Questions
Answer the following assignment questions. Provide comments or explanation where required and provide literature support for your explanation.
1. Calculate the annual returns for Apple Ltd, Orange Ltd and the Market using the information provided. Compare the annual returns of the market and 2 companies and comment.
2. Calculate the standard deviations of the returns of the Market and 2 companies.
3. Annualise the standard deviations of the Market and two companies. Compare annualised standard deviations of two companies and the Market. Do you see annualised standard deviation of the market is smaller than two companies' annualised standard deviation? If so, explain why?
4. Calculate the beta for both companies. Using the concept of the Beta as a 'measure of risk'. Comment on the riskiness of both companies.
5. You have decided to have a portfolio of Apple Ltd and Orange Ltd. Your portfolio consists of 40% of Apple Ltd shares and 60% of Orange Ltd shares. Calculate the Portfolio beta. Is portfolio beta is smaller or bigger that individual company beta? Explain your answer.
6. Calculate the required rate of return for both companies using the Capital Asset Pricing Model (CAPM). Use the information provided .
7. Calculate the Yield to Maturity (bond's market rate) for the both companies' .
8. Calculate the Weighted average cost of capital (WACC) of both companies assuming that Apple Ltd's capital structure consists of 50% debt and 50% equity whereas Orange Ltd's capital structure is made up of 30% debt and 70% equity. Compare their WACCs and comment.
9. Calculate the growth rate for both Apple Ltd and Orange Ltd using Compound Annual Growth Rate (CAGR) using the information provided.
10. Calculate the Market value of the share of both companies using the Dividend Discount Model. Compare the share prices of two companies and comment.
Answers
Introduction
This report provides discussion on some crucial concepts of finance applied in security valuation such as share valuation and bond valuation. The report covers discussion in the average return of companies, beta, standard deviation, capital assets pricing model, weighted average cost of capital, compounded’ growth rate (Grabowski, Harrington, and Nunes, 2015). Further, the report also covers the analysis of value of shares applying dividend discount model.
1. The annual return has been found to be 26.33% and 19.20% for Apple Ltd and Orange Ltd respectively. Further, the market’s overall return has been found to be 14.5%. It could be observed that both the companies are earning return higher than the market.
2. The standard deviation of Apple Ltd and Orange Ltd has been found to be 3.11% and 7.29% respectively. Apple Ltd has lower standard deviation than the Orange Ltd which means that Apple Ltd is less risky (Grabowski, Harrington, and Nunes, 2015). Further, the standard deviation of the overall market has been found to be 2.09%. It could be observed that both the companies have standard deviation higher than the market.
3. The annualized standard deviation of Apple Ltd and Orange Ltd is 44.49% and 132.61% respectively. The overall market has annualized standard deviation of 28.17%. It could be observed that market has lower standard deviation than the two companies. The overall market comprises many companies from different sectors, it is therefore the volatility of the overall market is supposed to be lower than an individual company (Grabowski, Harrington, and Nunes, 2015).
4. The beta of Apple Ltd and Orange Ltd has been found to be 0.30 times and 0.16 times respectively. The beta shows volatility of the stock relative to the overall market (Vollmer, 2014). The stock having higher beta would be considered having risk. As Apple Ltd has beta higher than Orange Ltd, thus, Apple Ltd can be said to be riskier than Orange Ltd.
5. The beta of portfolio comprising 40% Apple Ltd and 60% Orange Ltd has been found to be 0.21 times. It could be observed that the portfolio beta is lower than the beta of Apple Ltd, however; it is higher than the beta of Orange Ltd. The portfolio is formed to optimize the risk and return (Vollmer, 2014).
6. The capital asset pricing model is widely used for computing the investor’s desired rate of return (Giovanis, 2010). The rate of return computed under the CAPM model shows minimum return that the investor would require for investing in the stock.
7. The yield to maturity shows the return that the investor would earn on the investment made in the bond. The yield to maturity of Apple Ltd’s bond and Orange Ltd’s bond is 10.56% and 8.12% respectively.
8. The weighted average cost of capital (WACC) of Apple Ltd and Orange Ltd has been found to be 9.31% and 7.74% respectively. It could be observed that the WACC of Apple Ltd is higher than that of Orange Ltd. The high WACC shows high risk (Vernimmen et al., 2014).
9. The growth rate of dividend of Apple Ltd and Orange Ltd has been found to be 4.56% and 5.92% respectively.
10. The dividend discount model is widely used in ascertaining the fair value of the shares (Vernimmen et al., 2014). Applying this model, the price of Apple’s stock has been found to be $37.40 while that of Orange Ltd is $229.04. The stock of Orange Ltd has higher price than the stock of Apple Ltd.
Conclusion
In this report, an evaluation of Apple Ltd and Orange Ltd has been made. The comparison of both the companies shows that Apple Ltd has higher annual return (26.33%) than Orange Ltd (19.20%). Further, Apple Ltd also bears lower risk than Orange Ltd. The WACC of Apple Ltd is higher than that of Orange Ltd. The dividend growth rate of Orange Ltd (5.92%) is better than Apple Ltd (4.56%).
References
Giovanis, E. 2010. Application of Capital Asset Pricing (CAPM) and Arbitrage Pricing Theory (APT) Models in Athens Exchange Stock Market. GRIN Verlag.
Grabowski, R.J., Harrington, J.P., and Nunes, C. 2015. 2015 International Valuation Handbook: A Guide to Cost of Capital. John Wiley & Sons.
Vernimmen, P., Quiry, P., Dallocchio, M., Le Fur, Y., and Salvi, A. 2014. Corporate Finance: Theory and Practice. John Wiley & Sons.
Vollmer, M. 2014. A Beta-return Efficient Portfolio Optimisation Following the CAPM: An Analysis of International Markets and Sectors. Springer.
