Alex Sharpe's Portfolio

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SOLUTIONS TO
EXERCISES AND CASES

For

FINANCIAL STATEMENT ANALYSIS AND SECURITY VALUATION

Stephen H. Penman

Fifth Edition

CHAPTER ONE

Introduction to Investing and Valuation

Exercises
Drill Exercises
E1.1. Calculating Enterprise Value This exercise tests the understanding of the basic value relation: Enterprise Value = Value of Debt + Value of Equity Enterprise Value = \$600 + \$1,200 million = \$1,800 million (Enterprise value is also referred to as the value of the firm, and sometimes as the value of the operations.)
E1.2. Calculating Value Per Share Rearranging the value relations, Equity Value = Enterprise Value – Value of Debt Equity Value = \$2,700 - \$900 million = \$1,800 Value per share on 900 million shares = \$1,800/900 = \$2.00
E1.3 Buy or Sell? Value = \$850 + \$675 = \$1,525 million Value per share = \$1,525/25 = \$61 Market price = \$45 Therefore, BUY!

Applications
E1.4. Finding Information on the Internet: Dell Inc., General Motors, and Ford This is an exercise in discovery. The links on the book’s web site will help with the search.

E1.5. Enterprise Market Value: General Mills and Hewlett-Packard

a) General Mills
| | |
|Market value of the equity = \$36.50 ( 644.8 million shares = |\$23,535,2 million |
|Book value of total (short-term and long-term) debt = | 6,885.1 |
|Enterprise value |\$30,420.3 million |

Note three points: i) Total market value of equity = Price per share ( Shares...

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...FINA 5210: Investment Analysis (Prof. Abhiroop Mukherjee) Alex Sharpe’s Portfolio Discussion Guidelines 1. Download the raw data file from the LMES website under folder Cases Alex Sharpe’s Portfolio. Estimate and compare the average returns and variability of Reynolds and Hasbro. Which stock appears to be the riskiest by itself? Computing the average returns and standard deviations of Reynolds and Hasbro gives us the results shown in the table below. If the stocks are judged just by themselves, Reynolds has a higher standard deviation than Hasbro (9.37>8.12), hence it is more risky. Question: Can we also consider the sharpe-ratio? This would show some kind of risk adjusted-return! | REYNOLDS | HASBRO | Mean | 1.87% | 1.18% | Stdev | 9.37% | 8.12% | 2. Suppose Sharpe’s position had been 99% of equity funds invested in the Vanguard 500 Index and either 1% in Reynolds or 1% in Hasbro. Estimate the average return and volatility of the resulting portfolio. How does each stock affect the variability of the equity investment? How does this compare to your answer in question 1? For both portfolio a and b, the average return increases compared to holding 100% of V500. The average return on portfolio a is higher than that of portfolio b (0.587>0.580). For portfolio a, the volatility of the portfolio decreases, whereas the volatility of Portfolio b increases. It is interesting to note that although Reynolds has a much higher standard deviation...

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...Alex Sharpe’s Portfolio 1. Returns and Risk Estimate and compare the returns and variability (i.e. annual standard deviation over the past five years) of Reynolds and Hasbro with that of the S&P 500 Index. Which stock appears to be riskiest? S&P: Monthly average return=0.57% Annual return= 6.89% Annual SD= 12.477% (monthly SD 3.60* 3.46 (square of 12)) Reynolds: Monthly average return= 1.87% Annual return= 1.87% * 12= 22.50% Annual SD: 32.446% (monthly SD 9.37* 3.46 (square of 12)) Hasbro: Monthly average return= 1.18% Annual return= 1.18% * 14.21% Annual SD= 28.114% (monthly SD 8.12* 3.46 (square of 12)) Conclusion: Correlation between high risk and high return. Reynolds is the riskier stock with an annual SD of 32.41% over 5 years, compared to Hasbro’s 28.08%. Reynolds annual return over the 5 year period of 22.50% is also higher than Hasbro’s return of 14.21%. 2. Portfolio Risk Suppose Sharpe’s position had been 99 percent of equity funds invested in the S&P 500 and either one percent in Reynolds over one percent in Hasbro. Estimate the resulting portfolio position. How does each stock affect the variability of the equity investment? How does this relate to your answer in question 1 above? ER of .99 S&P + .01 Reynolds Annual: 7.0481% SD of Reynolds in Portfolio Monthly: 3.5933% Annual: 12.4476% ER of .99 S&P + .01 Hasbro Annual: 6.9651% SD Hasbro in Portfolio Monthly: 3.6174% Annual: 12.5310% Results: Although......

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Alex Sharpe's Portfolio

...Executive Summary Our team concludes that risk and return are strongly correlated. A higher risk usually yields a higher return. Our team observed that within Alex Sharpe’s portfolio, the Reynolds’ fund holds the highest risk (highest standard deviation of 32.45%), as well as the highest return (16.27% in comparison to Hasbro’s return of 11.31%). Although a lower standard deviation (lower risk) is ideal for an investment portfolio, the Reynolds’ fund yields a higher return for the higher associated risk. Furthermore, our team’s data illustrated that the mix of S&P with Reynolds has a higher return and lower standard deviation than the S&P alone. In addition, if Sharpe invests in Reynolds and Hasbro equally, at for instance, one percent, the average return for Reynolds is significantly higher (at 7.08%) than the average return for Hasbro (at 6.97%). Computing the Sharpe ratio for each of the portfolios, the one with 1% Reynolds is the highest at. Given this analysis, our team feels that Alex Sharpe should consider investing more in the Reynolds fund than in Hasbro fund. Stock Analysis 1. Returns and Risk Estimate and compare the returns and variability (i.e., annual standard deviation over the past five years) of Reynolds and Hasbro with that of the S&P 500 Index. Which stock appears to be riskiest? | S&P500 | Reynolds | Hasbro | Arithmetic Return | 6.89% | 22.50% | 14.21% | Std Dev | 12.48% | 32.45% | 28.11% | Reynolds has the highest......

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