12/7/2012

Chapter:
Problem:

6
15

a. Use the data given to calculate annual returns for Goodman, Landry, and the Market Index, and then
calculate average returns over the five-year period. (Hint: Remember, returns are calculated by
subtracting the beginning price from the ending price to get the capital gain or loss, adding the dividend
to the capital gain or loss, and dividing the result by the beginning price. Assume that dividends are
already included in the index. Also, you cannot calculate the rate of return for 2008 because you do not
have 2007 data.)
Data as given in the problem are shown below:
Goodman Industries
Year
Stock Price
Dividend
2013
$25.88
$1.73
2012
$22.13
$1.59
2011
$24.75
$1.50
2010
$16.13
$1.43
2009
$17.06
$1.35
2008
$11.44
$1.28

Landry Incorporated
Stock Price
$73.13
$78.45
$73.13
$85.88
$90.00
$83.63

Market Index
Dividend Includes Divs.
$4.50
17,495.97
$4.35
13,178.55
$4.13
13,019.97
$3.75
9,651.05
$3.38
8,403.42
$3.00
7,058.96

We now calculate the rates of return for the two companies and the index:
Goodman

Landry

Index

2013
2012
2011
2010
2009
Average
Note: To get the average, you could get the column sum and divide by 5, but you could also use the function
wizard, fx. Click fx, then statistical, then Average, and then use the mouse to select the proper range. Do this for
Goodman and then copy the cell for the other items.
b. Calculate the standard deviation of the returns for Goodman, Landry, and the Market Index. (Hint:
Use the sample standard deviation formula given in the chapter, which corresponds to the STDEV
function in Excel.)
Use the function wizard to calculate the standard deviations.
Goodman

Landry

Index

Standard deviation of returns

c. Construct a scatter diagram graph that shows Goodmans and Landry returns on the vertical axis and
the Market Indexs returns on the horizontal axis.

It is easiest to make scatter diagrams with a data set that has the X-axis variable in the left
column, so we reformat the returns data calculated above and show it just below.
Year

Index
0.0%
0.0%
0.0%
0.0%
0.0%

2013
2012
2011
2010
2009

Goodman
0.0%
0.0%
0.0%
0.0%
0.0%

Landry
0.0%
0.0%
0.0%
0.0%
0.0%

To make the graph, we first selected the range with the returns and the column heads, then clicked the chart
wizard, then choose the scatter diagram without connected lines. That gave us the data points. We then used
the drawing toolbar to make free-hand ("by eye") regression lines, and changed the lines color and weights to
match the dots.

beta and Landry a negative one.

d. Estimate Goodmans and Landrys betas as the slopes of regression lines with stock returns on the
vertical axis (y-axis) and market return on the horizontal axis (x-axis). (Hint: use Excels SLOPE
function.) Are these betas consistent with your graph?
Goodman's beta =
Landry' beta =

e. The risk-free rate on long-term Treasury bonds is 6.04%. Assume that the market risk premium is 5%. What is the
expected return on the market? Now use the SML equation to calculate the two companies' required returns.
Market risk premium (RPM) =
Risk-free rate =

5.000%
6.040%

Expected return on market =

=
=
Required return

Risk-free rate
6.040%
11.040%

+
+

Market risk premium

5.000%

Goodman:
Required return

=
=

Landry:
Required return

=
=

f. If you formed a portfolio that consisted of 50% Goodman stock and 50% Landry stock, what would be
its beta and its required return?
The beta of a portfolio is simply a weighted average of the betas of the stocks in the portfolio, so this portfolio's beta
would be:
Portfolio beta =
g. Suppose an investor wants to include Goodman Industries stock in his or her portfolio. Stocks A, B,
and C are currently in the portfolio, and their betas are 0.769, 0.985, and 1.423, respectively. Calculate
the new portfolios required return if it consists of 25% of Goodman, 15% of Stock A, 40% of Stock B,
and 20% of Stock C.
Beta
Goodman
Stock A
Stock B
Stock C

0.769
0.985
1.423

Portfolio Weight
25%
15%
40%
20%
100%

Portfolio Beta =
Required return on portfolio:

=
=
=

Risk-free rate

+ Market Risk Premium

Beta

m is 5%. What is the

red returns.

olio's beta