Problem 7-2

The following table shows the nominal returns on U.S. Stocks and the rate of infla

Year

2004
2005
2006
2007
2008

Nominal Inflation (%)

Return (%)
12.5
6.4
15.8
5.6
-37.2

3.3
3.4
2.5
4.1
0.1

a)What was the standard deviation of the market returns?

b)Calculate the average real return.

Answers:
a)What was the standard deviation of the market returns?
Find the standard deviation by completing the table with the appropriate formulas
Year

Nominal
Return (%)

Difference
from
Average

Squared
Difference

2004
2005
2006
2007
2008

12.5
6.4
15.8
5.6
-37.2

C
C
C
C
C

C
C
C
C
C

Total 20042008

Average
Std.
Deviation

C
C

TIP: Click on the cell for

directions

Use SQRT function for this answ

b)Calculate the average real return.

Find the average real return by completing the table with the appropriate formulas

Year

2004
2005
2006
2007
2008
Average

Nominal Inflation (%) Real Return

Return (%)
(%)
12.5
6.4
15.8
5.6
-37.2

3.3
3.4
2.5
4.1
0.1

C
C
C
C
C
C

TIP: Click on the cell for

directions

ate formulas

TIP: Click on the cell for

directions

se SQRT function for this answer only

ate formulas

TIP: Click on the cell for

directions

Problem 8-6
Suppose that the Treasury bill rate were 6% rather than 4%. Assume that the expected return
on the market stays at 10%. Use the betas in Table 8.2 (p. 193) - also provided below.
a. Calculate the expected return from Dell.
b. Find the highest expected return that is offered by one of these stocks.
c. Find the lowest expected return that is offered by one of these stocks.
d. Would Ford offer a higher or lower expected return if the interest rate were 6% rather than
4%? Assume that the expected market return stays at 10%.
e. Would Exxon Mobil offer a higher or lower expected return if the interest rate were 8%?

Answers:
A. Dell's expected return

Formula
Rf + (Beta (Rm - Rf))

Calculation
C

B./C.
Revised T
Beta Bill RiskFree Rate

Stoc

Exp
ecte
d
retu
rn

Market
Return

Amazon

2.16

Ford

1.75

Dell

1.41

Starbucks

1.16

Boeing

1.14

Disney

0.96

Newmont

0.63

Exxon Mobil

0.55

Johnson & Jo

0.5

Campbell So

0.3

B. Highest

C. Lowest

D. FORD will offer a ________ expected return at 6%.

Higher or lower?
Interest rate

4%

Rate of return

6%
C

E. Exxon will offer a _______ expected return at 8%. Higher or lower?

Interest rate

4%

8%

Rate of return

Problem 9-2
A company is 40% financed by risk-free debt. The interest rate is
10%, the expected market risk premium is 8%, and the beta of the
companys common stock is .5.
Risk Free
Debt

Interest
Rate

Market Risk
Premium

Beta

Taxes

40%

10%

8%

0.5

35%

a.
b.

What is the company cost of capital?

What is the after-tax WACC, assuming that the company pays tax at a 35% rate?

Answers:
Step 1:
r(d)=
r(e)=
D/V
E/V
Step 2:
a.

b.

F
C
C
C

TIP: D + E = V

Formula (in words)

Calculation
Cost of CapitaT
C
WACC

Problem 10-14
Suppose that the expected variable costs of Otobais project are 33 billion a year and that
fixed costs are zero.
a. How does this change the degree of operating leverage (DOL)?
b. Now recompute the operating leverage
assuming that the entire 33 billion of costs are fixed.
Answers:
See page 243, Table 10.1, of textbook for additional information. Copy is also provided below.

a.
b.

DOL Formula
1+(Fixed cost +
depreciation)/ operating

Fixed Costs Calculation

F
C

1+(Fixed cost +
depreciation)/ operating

y is also provided below.