THIS IS THE DISCUSSION PART PLEASE READ AND FOLLOW INSTRUCTIONS PUT EACH ANSWER UNDER EACH PART.
“Risk and Return” Please respond to the following:
* From the e-Activity, determine whether stock prices are affected more by long-term or short-term performance. Week 4 e-Activity
Use the Internet to research instances where a company’s stock prices are affected more by long-term or short-term performance. Be prepared to discuss.Provide one (1) example of the effect that supports your claim.
* From the scenario, value a share of TFC’s stock using a growth model method and compare that value to the current trading price of a share of TFC. Determine whether the stock is undervalued or overvalued. Provide a rationale for your response
FIN534 Week 4 Scenario Script: The CAPM and Market Efficiency and
Valuing Common Stocks
• Don and Linda in Parking Lot Before Work
• Show Strayer banner
• End of scene
FIN534_4_2_Don-1: I see you are here bright and early as usual.
You and your intern have been doing fabulous work. We are looking for someone like your intern to come on board, but I would like to see your intern work on some more projects before we consider extending an offer.
FIN534_4_2_Linda-1: Of course, I understand Don. So far, our intern has done excellent work. Strayer University is really teaching its students well. Our intern has seemingly learned the concepts taught in class and has been able to apply here on the job.
• Don and Linda in front of TFC
• Go to next slide
FIN534_4_3_Linda-1: Don, you mentioned some more work?
FIN534_4_3_Don-1: Yes, Linda. Since TFC went public, we have always considered our stockholder risk averse, as they want to see their investment grow but without a lot of risk. Based on the ratio analysis you showed me, it seems we have been doing just that. However, this expansion project is not revealing the same picture. When Joe talks to our investors, he wants to be able to explain why this project is good for TFC’s future even though financially, it may not seem like the best move. With that, I would like you and your intern to come up with the expected rate of return that our investors are currently benefiting from their equity. This will also be our required rate of return for the project, as we have to give the investors a return on their investment.
FIN534_4_3_Linda-2:Sounds great Don. Let’s go inside. I am going to meet the intern in the conference room to discuss our next project.
• Linda In conference room
• Show CAPM acronym
• Equation on slide TFC’s Required Rate of Return = Risk-free rate + Risk premium
• Go to next slide
FIN534_4_4_Linda-1: I just met with Don and he has given us another project. He asked that we calculate TFC’s expected rate of return, which is also the required rate of return for our stockholders. In order to do that we are going to use the Capital Asset Pricing Model, or CAPM. With the help of the Security Market Line, or SML, we will use inputs to calculate the required rate of return. In general the required rate of return for TFC will be a risk-free rate plus some additional market premiums. When we put it all together, we will come up with our required rate of return.
FIN534_4_4_Linda-2: Our formula can be thought of as the required rate of return for TFC is equal to the risk-free rate plus a risk premium for TFC’s stock.
• In conference room
• List components and equation
• RTFC = rRF+ betaTFC x RPM
• Linda discusses the variables
Go to next slide
FIN534_4_5_Linda-1: In order for us to calculate the required rate of return, let’s go over all the components of the calculation.
FIN534_4_5_Linda-2: First, let’s look at the Risk-free rate. This is simply the rate on riskless securities and is commonly measured by the yield on long term U.S. Treasury bonds. It is based in the understanding that the U.S. government will not default on their obligations so the bonds are considered risk free.
FIN534_4_5_Linda-3: Next is the Market Risk Premium, or RP sub M. The Market Risk Premium can be thought of as the additional risk that comes with investing in a non-government security. This is that extra risk premium that is put on any security that is above the risk-free rate. From an investor’s standpoint, they want a premium on any investment that is not risk-free because they will be assuming the risk and the trade off is the higher the risk, the higher the return demanded. The RP sub M is the difference between what the market is returning and the risk free rate.
FIN534_4_5_Linda-4: And lastly is Beta, which is a measure of how much TFC’s risk would contribute to a well diversified portfolio. Typically stocks have a beta between zero point four and zero point six.
• Still in conference room with paper on table
• Linda makes a phone call (get sound effect of phone dialing)
• Go to next slide
FIN534_4_6_Linda-1: Now that we have our variables, let us determine what the expected value is. Before we do that, we need to call the Accounting Department to get some numbers from them, such as the beta for TFC and the risk free and market rates.
(Linda makes a phone call)
FIN534_4_6_Linda-2: This is Linda who is working on the expansion project and we would like to know the long-term U.S. Treasury bond rate, market portfolio rate, and TFC’s beta.
(Linda hangs up)
FIN534_4_6_Linda-3: (makes a quick laugh) It is something how once you mention the expansion project everyone stops what they are doing and gives you what you need.
FIN534_4_6_Linda-4: Accounting said that the long term bond rate is three percent, the market rate is eighteen percent and TFC’s calculated beta is point eight.
FIN534_4_6_Linda-5: I am going to the Accounting Department to personally thank them. While I am gone, can you calculate the required rate of return based on this data?
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whether stock prices was first posted on November 13, 2019 at 4:34 pm.
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