Chapter Eleven

Risk and return in capital markets

Answers to Problems
Note: All problems in this chapter are available in MyLab Finance. An asterisk (*) indicates problems with
a higher level of difficulty.

1. You bought a share one year ago for $30 and sold it today for $33. It paid a $1 per share
dividend today. What was your realised return?

Plan: Compute the realised return on this equity investment.

1  33  30 
Execute: R   0.1333  13.33%
30
Evaluate: The realised return on the equity investment is 11%.

4. You have just purchased a share for $30. The company is expected to pay a dividend of
$0.50 per share in exactly one year. If you want to earn a 10% return on your
investment, what price do you need if you expect to sell the share immediately after it
pays the dividend?

Plan: Compute the future sale price that is necessary to produce a 10% return.
0.50   P1  30 
Execute:  0.10  P1  $32.50
30
Evaluate: The selling price immediately after the dividend would need to be $32.50 for you to earn
a 10% return on the investment.

7. Ten annual returns are listed in the following table.

a. What is the arithmetic average return over the 10-year period?

b. *What is the geometric average return over the 10-year period?

c. If you invested $100 at the beginning, how much would you have at the end?

Plan: For part (a), to compute the arithmetic average, use Eq.11.3. For part (b), to compute the
geometric average, take the product of 1 + each return and then take the 10th root of that product
(see ‘Finance in Focus’ on page 334). For part (c), realise that the total return computed in part (b)
before taking the average can be applied directly to the $100.

Copyright ©2018 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781488611001/Berk/Fundamentals of
Corporate Finance/3e
 Execute:
1
a. R 
T 1
 R  R2  ...  Rn 
1

10
 19.9  16.6  18.0  50.0  43.3  1.2  16.5  45.6  45.2  3.0
 8.05%

 0.801 1.166  1.180  0.500 1.433 

1/10

*b. R     1  3.19%
1.012   0.835 1.456  1.452  0.970 

c. In part (b) we computed the total realised return as the product of 1 + each year’s return. We
would have earned that return on the $100, so the answer is $100(1.3683) = $136.83.

Evaluate: The geometric average return is a better representation of what actually happened.
However, the arithmetic average is a better estimate of what you can expect to happen in any given
year (if you were trying to forecast the return for next year, for example).

8. Using the data in the table below, calculate the return for investing in ABC shares from
1 January to 31 December. Prices are after the dividend has been paid (see MyLab
Finance for the data in Excel format).

Plan: Calculate the realised return for each period and then compound those returns.
30.67  0.17
Execute: R1   1  0.08973
33.88
29.49  0.17 32.38  0.17
R2   1  0.03293 R3   1  0.10376
30.67 29.49
39.07  0.17 41.99
R4   1  0.21186 R5   1  0.07474
32.38 39.07
RTotal   0.91027   0.96707  1.10376  1.21186  1.07474   1  26.55%

Evaluate: Taking into account both dividends and price changes, the return on this share for the
year was 26.55%.

Copyright ©2018 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781488611001/Berk/Fundamentals of
Corporate Finance/3e