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Expected Return and Standard Deviation Alternatives

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Problem 1

The risk and return profiles of Assets P and Q are given below along with the assigned probability of distributions.

Economy Probability Possible Returns on P Possible Returns on O
Boom .20 .19 .15
Normal .60 .15 .11
Recession .20 -.04 .05

a. Compute the expected return and standard deviation for each asset.
b. Which asset is riskier? Why?
c. Which asset would you choose for investment purposes? Why?

Problem 2

The Lumbar Company of Tempe, Arizona had developed the below data regarding the proposed new project.

State Probability Possible Returns on Market Possible Returns on Project
1 .05 -.20 -.30
2 .25 .10 .05
3 .35 .15 .20
4 .20 .20 .25
5 .15 .25 .30

a. Calculate the expected return on the Market and Project and discuss your results.
b. Calculate the variance of the Market and Project and interpret your results
c. Calculate the Standard for the Market and Project and interpret your results
d. Determine the covariance between the Market and Project and discuss your results
e. Determine the correlation coefficient between the Market and Project and discuss your results
f. What conclusion can you derive from parts a through e?

Problem 3

Investment A Investment B
Probability Return Probability Return
Boom .25 .35 .25 .20
Stable .55 .20 .55 .15
Recession .20 -.05 .20 .08

a. Calculate the expected return and standard deviation for each alternative and discuss your results.
b. Calculate the portfolio expected return and standard deviation if you invested 40% of your money in Investment A and the remaining 60% in investment B.
c. Determine the effect on the expected return and standard deviation of your portfolio if you instead decided 20% of your funds in A and 80% in B .
d. What conclusions can you draw from your calculations?

Problem 10

Woodson and Sons, Inc. of Chandler, Arizona wishes to evaluate the proposed merger into the Oxley Group. Woodson had 2004 earnings of $200,000 and 100,000 shares of common stock outstanding, and expect earnings to grow at an annual rate of 7 percent. Oxley, on the other hand, had 2004 earnings of $800,000 with 200,000 shares of common stock outstanding, and expects its earnings to grow at an annual rate of 3%.

a. Calculate the earnings per share (EPS) for Woodson for the next 8 years without merger.
b. What would Woodson's shareholders earn in each of the next 8 years on each of their shares swapped for Oxley's shares at the ratio of (1) 0.6 and (2) 0.08 shares of Oxley for one share of Woodson?
c. If you were the financial manager of Woodson and Sons, which option would your recommend? B-1 or B-2? Why?

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The solution examines expected returns and standard deviation alternatives.

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