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Investments

1. Joe's Clambake Company is considering the purchase of a C130 airplane to help spot monster clams on the bottom of Chesapeake Bay. In estimating the worth of adding the plane to the company the following cash flow analysis has been developed:

Cash inflow at the end of year 1: $12,000
Cash inflow at the end of year 1: $12,000
Cash inflow at the end of year 1: $12,000
Cash inflow at the end of year 1: $12,000
Cash inflow at the end of year 1: $12,000
Cash inflow at the end of year 1: $30,000

If Joe's required rate of return is 10%, how much is the plane worth to him today?

2. You hold a portfolio of stocks consisting of the following:

Stock Beta Current value
Blackwater Gas 0.5 10,000
Tidy Tom's Cleaners 0.9 5,000
Globular Grabbus 1.2 20,000
Creative Crafts 1.4 4,000
Total 39,000

a. What is the beta of the portfolio?

b. You have decided to sell Creative Crafts for 4,000 and to use the proceeds to buy $4,000 of International Steel stock with a beta of 2.0. After the transaction is complete, what will be the new beta of the portfolio? (Disregard any commissions on the buy and sell transactions)

3. You have been scouring The Wall Street Journal looking for stocks that are good values and have found the following five candidates for addition to your portfolio:

Stock Expected Return Beta
A 11% 1.1
B 7% 1.0
C 10.50% 1.4
D 5% 0.8
E 11.50 0.7

However, you can afford to buy only one of these stocks. Based solely on the stocks expected returns and risk, as measured by Beta, which one represents the best investment? Please justify answer.

Solution Preview

1. Joe's Clambake Company is considering the purchase of a C130 airplane to help spot monster clams on the bottom of Chesapeake Bay. In estimating the worth of adding the plane to the company the following cash flow analysis has been developed:

Cash inflow at the end of year 1: $12,000
Cash inflow at the end of year 2: $12,000
Cash inflow at the end of year 3: $12,000
Cash inflow at the end of year 4: $12,000
Cash inflow at the end of year 5: $12,000
Cash inflow at the end of year 6: $30,000

If Joe's required rate of return is 10%, how much is the plane worth to him today?

We need to find the present value of the cash inflow the six years to find how much the plane is worth to him today.

PV = FV where PV is the present value
(1 + i)n FV is the cash inflow in the future
i is the required rate of return
n is the period

PV = $12,000 + $12,000 + ...

Solution Summary

This solution is comprised of a detailed explanation to answer the request of the assignment of more than 500 words of text.

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