Case Analysis 2
FINANLY/FINLYTS
General Instruction: Show your complete solution. The final submission shall be in PDF format.
Hint: You may solve the items first using any method before resolving them using R.
Case: Analyzing Risk and Return on Chargers Products Investments
Justin Winner, a financial analyst for Chargers Products, a manufacturer of stadium benches, must evaluate the risk and return of two assets, X and Y. The firm is considering adding these assets to its diversified asset portfolio. To assess the return and risk of each asset, Junior gathered data on the annual cash flow and beginning and end-of-year of each asset over the immediately preceding 10 years, 1997-2006. These data are summarized in the table below. Justin’s investigation suggests that both assets, on average, will tend to perform in the future just as they have during the past 10 years. He therefore believes that the expected annual return can be estimated by finding the average annual return for each asset over the past 10 years.
Return Data for Assets X and Y, 1997-2006
Asset X
Asset Y
Value
Value
Year
Cash Flow
Beginning
Ending
Cash Flow
Beginning
Ending
1997
1,000
20,000
22,000
1,500
20,000
20,000
1998
1,500
22,000
21,000
1,600
20,000
20,000
1999
1,400
21,000
24,000
1,700
20,000
21,000
2000
1,700
24,000
22,000
1,800
21,000
21,000
2001
1,900
22,000
23,000
1,900
21,000
22,000
2002
1,600
23,000
26,000
2,000
22,000
23,000
2003
1,700
26,000
25,000
2,100
23,000
23,000
2004
2,000
25,000
24,000
2,200
23,000
24,000
2005
2,100
24,000
27,000
2,300
24,000
25,000
2006
2,200
27,000
30,000
2,400
25,000
25,000
Justin believes that each asset’s risk can be assessed in two ways: in isolation and as part of the firm’s diversified portfolio of assets. The risk of the assets in isolation can be found using the standard deviation and coefficient of variation of returns over the past 10 years. The capital asset pricing model (CAPM) can be used to assess the asset’s risk as part of the firm’s portfolio of asset’s risk as part of the firm’s portfolio of assets. Applying some sophisticated quantitative techniques, Justin estimated betas for assets X and Y of 1.60 and 1.10, respectively. In addition, he found that the risk-free rate is currently 7% and that the market return is 10%.
Calculate the annual rate of return for each asset in each of the 10 preceding years and use those values to find the average annual return for each asset over the 10-year period.
Use the returns calculated in part a to find the standard deviation.
Use your findings in parts A and B to evaluate and discuss the return and risk associated with each asset. Which asset appears to be preferable? Explain.
Use the CAPM to find the required return for each asset.
Compare and contrast your findings in parts C and D. What recommendations would you give Justin about investing in either of the two assets?
Rework parts D and E under the following circumstance:
As a result of favorable political events, investors suddenly become less risk-averse, causing the market return to drop by 1%, to 9%.
