BAO2001 Corporate Finance

Answer the following assignment questions. Provide comments or explanation where required and provide literature support for your explanation with proper in-text citation and references.

1.Calculate the annual returns for Apple Ltd, Orange Ltd and the Market using the information provided in Appendix A. 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 in Appendix D to calculate the risk free rate.

7.Calculate the Yield to Maturity (bond's market rate) for the both companies' using the information given in Appendix C.

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 in Appendix B.

 Calculation of annual returns:

(Source: Appendix A) (Source: Appendix A) (Source: Appendix A)

Comment:

It is seen that annual return of Apple ltd and annual return of orange ltd are more than market index annual return. Further it is also seen that Apple ltd annual return is more that Orange ltd which shows that both companies are performing well according to market index but Apple ltd is performing best among the three (Fama, 1990).

Calculation of standard deviations:

(Source: Appendix A) (Source: Appendix A) (Source: Appendix A)

Beta of a stock measures the volatility of the stock with repect to market index. If beta value of a stock is more than one then it is referred as 'high beta stock' means this types of stock are riskier than market index whereas if beta value of a stock is less than one then it is referred as 'low beta stock' this means stocks under this category are not riskier than market index (Babcock, 1972).

Here the beta of Apple ltd and orange ltd are less risky than market index. But comparing the beta of these two companies it can be said beta with high are more risky than beta with low value. Hence, Apple ltd has more risk than Orange Ltd.

Comment:

Calculation of Risk free rate (Rf):

(Source: Appendix D)

Calculation of Expected returns of Apple Ltd and Orange Ltd as per CAPM model:

Ri = Rf + β(Rm-Rf)

(Bruner, et.el., 2008).

Where,

 (Rode.et el, 1976)

WACC is very useful for investors because it represents minimum rate of return. In other words, WACC is the overall cost of capital of the company which comprises of different category of capital is proportionately weighted. It includes common stock, debts, preferred stock. Thus, WACC of orange ltd is higher than WACC of Apple ltd which indicates investors should invest money in Orange ltd (Farber, Gillet and Szafarz, 2006).

Calculation of growth rate as per CAGR method:

(Source: Appendix B)

(Source: Appendix B)

Calculation of market value of shares as per dividend discount model:

(Penman, 1998).

Penman, S.H., 1998, ‘a synthesis of equity valuation techniques and the terminal value calculation for the dividend discount model’, A review of accounting studies, vol.2, no.4, pp.303-323.

Rode, F., Crowley, Jr, W.L., Walker, A.D. and Cochran, D.S., Hewlett-Packard company, 1976, general purpose calculator with capability for performing yield-to-maturity of a bond calculation, U.S.

Markowitz, H.M., 1991, ‘foundation of portfolio theory’, the journal of finance, vol.46, no.2, pp.469-477.

Fama, E.F., 1990, ‘stock returns, expected returns, and real activity’, the journal of finance, vol.45, no.4, pp.1089-1108.

Tsiang, S.C., 1972, ‘the rationale of the mean-standard deviation analysis, skewness preference and the demand for money’, the American economic review,vol.62, no.3, pp.354-371.

Babcock, G.C., 1972, ‘a note on justifying beta as a measure of risk’, the journal of finance, vol.27, no.3,  pp.699-702.

Bruner, R.F., Li,W., Kritzman, M., Myrgren, S. and Page, S., 2008, ‘market integration in developed and emerging markets: evidence from the CAPM’, Emerging markets review, vol.9, no.2, pp.89-103.

Farber, A., Gillet, R.L. and Szafarz, A., 2006, a general formula for the WACC.

Lettau, M and Ludvigson, S.C., 2005, ‘expected returns and expected dividend growth’, Journal of financial Economics, vol.76, no.3, pp.583-626.