24 MARCH 2015TUESDAY

Case/Problem Set: Beta Management

Assignment questions:

The underlying question is how much will Ms. Wolfe require/expect to earn on each stock (given its riskiness) in order to hold it?

1. Calculate the variability (standard deviation) of the stock returns of California REIT and Brown Group during the past 2 years. How variable are they compared with Vanguard Index 500 Trust? Which stock appears to be the riskiest?

2. Suppose Beta’s position had been 99% of equity funds invested in the index fund, and 1% in the individual stock. Calculate the variability of the portfolio using each stock. How does each stock affect the variability of the equity investment, and which stock is the riskiest? Explain how this makes sense in view of your answer to Question #1 above.

3. Perform a regression of each stock’s monthly returns on the Index returns to compute the “beta” for each stock. How does this relate to the situation described in Question #2 above?

4. How might the expected return for each stock relate to its riskiness? What future returns should she expect for each stock?

5. How can the CAPM be used to measure a company’s cost of equity capital? What problems do you see in using the CAPM to estimate a company’s cost of equity? Evaluate it against alternative procedures available.

6. Suppose the CAPM has been used to estimate a company’s cost of equity, and that the company is now considering a change in its capital structure. Would you expect the cost of equity to change? How could you estimate the cost of equity for the new capital structure?

IN ADDITION TO THE READINGS IN THE TEXTBOOK, ANOTHER SOURCE OF INFORMATION IS THE HARVARD BUSINESS SCHOOL NOTE “DIVERSIFICATION, THE CAPITAL ASSET PRICING MODEL, AND THE COST OF EQUITY CAPITAL” NOTE # 9-276-183 WHICH CAN BE DOWNLOADED IF YOU WISH TO PURCHASE IT FROM WWW.HARVARDBUSINESSONLINE.HBSP.HARVARD.EDU.

26 MARCH 2015THURSDAY

Case: Cost of Capital at Ameritrade- Day 1

Assignment Questions:

1. What factors should Ameritrade management consider when evaluation the proposed advertising program and technology upgrades? Why?

2. How can the Capital Asset Pricing Model be used to estimate the cost of capital for a real (not financial) investment decision?

3. What is the estimate of the risk-free rate that should be employed in calculating the cost of capital for Ameritrade?

4. What is the estimate of the market risk premium that should be employed in calculating the cost of capital for Ameritrade?

5. In principle, what are the steps for computing the asset beta in the CAPM for purposes of calculating the cost of capital for a project?

31 MARCH 2015TUESSDAY

Case: Cost of Capital at Ameritrade- Day 2

Assignment Questions:

1. Ameritrade does not have a beta estimate as the firm has been publicly traded for only a short time period. Exhibit 4 provides various choices of comparable firms. What comparable firms do you recommend as the appropriate benchmarks for evaluating the risk of Ameritrade’s planned advertising and technology investments?

2. Using the stock price and returns data in Exhibits 4 and 5, and the capital structure information in Exhibit 3, calculate the asset betas for the comparable firms.

3. How should Joe Ricketts, the CEO of Ameritrade, interpret and use the cost of capital estimate you have calculated?