Corporate Finance
BAO3307
Assignment Semester 2 2015
Introduction
The focus of this assignment is on risk, return and equity valuation. The expectation is that students will develop skills in measuring returns, risk assessment and analysis and valuation. Students are required to use the data provided in the exhibits to answer a series of questions.
Assignment Components
The exhibits contain historical share price information for three publicly listed companies and historical data for the share market index. It also contains historical dividend information relating to the three companies.
Required:
You will be required to complete this assignment in teams of three. It is important that you form your teams as soon as possible. VU collaborative can be used to identify other students who are seeking partners for a team. We can make announcements prior to the lecture to alert other students without a team to meet after the class. Team members do not need to be in the same tutorial.
Please note that under NO circumstances will we allow assignments to be submitted by individuals (This is a group assignment).
Assignments should be stapled in the top left hand corner. Please do not submit assignments in folders. It is also a requirement that all assignments be submitted with a college of business assignment cover sheet signed by all team members. Assignments will not be accepted or marked if they are lodged without this cover sheet.
The assignment requires each team to undertake independent work. No further assistance will be provided to teams in completing the assignment. We have also attached a further reference for the assignment on VU Collaborative. All teams are also expected to conduct independent research when completing the assignment.
The assignment accounts for 10% of the subject’s assessment.

Requirements for the Assignment
• Excel functions can and should be used to complete statistical calculations.
• Your answers should be clearly labeled on an answer sheet(s) by reference to the question number, with any further supporting calculations referenced to an appendix.
• The standard of your presentation will be assessed and marked.
• Evidence of your team’s breadth and depth of research will be assessed.
• We expect that you will provide explanations as to how you established each answer. All detail relating to your answers needs to be shown within the assignment. This may include explanation of procedures undertaken, assumptions made and the choice of a formula to solve a problem. We require detailed explanations.
• You need to reference. This requires the use of both footnotes and a reference sheet. Marks will be deducted from assignments that fail to reference.
• There is an expectation that each team will work collectively rather than independently when completing this assignment. As members of a team you are all jointly responsible for the contents of your assignment.
Assignment Submission
A hardcopy of your assignment must be submitted with a signed assignment cover sheet to your lecturer or Tutor in the week beginning 14 September 2015. Late submissions will be penalised 2 marks from the assignment total mark for each day that the assignment is overdue.

Background Information
Your lecturer requires your team to develop a written presentation based on information that he has collected for this assignment. The information itself is not complex, but the difficulty of your task is in the analysis and clarity of your explanations of the results.
Each team is required to review the information provided and break it down into its simplest components and figure out a way to show how risk is treated in the financial markets and when making investment decisions. The presentation should be as comprehensive as each team feels is necessary.
There are two ways to understand risk: risk could be measured in conjunction with an investor’s portfolio, or risk could be measured as the potential for variation of returns from a single investment. It is stressed that each team should work out these two different meanings of risk in the presentation and make sense of each. In addition, your lecturer is concerned that the techniques used in finance are complicated and tedious, and wants this presentation to discuss and demonstrate how these techniques can actually make sense when considered carefully and in the context of the requirements of this assignment. Therefore, we expect you to use of excel statistical functions to make any calculations. This should ensure that your team does not spend much time with these calculations. The emphasis is on analysis of your results.
The Numbers
Your lecturer had provided several sets of numbers for the team to use in the presentation (Exhibit 1). The first set is 25 observations of historical monthly share prices for three different stocks and the historical monthly share market index over the same period. He has extracted these representative numbers from the Internet. He also indicates to each team that the proper measure of risk for a portfolio would have to be calculated using this kind of data series.
Exhibit 1: Monthly Share prices for Three Traded Stocks and the monthly Share Price Index.
Month Market index Carbon Ltd ($) Oxygen Ltd ($) Helium Ltd ($)
1 4650 13.05 8.00 20.55
2 4770 13.40 7.60 21.15
3 4840 13.87 7.00 20.95
4 4940 13.12 7.70 18.75
5 4815 13.37 8.10 17.10
6 4788 13.00 8.60 19.35
7 5055 13.50 8.30 20.10
8 5125 13.90 8.90 21.05
9 5035 14.12 9.70 22.15
10 5115 14.87 10.20 23.85
11 5200 15.25 10.65 22.90
12 5255 16.05 11.05 21.85
13 5305 16.40 11.45 23.80
14 5408 16.00 10.95 25.05
15 5510 16.25 10.55 26.25
16 5430 16.50 11.00 25.00
17 5360 17.00 10.55 26.65
18 5420 17.35 10.10 28.15
19 5490 18.00 10.70 32.80
20 5555 18.35 9.45 35.70
21 5500 18.55 10.12 32.55
22 5575 19.20 10.45 30.30
23 5645 18.70 10.05 32.90
24 5695 18.20 10.85 34.50
25 5770 18.75 11.15 35.75
Exhibit 2
Dividend History: Annual dividends paid for the last 6 years.
Carbon Ltd ($) Oxygen Ltd ($) Helium Ltd ($)
1.00 0.60 1.50
1.05 0.63 1.60
1.10 0.66 1.70
1.15 0.70 1.80
1.20 0.74 1.90
1.25 0.77 2.00

Questions
Your lecturer has instructed each team to specifically address all of the following questions:
1. Using the information given in Exhibit 1, calculate the historical monthly returns for each company and the market index.
2. With the use of the excel functions calculate the average monthly return and standard deviation of returns for each company and the market index.
3. Using your answers to question 1, above, and assuming that investors can only invest in one of the three alternatives in Exhibit 1, use both the average return and standard deviation to determine which share would be the most appropriate for a risk-averse investor. Provide numerical justification for your selection.
4. Calculate the covariance of returns and correlation coefficients between all shares. Provide an explanation of your results and the implications for diversification.
5. Determine the expected return and standard deviation of a two-asset portfolios comprised of Carbon and Oxygen; Carbon and Helium; and Oxygen and Helium. Assume equal weightings of each share within each portfolio. Interpret your results and comment and illustrate the impact on risk when combining shares into a portfolio.
6. Determine the expected return and standard deviation of a three-asset portfolio comprising all three shares. Assume equal weightings of each share within the portfolio. Why is the computation more complex than a portfolio comprising of only two shares? Is this portfolio more efficient than the portfolios constructed in question 5? Provide numerical evidence to support your answer.
7. Determine the systematic risk (Beta) of all three shares. Interpret your answers. The use of excel functions is acceptable to calculate Beta.
8. Calculate the required rate of return for all three shares. Assume the risk-free rate of return is 4%. You will need to provide an explanation for all your workings given the method of approach you have adopted.
9. Utilising the required rates of return calculated in question 8 above and the historical dividend information in exhibit 2; calculate the present value for all three shares. You will need to state any assumptions that you have made and a justification for your approach to each valuation.