PROBLEM 1 CAPITAL ASSET PRICING MODEL (MARKET MODEL)

Apply Linear Regression to the 5 years of IBM stock returns compared to those of the Standard & Poor's stock index:
0. Draw a graph of x axis = S&P500 returns y axis = IBM returns; use Trendline to obtain equation of line of best fit
1. Estimate the Beta (slope) of the least squares line of best fit; S&P500 as the independent variable, IBM as the dependent variable
2. Interpret the meaning of IBM beta. What does the intercept mean ?
3. If you believe a recession is coming , would you invest in high-beta or low-beta stock ? Why ?
4. During a month in which the stock market goes up 1% , what is the expected IBM return ? Explain.

International Business Machines Corp., monthly rates of return ANSWER:

International Business Machines Corp. (IBM)

Dividend(IBM, Price(S&P 500,
t Date Price(IBM, t) R(IBM, t) R(S&P 500, t)
t) t)
0 Jan 31, 2012 192.60 1,312.41
1 Feb 29, 2012 196.73 0.75 2.53% 1,365.68 4.06%
2 Mar 31, 2012 208.65 6.06% 1,408.47 3.13%
3 Apr 30, 2012 207.08 -0.75% 1,397.91 -0.75%
4 May 31, 2012 192.90 0.85 -6.44% 1,310.33 -6.27%
5 Jun 30, 2012 195.58 1.39% 1,362.16 3.96%
6 Jul 31, 2012 195.98 0.20% 1,379.32 1.26%
7 Aug 31, 2012 194.85 0.85 -0.14% 1,406.58 1.98%
8 Sep 30, 2012 207.45 6.47% 1,440.67 2.42%
9 Oct 31, 2012 194.53 -6.23% 1,412.16 -1.98%
10 Nov 30, 2012 190.07 0.85 -1.86% 1,416.18 0.28%
11 Dec 31, 2012 191.55 0.78% 1,426.19 0.71%
12 Jan 31, 2013 203.07 6.01% 1,498.11 5.04%
13 Feb 28, 2013 200.83 0.85 -0.68% 1,514.68 1.11%
14 Mar 31, 2013 213.30 6.21% 1,569.19 3.60%
15 Apr 30, 2013 202.54 -5.04% 1,597.57 1.81%
16 May 31, 2013 208.02 0.95 3.17% 1,630.74 2.08%
PROBLEM 2: CAPITAL BUDGETING

Remarks:
A project is acceptable if its NPV > 0 .
When NPV > 0 then it generates a return that is greater than the cost of funds needed to purchase the project.
The NPV method requires that the investor starts with a discount rate, a required rate of return.
Another approach is to compute the rate of return that the project will produce, the IRR.
It is defined as that discount rate such that NPV = 0
When a project has an IRR > required rate of return then it generates a return greater than the cost of funds needed to purchase the project
A bond's yield to maturity and a capital budgeting project's IRR are the same.
Unfortunately, when comparing two or more projects the NPV and IRR do not always agree as to which project is best !

An NPV profile is a graph and associated Datatable that shows the NPVs of a project(s) at various discount rates (required rates of return).
The crossover point, or point of indifference, if it exists, is that discount rate such that NPV Project 1 = NPV Project 2
It can be computed with Goal Seek or simply using the IRR function after subtracting the nominal cash flows: Project 1 - Project 2

QUESTION:
Develop an NPV profile and an anlaysis of the following project opportunities:
use discount rates ranging from 1% to 15%, increasing by 1%
What are your observations ?
cash flows
year project1 project2 difference
0 (1,000) (1,000) -
1 200 220 (20)
2 200 220 (20)
3 200 220 (20)
4 200 220 (20)
5 200 220 (20)
6 200 220 (20)

ANSWER:
PROBLEM 3 LINEAR REGRESSION MODEL: CONDOMINIUM SQUARE FOOTAGE AND SALES PRICES: RECENT DATA - CENTRAL FLORIDA

DATA BELOW ARE FOR RECENT SALES; SQUARE FOOTAGE AND RESPECTIVE SALE PRICES

A) YOU BUILD A 500 FOOT ADDITION TO YOUR CONDO; HOW MUCH DO YOU THINK YOUR CONDO WILL INCREASE IN VALUE ?

B) WHAT PERCENTAGE OF THE VARIATION IN CONDO VALUE IS EXPLAINED BY VARIATION IN CONDO SIZE ?

C) A 3,000 SQUARE FOOT CONDO IS SELLING FOR $500,000 .

IS THIS PRICE OUT OF LINE WITH TYPICAL REAL ESTATE VALUES, AS PER OUR DATA ?

Square Footage Sale Price

2000 $ 238,139.37
2200 $ 259,711.95
2400 $ 300,953.67
3000 $ 369,965.73
3200 $ 340,091.30
3600 $ 405,425.02
2900 $ 345,131.03

ANSWER:
PROBLEM 4.
NPV AS A FUNCTION OF BOTH DISCOUNT RATE AND CASH FLOW GROWTH RATE

CONSIDER A PROJECT WITH INITIAL COST = -CF(0)

AND 7 SUBSEQUENT CASH FLOWS; CF(1)…CF(7)
THESE CASH FLOWS, GROW AT A RATE g THAT IS: CF(2)=CF(1)*(1+g)^1, CF(3)=CF(1)*(1+g)^2, CF(4)=CF(1)*(1+g)^3 … CF(7)=CF(1)*(1+g)^6
HENCE:
NPV = CF(0) + CF(1) / (1+r) + CF(2) / (1+r)^2 + CF(3) / (1+r)^3… CF(7) / (1+r)^7
WHERE:
r = DISCOUNT RATE

QUESTION: DEVELOP A DATATABLE TO SHOW:

NPV AS A FUNCTION OF BOTH DISCOUNT RATE AND CASH FLOW GROWTH RATE
WHAT ARE YOUR OBSERVATIONS ?

INPUTS:
CF(0)= (1,150)
CF(1)= 234
LET g RANGE FROM 1% TO 15% WITH 1% INCREMENTS
LET r RANGE FROM 10% TO 20% WITH 1% INCREMENTS

ANSWER::