FIN 534 â€“ Homework Set #3

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Directions: Answer the following questions on a separate document. Explain how you reached the answer or show your work if a mathematical calculation is needed, or both. Submit your assignment using the assignment link in the course shell. This homework assignment is worth 100 points.

Use the following information for questions 1 through 8:

The Goodman Industriesâ€™ and Landry Incorporatedâ€™s stock prices and dividends, along with the Market Index, are shown below. Stock prices are reported for December 31 of each year, and dividends reflect those paid during the year. The market data are adjusted to include dividends.

Goodman Industries Landry Incorporated Market Index

Year Stock Price Dividend Stock Price Dividend Includes Dividends

2013 $25.88 $1.73 $73.13 $4.50 17.49 5.97

2012 22.13 1.59 78.45 4.35 13.17 8.55

2011 24.75 1.50 73.13 4.13 13.01 9.97

2010 16.13 1.43 85.88 3.75 9.65 1.05

2009 17.06 1.35 90.00 3.38 8.40 3.42

2008 11.44 1.28 83.63 3.00 7.05 8.96

1. Use the data given to calculate annual returns for Goodman, Landry, and the Market Index, and then calculate average annual returns for the two stocks and the index. (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 then 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.)

2. Calculate the standard deviations 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.)

3. Estimate Goodmanâ€™s and Landryâ€™s betas as the slopes of regression lines with stock return on the vertical axis (y-axis) and market return on the horizontal axis (x-axis). (Hint: Use Excelâ€™s SLOPE function.) Are these betas consistent with your graph?

4. The risk-free rate on long-term Treasury bonds is 6.04%. Assume that the market risk premium is 5%. What is the required return on the market using the SML equation?

5. If you formed a portfolio that consisted of 50% Goodman stock and 50% Landry stock, what would be its beta and its required return?

6. What dividends do you expect for Goodman Industries stock over the next 3 years if you expect you expect the dividend to grow at the rate of 5% per year for the next 3 years? In other words, calculate D1, D2, and D3. Note that D0 = $1.50.

7. Assume that Goodman Industriesâ€™ stock, currently trading at $27.05, has a required return of 13%. You will use this required return rate to discount dividends. Find the present value of the dividend stream; that is, calculate the PV of D1, D2, and D3, and then sum these PVs.

FIN 534 â€“ Homework Set #3

Â© 2014 Strayer University. All Rights Reserved. This document contains Strayer University Confidential and Proprietary information and may not be copied, further distributed, or otherwise disclosed in whole or in part, without the expressed written permission of Strayer University. FIN 534 Homework Set #3 Page 2 of 2

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8. If you plan to buy the stock, hold it for 3 years, and then sell it for $27.05, what is the most you should pay for it?

Use the following information for Question 9:

Suppose now that the Goodman Industries (1) trades at a current stock price of $30 with a (2) strike price of $35. Given the following additional information: (3) time to expiration is 4 months, (4) annualized risk-free rate is 5%, and (5) variance of stock return is 0.25.

9. What is the price for a call option using the Black-Scholes Model?