Question

Question 1 (35 marks) You are assistant to Robert Su, the senior vice president of Ping An Insurance (Group) Company of China Ltd., responsible for equity investments. Su has asked you to analyze the New Technology Company, an employment agency that supplies word processor operators and computer programmers to business with temporarily heavy workloads. You started to gather information that may help you to analyze the New Technology Company. H The returns for the shares of New Technology and the returns for the market for the past 5 years are as follows: Time Return of the market (%) T . 12 T24 T34 T4 T5 Return of New Technology (%) 11€ 11€ 82 16 14 132 10 14 16 4 The correlation coefficient, Pim, between the returns on New Technology Company's shares and the market is +0.65. The risk-free rate is 6%. The New Technology Company recently announced and paid a dividend of $2.00 per share. The projected growth rates of the dividend for the coming 3 years are 20%, 10% and 7%. After that, it will grow at a constant rate of 4% forever. 4

Answer 1

a..
Time, t=	R(NT)	R(Mkt.)
1	11%	12%
2	11%	13%
3	8%	10%
4	16%	14%
5	14%	16%
Av.Ret.	12%	13%

Av. Return(NT)=Sum of returns/No.of years

ie.(11%+11%+8%+16%+14%)/5=

12%

Av. Return(Mkt.)=Sum of returns/No.of years

(12%+13%+10%+14%+16%)/5=

13%

Std. deviation of returns (NT)=

(Sum (R(NT)-R(Av.)^2/(n-1))^(1/2)

Std. Dev.of returns of NT:

(((11%-12%)^2+(11%-12%)^2+(8%-12%)^2+(16%-12%)^2+(14%-12%)^2)/(5-1))^(1/2)=

0.0308

Std. Dev.of returns of Mkt.

(((12%-13%)^2+(13%-13%)^2+(10%-13%)^2+(14%-13%)^2+(16%-13%)^2)/(5-1))^(1/2)=

0.0224

b. Beta of NT= Corr. Coeff.(bet. R(NT)&R(mkt.)*(SD(NT)/SD(Mkt.)

ie. Beta(NT)=0.65*(0.0308/0.0224)=

0.89

New Technology is LESS VOLATILE & hence LESS RISKY than the market , as beta less than 1,ie.0.89 indicates

NT's returns move in the same direction as that of the market, as the correlation coefficient between their returns, 0.65 indicates.

c.Stock price of New Technology:

As per CAPM, the required return =RFR+Beta*(RFR-Av.Market return)

ie. 6%+(0.89*(12%-6%)=

11.34%

With this required return, we will discount the dividend cash flows given, to find the current stock price of NT, as follows:

Div. CFs			PV F at 11.34%	PV at 11.34%
D1=	2*1.2=	2.4	0.89815	2.1556
D2=	2.4*1.1=	2.64	0.80667	2.1296
D3=	2.64*1.07=	2.8248	0.72451	2.0466
V3=	(2.8248*1.04)/(11.34%-4%)=	40.02441	0.72451	28.9982
Sum of PVs of dividend cash flows				35.3300
So,the current (T0)Stock price of New Technology = $ 35.33