Use the following information to answer question 8-10: Your financial planner ga
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Question
Use the following information to answer question 8-10: Your financial planner gave you the following information about the two stocks. The risk free rate is 3%. Which one is a better investment opportunity based on Sharpe Ratio? You want to invest $ 10,000, out of which S3.000 on GE and the rest $7,000 on Google. What is the expected return of your portfolio? Use Google's Beta and E(r), what must be the expected return rate of the stock market E(r_m) according to CAPM? Use the following information to answer question 11-13: Bill plans to open a do-it-yourself dog grooming center. The property and equipment will cost $40,000 year 0. Bill expects the cash inflows to be $15,000 annually for the next 4 years, after which there will no residual value left. The cost of capital for Bill is 10%. What is the project's payback period? If Bill need to recover all the investment in 2.5 years, could the project be taken? What is the project's NPV? Should it be accepted? What is the project's PI? Should it be accepted?Explanation / Answer
8. sharpe ratio = (stock return - risk free rate)/standard deviation
sharpe ratio of google = (15%-3%)/8% = 1.5%
sharpe ratio of GE = (9%-3%)/5% = 1.2%. As Google has a higher sharpe ratio, it is a better investment opportunity as the risk adjusted return of Google is higher.
9. Expected return on portfolio = weight of Google*its return + weight of GE*its return
= (7,000/10,000)*15% + (3,000/10,000)*9% = 0.7*15% + 0.3*9% = 10.5%+2.7% = 13.2%
10. As per CAPM: return on a stock = risk free rate + beta*(market return - risk free rate)
15% = 3%+1.2*(market return - 3%)
15% = 3% + 1.2 * market return - 3.6%
15.6% = 1.2*market return
market return = 15.6%/1.2 = 13%.