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MGT201 Financial Management Assignment 2 Solution Fall 2012

SEMESTER FALL 2012
FINANCIAL MANAGEMENT (MGT201)
ASSIGNMENT NO. 02

DUE DATE: 10 TH JANUARY 2013 MARKS: 20

“Risk and Return – Stock Valuation”

Learning Outcomes:
After attempting this assignment, the students would be able to:
 Understand the analysis of risk and return for single stock investment.
 Recognize the evaluation and application of common stock pricing and
dividend growth models

The Case:
Recently after graduating from Local Business College (LBC), you have started your
own investment consultancy firm – Prudent Consultants (PC’s) to earn your
livelihood. Mr. Zain, a regular investor approaches you to get some financial advice
on different intended stocks. On the basis of his preliminary research, Zain is curious
in reaping the risk and returns associated with these stocks. For your convenience,
he has also brought necessary information regarding these stocks along with him:

 MAQ Motors’ possible returns on investment of Rs.10,000 in common stock,  over the coming year is as follows:

Economic conditions Probability (p) Returns (r) in Rupees
Recession 0.20 – 1, 000
Normal 0.60 1, 500
Boom 0.20 2, 500

 Wahid Consultant Company, on its stock, is currently paying Rs. 2 per share as dividend, which is expected to grow at a constant rate of 7 percent per year.

 Zahoor Company’s stock Y is expected to pay a dividend of Rs. 57; while, stock Z is expected to pay a dividend of Rs. 54 in the upcoming year. The expected growth rate of dividends for both stocks is 7%.

 Ideal Contractors’ common stock (a very long term investment) is also available. Mr. Zain’s required return on this investment (based on risk) is 25% (rCE). The present dividend offered by the Company is Rs 10; while, the par value of each stock is Rs 100.


Based on provided information:

a) You need to calculate the expected return, standard deviation of returns and coefficient of variations for MAQ Motors’ investment opportunity. [7 marks]

b) You are expected to analyze the price of Wahid Consultant Company’s stock in case Mr. Zain requires a rate of return of 16 percent to invest in this stock with this degree of riskiness. [4 marks]

c) You need to identify which stock of Zahoor Company has higher intrinsic value; in case, Mr. Zain wishes to earn a return of 9% on each stock. [5 marks]

d) You are supposed to determine the dividend yield pricing for common stock of Ideal Contractors using both: ‘Zero Growth Pricing’ plus ‘Constant Growth Pricing’ Models (where: g=10%). Also compare & interpret the result. [4 marks]

(Show complete formulas, calculation and working as they carry marks)

Solution:

expected return = rp* = xA rA + xB rB

coefficient of variations = S.D / Expected return

 

Now, how can we put these values in the above given fomulas………

 

PART B)

PV = P0* = DIVI / (rCE –g)

Here,

DIVI = 2 , g = 7 %, rCE = 16%

PV = P0* = 22.22

 

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