978-0133546408 Chapter 8 Solution Manual Part 2

P8-10. Assessing return and risk

LG 2; Challenge

a. Project 257

(1) Range: 1.00  (.10)  1.10

(2) Expected return:

=1

n

i ri

i

r r P= ´

å

Rate of Return

ri

Probability

Pr i

Weighted Value

ri  Pr i

Expected Return

å

1=

= ´

n

i ri

i

r r P

(3) Standard deviation:

2

1

( )

n

i ri

i

r r Ps

=

= – ´

å

ri

r

–

i

r r

( )–

i

r r

2Pr i

( )–

i

r r

2Pr i

2 Gitman/Zutter Principles of Managerial Finance, Brief, Seventh Edition

Project 432

1

i

=

Rate of Return

ri

Probability

Pr i

Weighted Value

riPri

Expected Return

å

=1

= ´

n

i ri

i

r r P

(3) Standard deviation:

2

1

( )

n

i ri

i

r r Ps

=

= – ´

å

ri

r

–

i

r r

2

( )

i

r r–

Pri

P

2

( )

i ri

r r– ´



Project 432 

0.011250

 0.106066

(4)

0.106066 0.3536

0.300

CV = =

b. Bar Charts

Chapter 3: Financial Statements and Ratio Analysis 3

c. Summary statistics

Project 257 Project 432

Because Projects 257 and 432 have differing expected values, the coefficient of variation should be the criterion

P8-11. Integrative—expected return, standard deviation, and coefficient of variation

LG 2; Challenge

a. Expected return:

1

n

i ri

i

r r P

=

= ´

å

Continued

Asset G 0.35 0.40 0.14

Asset H 0.40 0.10 0.04

Asset G provides the largest expected return.

2

n

Chapter 3: Financial Statements and Ratio Analysis 5

Based on standard deviation, Asset G appears to have the greatest risk, but it must be measured against its

c.

standard deviation ( )

Coefficient of variation = expected value

s

Asset F:

0.1338 3.345

0.04

CV = =

Asset G:

0.2278 2.071

0.11

CV = =

Asset H:

0.1483 1.483

0.10

CV = =

P8-12. Normal probability distribution

LG 2; Challenge

a. Coefficient of variation: CV 

rrs¸

b. (1) 68% of the outcomes will lie between 1 standard deviation from the expected value:

1 0.189 0.14175 0.33075

1 0.189 0.14175 0.04725

s

+ = + =

– = – =

(2) 95% of the outcomes will lie between  2 standard deviations from the expected value:

2 0.189 (2 0.14175) 0.4725

2 0.189 (2 0.14175) 0.0945

s

+ = + ´ =

– = – ´ =–

(3) 99% of the outcomes will lie between 3 standard deviations from the expected value:

3 0.189 (3 0.14175) 0.61425

3 0.189 (3 0.14175) 0.23625

s

+ = + ´ =

– = – ´ =–

c.

6 Gitman/Zutter Principles of Managerial Finance, Brief, Seventh Edition

P8-13. Personal finance: Portfolio return and standard deviation

LG 3; Challenge

a. Expected portfolio return for each year: rp  (wLrL)  (wMrM)

Year

Asset L

(wLrL)

Asset M

(wMrM)

Expected

Portfolio Return

rp

6.0%)

b. Portfolio return:

1

n

j j

j

p

w r

rn

=

´

=

å

17.6 16.4 16.0 15.2 14.0 13.6 15.467 15.5%

6

p

r+++++

= = =

c. Standard deviation:

2

1

( )

( 1)

n

i

rp

i

r r

n

s

=

–

=–

å

Chapter 3: Financial Statements and Ratio Analysis 7

2 2 2

222

(17.6% 15.5%) (16.4% 15.5%) (16.0% 15.5%)

(15.2% 15.5%) (14.0% 15.5%) (13.6% 15.5%)

6 1

rp

s

– + – + –

é ù

ê ú

+ – + – + –

ë û

=–

222

2 2 2

(2.1%) (0.9%) (0.5%)

( 0.3%) ( 1.5%) ( 1.9%)

5

rp

s

+ +

é ù

ê ú

+ – + – + –

ë û

=

(.000441 0.000081 0.000025 0.000009 0.000225 0.000361)

5

rp

s+ + + + +

=

0.001142 0.000228% 0.0151 1.51%

5

rp

s= = = =

d. The assets are negatively correlated.

P8-14. Portfolio analysis

LG 3; Challenge

a. Expected portfolio return:

Chapter 3: Financial Statements and Ratio Analysis 9

P8-15. Correlation, risk, and return

LG 4; Intermediate

a. (1) Range of expected return: between 8% and 13%

b. (1) Range of expected return: between 8% and 13%

c. (1) Range of expected return: between 8% and 13%

P8-16. Personal finance: International investment returns

LG 1, 4; Intermediate

a. Returnpesos 

24,750 20,500 4,250 0.20732 20.73%

20,500 20,500

–= = =

b.

Price in pesos 20.50

Purchase price $2.22584 1,000 shares $2,225.84

Pesos per dollar 9.21

= = ´ =

Price in pesos 24.75

Sales price $2.51269 1,000 shares $2,512.69

Pesos per dollar 9.85

= = ´ =

c. Returnus$ 

2,512.69 2,225.84 286.85 0.12887 12.89%

2,225.84 2,225.84

–= = =

d. The two returns differ due to the change in the exchange rate between the peso and the dollar. The peso had

depreciation (and thus the dollar appreciated) between the purchase date and the sale date, causing a decrease in

total return. The answer in part c is the more important of the two returns for Joe. An investor in foreign securities

will carry exchange-rate risk.

P8-17. Total, nondiversifiable, and diversifiable risk

LG 5; Intermediate

a. and b.

c. Only nondiversifiable risk is relevant because, as shown by the graph, diversifiable risk can be virtually

10 Gitman/Zutter Principles of Managerial Finance, Brief, Seventh Edition

P8-18. Graphic derivation of beta

LG 5; Intermediate

a.

b. To estimate beta, the “rise over run” method can be used:

Rise

Beta Run

Y

X

D

= =D

c. With a higher beta of 1.33, Asset B is more risky. Its return will move 1.33 times for each one point the market

P8-19. Graphical derivation and interpretation of beta

LG 5; Intermediate

a. With a return range from 0% to  30%, Biotech Cures, exhibited in Panel B, is the more risky stock. Returns

b. The returns on Cyclical Industries Incorporated’s stock are more closely correlated with the market’s performance.

Hence, most of Cyclical Industries’ returns fit around the upward-sloping least-squares regression line. By

c. On a standalone basis, Biotech Cures Corporation is riskier. However, if an investor was seeking to diversify the

risk of their current portfolio, the unique, nonsystematic performance of Biotech Cures Corporation makes it a