Scribd
Upload
58 views

Financial Investment

The document contains 4 tasks that discuss various financial concepts: 1. Calculates the optimal portfolio weights of Stock A and Treasury bills given return assumptions. 2. Calculates an expected annual return (R) of 12.54% given interest rate (r) and risk premium (h) assumptions. 3. Uses the dividend discount model to calculate the current stock price given growth assumptions. 4. Discusses advantages and disadvantages of using the internal rate of return (IRR) method for capital budgeting decisions. The advantages are its consideration of time value of money and simplicity, while disadvantages are its ignoring of project size, future costs, and reinvestment rates.

Uploaded by

Nguyễn Tr
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
58 views

Financial Investment

The document contains 4 tasks that discuss various financial concepts: 1. Calculates the optimal portfolio weights of Stock A and Treasury bills given return assumptions. 2. Calculates an expected annual return (R) of 12.54% given interest rate (r) and risk premium (h) assumptions. 3. Uses the dividend discount model to calculate the current stock price given growth assumptions. 4. Discusses advantages and disadvantages of using the internal rate of return (IRR) method for capital budgeting decisions. The advantages are its consideration of time value of money and simplicity, while disadvantages are its ignoring of project size, future costs, and reinvestment rates.

Uploaded by

Nguyễn Tr
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
You are on page 1/ 5

Task 1

WA + W B = 1

Βportfolio = (WAxβA) + (WB+βB)

1.0 = (WA*1.8) + [(1-WA)*0]

WA=0.5556=55.56%
Weight of Stock A = 55.56%
Weight of Treasury bills = 100% - 55.56% = 44.44%
Task 2:

(1  R )  (1  r )  (1  h )
1  R  (1  .09)  (1  .0325)
1  R  1.125425
R  .125425
R  12.54%
Task 3:

D1  $1.20  (1  .20)  $1.44


D 2  $1.20  (1  .20) 2  $1.728

D3 D  (1  g )
P2   2
rg r g
$1.44 $1.728  $17.9712
$1.728  (1  .04) P0  
 (1  .14)1
(1  .14) 2
.14  .04
$1.79712  $1.26316  $15.15789

.10  $16.42105
 $17.9712  $16.42
Task 4

Advantages of IRR criteria

 Time Value of Money

Internal rate of return is measured by calculating the interest rate at which the present

value of future cash flows equals the required capital investment. The advantage is that

the timing of cash flows in all future years is considered and, therefore, each cash flow is

given equal weight by using the time value of money.

 Simplicity

The IRR is an easy measure to calculate and provides a simple means by which to

compare the worth of various projects under consideration. The IRR provides any small

business owner with a quick snapshot of what capital projects would provide the greatest

potential cash flow. It can also be used for budgeting purposes such as to provide a quick

snapshot of the potential value or savings of purchasing new equipment as opposed to

repairing old equipment.

 Hurdle Rate Not Required

In capital budgeting analysis, the hurdle rate, or cost of capital, is the required rate of

return at which investors agree to fund a project. It can be a subjective figure and

typically ends up as a rough estimate. The IRR method does not require the hurdle rate,

mitigating the risk of determining a wrong rate. Once the IRR is calculated, projects can

be selected where the IRR exceeds the estimated cost of capital.


Disadvantages of IRR criteria

 Ignores Size of Project

A disadvantage of using the IRR method is that it does not account for the project size

when comparing projects. Cash flows are simply compared to the amount of capital

outlay generating those cash flows. This can be troublesome when two projects require a

significantly different amount of capital outlay, but the smaller project returns a higher

IRR.

For example, a project with a $100,000 capital outlay and projected cash flows of

$25,000 in the next five years has an IRR of 7.94 percent, whereas a project with a

$10,000 capital outlay and projected cash flows of $3,000 in the next five years has an

IRR of 15.2 percent. Using the IRR method alone makes the smaller project more

attractive, and ignores the fact that the larger project can generate significantly higher

cash flows and perhaps larger profits.

 Ignores Future Costs

The IRR method only concerns itself with the projected cash flows generated by a capital

injection and ignores the potential future costs that may affect profit. If you are

considering an investment in trucks, for example, future fuel and maintenance costs

might affect profit as fuel prices fluctuate and maintenance requirements change. A

dependent project may be the necessity to purchase vacant land on which to park a fleet

of trucks, and such cost would not factor in the IRR calculation of the cash flows

generated by the operation of the fleet.


 Ignores Reinvestment Rates

Although the IRR allows you to calculate the value of future cash flows, it makes an

implicit assumption that those cash flows can be reinvested at the same rate as the IRR.

That assumption is not practical as the IRR is sometimes a very high number and

opportunities that yield such a return are generally not available or significantly limited.

You might also like