Question

Part A

1. Discuss the overall purpose people have for investing. Define investment.

2. As a student, are you saving or borrowing? Why?

3. Some financial theorists consider the variance of the distribution of expected rates of return

to be a good measure of uncertainty. Discuss the reasoning behind this measure of risk and

its purpose.

Part B

1. Your rate of return expectations for the common stock of XYZ Company during the

next year are:

Possible Rate of Return Probability

-0.100.25

0.000.15

0.100.35

0.25 0.25

i. Compute the expected return [E(Ri)] on this investment, the variance of this return (2),

and its standard deviation ().

2. Your rate of return expectations for the stock of KLM Company during the next year

are:

Possible Rate of Return Probability

-0.600.15

-0.300.10

- 0.100.05

0.200.40

0.400.20

0.800.10

i. Compute the expected return [E(Ri)] on this stock, the variance (2) of this return, and its

standard deviation ().

ii. On the basis of expected return [E(Ri)] alone, discuss whether XYZ or KLM is preferable.\

iii. On the basis of standard deviation () alone, discuss whether XYZ or KLM is preferable.()

Part C - Stock Valuation

1. The Fijian Holding Limited's last dividend was $1.25 and the directors expect to maintain the

historic 4 percent annual rate of growth. You plan to purchase the stock today because you feel

that the growth rate will increase to 7 percent for the next three years and the stock will then

reach $25.00 per share.

i. How much should you be willing to pay for the stock if you require a 16 percent return?

ii. How much should you be willing to pay for the stock if you feel that the 7 percent growth2.

2. Communications Fiji Limited just paid dividends of $2 per share. Assume that over the next

three years dividends will grow as follows, 5% next year, 15% in year two, and 25% in year 3.

After that growth is expected to level off to a constant growth rate of 10% per year. The required

rate of return is 15%. Calculate the intrinsic value using the multistage model)

3. Consider a firm that has just paid a dividend of $2. An analyst expects dividends to grow at a

rate of 8% per year for the next five years. After that dividends are expected to grow at a normal

rate of 5% per year. Assume that the appropriate discount rate is 7%.

i. Calculate the dividends for years 1, 2, and 3.

ii. What is the price of the stock in year 5?

iii. Calculate the present value today of dividends for years 1 to 5.

iv. What is the price of the stock today (P0)?