Junior Sayou, a financial analyst for Chargers Products, a manufacturer of stadium benches, must evaluate the risk and return of two assets, X and Y. The firm is considering adding these assets to its diversified asset portfolio. To assess the return and risk of each asset, Junior gathered data on the annual cash flow and beginning-and end-of-year values of each asset over the immediately preceding 10 years, 2006-2015. These data are summarized in the attached table.

Income statement 31, 2014

Sales revenue $5,075,000

Less: Cost of goods sold 3,704,000

Gross Profit $1,371,000

Less: Operating expenses

Selling expense $650,000

General and administrative expenses $416,000

Depreciation expense 152,000

Total operating expense 1,218,000

Operating profit 153,000

Less: Interest expense 93,000

Net profit before taxes 60,000

Less: Income Taxes 24,000

Net profit 36,000

*Preferred stock dividends of $3,000 were paid. **EPS for common stock is $0.33

Martin Manufacturing Company Balance Sheet December 31, 2014

Assets

Current assets:

Cash 25,000

Accounts receivable 805,556

Inventory 700,625

Total current assets $1,531,181

Gross fixed assets (at cost) $2,093,819

Less: Accumulated depreciation 500,000

Net fixed assets 1,593,819

Total assets 3,125,000

Liabilities and Stockholders Equity

Current liabilities:

Accounts payable $ 230,000

Notes payable 311,000

Accruals 75,000

Total Current Liabilities $ 616,000

Long-term debt $1,165,250

Total liabilities $1,781,250

Stockholders Equity

Preferred stock (2,500 shares) $50,000

Common stock (100,000 shares @$4.00 par) 400,000

Paid in capital 593,750

Retained earings 300,000

Total stockholders eq 1,343,750

Total liabilities and stockholders eq $3,125,000

***The firms 100,000 outstanding shares of common stock closed 2014 at a price of $11.38 Per share.

Data Table: Projected financial data for 2015:

Sales revenue $6,500,000

Minimum cash balance 25,000

Inventory turnover (times) 7.0

Average collection period 50 days

Fixed-asset purchases 400,000

Total dividend payments 20,000

Depreciation expense 185,000

Interest expense 97,000

Accounts payable increase 20%

Accruals and long-term debt unchanged

Notes payable, preferred and unchanged

Common stock

Juniors investigation suggests that both assets, on average, will tend to perform in the future just as they have during the past 10 years. He, therefore, believes that the expected annual return can be estimated by finding the average annual return for each asset over the past 10 years.

Junior believes that each assets risk can be assessed in two ways: in isolation and as part of the firms diversified portfolio of assets. The risk of the assets in isolation can be found by using the standard deviation and coefficient of variation of returns over the past 10 years. The capital asset pricing model (CAPM) can be used to assess the assets risk as part of the firms portfolio of assets. Applying some sophisticated quantitative techniques, Junior estimated betas for assets X and Y of 1.60 and 1.10, respectively. In addition he found that the risk-free rate is currently 7.0% and that the market return is 10.0%.

Respond to the following:

A) Calculate the annual rate of return for each asset in each of the 10 preceding years, and use those values to find the average annual return for each asset over the 10-year period.

B) Use the returns calculated in part 1 to find (a) the standard deviation and (b) the coefficient of variation of the returns for each asset over the 10-year period.

C) Use your findings in part 1 and 2 to evaluate and discuss the return and risk associated with each asset. Which asset appears to be preferable? Explain.

Gitman, Lawrence J. & Zutter, Chad J. (2015) Principles of managerial finance (14th ed.) Prentice Hall. book reference