.05 5.25% 21.85 -4.59% 5255 1.06%
Jan 17 16.40 2.18% 23.80 8.92% 5305 0.95%

Question 2: Annualize monthly returns for Market and two companies.

Average Sum of all returns/number of returns

Heavy Light
Ltd Ltd Market Index
Sum 23.61% 17.69% 13.49%
Number of months 12 12 12
Average 1.97% 1.47% 1.12%

Annual Market Return ((1 + average of return) ^n)-1

Heavy Ltd Light Ltd Market Index
N 12 12 12
Average 1.97% 1.47% 1.12%
((1 + .0197) ^12)- ((1 + .0147) ^12)- ((1 + .0112) ^12)-
1 1 1
Annual Market Return 26.33% 19.20% 14.35%
It appears that after annualizing the returns of both companies, Heavy limited has higher
annuuesal return of market than Light limited.
Question 3: Calculate the standard deviations of the returns of the Market
and two companies.

Heavy Ltd Light Ltd Market Index

standard
deviations* Daily 2.98% 6.978% 2.001%
Variance* Daily square of Standard deviation
Variance Daily 0.000889 0.004869 0.000400
Number of months 12 12 12

*(excel is used to calculate standard deviation and variance)

Question 4:

Heavy Ltd Light Ltd Market Index

Variance Annualized Variance * number of months
Variance Annualized 0.000889 * 12 0.004869 * 12 0.0004 * 12
Variance Annualized 0.01067 0.05843 0.00480
standard deviations Annualized Square root of annualized variance
standard deviations Annualized (0.01067)^1/2 (0.05843)^1/2 (0.00480)^1/2
standard deviations Annualized 10.33% 24.17% 6.93%

Standard deviation tells us that how much the returns can vary from its mean value. In
above results the standard deviation of the market is smaller because the risk in market is
minimized. In market, there are many types of stocks which minimize the risk of the investment.

Question 5:
Heavy Ltd Light Ltd
Beta* 0.295013921 0.159326196

(calculated from regression method, see Appendix 1:)

Question 6: Portfolio beta

 Expected Weight Expected Return Portfolio Beta
Stock Return Beta s E(r)*W B*W
Heavy Ltd 26.33% 0.295013921 0.4 0.105339299 0.118005568
Light Ltd 19.20% 0.159326196 0.6 0.115181718 0.095595718
0.220521017 0.213601286
Portfolio beta = (B1 * weight1) + (B2 * weight2)
= (0.295 * 0.4) + (0.1593 * 0.6)
= 0.21360
Beta is the measure of the risk. If we compare the beta of these companies Heavy limited
company ha higher beta than Light limited company. It means that the Heavy limited is more
risker than the Light limited. When we make a portfolio of these two companies, the portfolio
beta is smaller than Heavy limited but higher than Light limited company. The portfolio reduces
the overall risk of the investment. If a person is currently invested his money only in Heavy
limited company, he can reduce his risk by investing in Light limited.

Question 7: Capital Asset Pricing Model (CAPM)

Re = RF + B * ( Rm - Rf)

(CAPM) FOR HEAVY LTD.

Risk free rate (Rf) 4.50%

Beta (B) 0.295013921
Market Return (Rm) 14.35%
Market risk premium ( Rm - Rf) (0.1435 - 0.045)
Market risk premium ( Rm - Rf) 9.85%
Expected Return (Re) 7.41%

Re = (0.045 + .02950 * (0.1435 – 0.045)

= 7.41%

(CAPM) FOR Light LTD.

Risk free rate (Rf) 4.50%
Beta (B) 0.159326196
Market Return (Rm) 14.35%
Market risk premium ( Rm - Rf) (0.1435 - 0.045)
Market risk premium ( Rm - Rf) 9.85%
Expected Return (Re) 6.07%
Re = (0.045 + .015932 * (0.1435 – 0.045)
= 6.07%

Question 8: After tax, weighted average cost of capital (WACC)

WACC = rD (1- Tc )*( D / V )+ rE *( E / V )

Heavy Ltd.
D / V = 65%
E / V = 35%
rE = 7.41%
Tc = not given
rD = not given

Light Ltd.

D / V = 60%
E / V = 30%
rE = 6.07 %
Tc = not given
rD = not given

Question 9: Compound Annual Growth Rate (CAGR)

CAGR = ((Ending dividend / beginning dividend) ^1/number of years) -1
Heavy Ltd.
Dividend 1 = D0 = 1
Dividend 5 = D5 = 1.25
Number of years = n = 5

CAGR = ((1.25/1) ^1/5)-1

= 1.04563955 – 1
= 4.56%

Light Ltd.
Dividend 1 = D0 = 1.5
Dividend 5 = D5 = 2
Number of years = n = 5

CAGR = ((2/1.5) ^1/5)-1

= 1.05922 – 1
= 5.922%

Question 10: Market value (price) of the shares

Price of share = Do * (1 + g)/ k-g
Heavy Ltd.
K = 7.41%
G = 4.56%
D2016 = 1.25
D2017 = D2016 * (1+g)
= 1.25 * (1 + 0.0456)
= 1.3075
P2016 = D2017 /k-g
= 1.3075/0.0741 – 0.0456
= 1.3075/0.02843
= 45.97

Light Ltd.
K = 6.07%
G = 5.92%
D2016 = 1.25
D2017 = D2016 * (1+g)
= 2 * (1 + 0.0592)
= 2.118
P2016 = D2017 /k-g
= 2.118/0.0607 – 0.0456
= 2.118/0.0014761
= 1435.144711

I would suggest investor to invest in Heavy limited company because Light limited company is
massively overvalued. I would invest in Heavy limited.
Appendixes:
Appendix 1: Regression Analysis to calculate beta.
Beta for Heavy Ltd.
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.198
R Square 0.039
Adjusted R
Square (0.057)
Standard
Error 0.032
Observations 12.000

ANOVA

Significanc
df SS MS F eF
Regression 1.000 0.000 0.000 0.408 0.537
Residual 10.000 0.010 0.001
Total 11.000 0.011

Uppe
Coefficient Standard P- r Lower Upper
s Error t Stat value Lower 95% 95% 95.0% 95.0%
Intercept 0.016 0.011 1.543 0.154 (0.007) 0.040 (0.007) 0.040
X Variable 1 0.295 0.462 0.639 0.537 (0.734) 1.324 (0.734) 1.324
 Beta for Light Ltd
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.046
R Square 0.002
Adjusted R
Square (0.098)
Standard Error 0.076
Observations 12.000

ANOVA
Signifi
cance
df SS MS F F
Regression 1.000 0.000 0.000 0.021 0.888
Residual 10.000 0.058 0.006
Total 11.000 0.058

Coefficient Standar P- Lower Upper Lower Upper

s d Error t Stat value 95% 95% 95.0% 95.0%
(0.043 (0.043
Intercept 0.013 0.025 0.512 0.620 ) 0.069 ) 0.069
(2.295 (2.295
X Variable 1 0.159 1.102 0.145 0.888 ) 2.614 ) 2.614