Corporate Finance Analysis of Construction Limited and Financial Limited Stocks
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Added on 2023/06/12
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This report analyses the stocks of Construction Limited and Financial Limited using various measures like stock return over 24 months of period, mean return, standard deviation, coefficient of variation, standard deviation of the project and beta coefficient.
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Running head: CORPORATE FINANCE Corporate finance Name of the student Name of the university Student ID Author note
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3CORPORATE FINANCE Introduction The objective of the report is to analyse the stocks of Construction Limited and Financial Limited. For the purpose of analysis various measures like stock return over 24 months of period will be considered. Other factors those will be computed are mean return and standard deviation of the stocks, coefficient of the variation, standard deviation of the project and beta coefficient. Answer 1 Monthly return
4CORPORATE FINANCE Answer 2 Mean return and standard deviation Market IndexFinancial LtdConstruction Ltd Mean return0.92%1.56%1.56% Standard deviation0.01680.02740.0595 It is recognised from the above table that the mean return of Financial Ltd is 1.56% and the same for Construction Ltd is also 1.56%. However, the mean return for the same period for market index is 0.92%. Thus, both the stock’s return is better than the market index (Corder and Foreman 2014). SD (Standard deviation) of the stock states the stock’s variability or risk. it is used to measure the dispersion of the data set from the mean. Higher dispersion signifies that the SD of the stock is high and on the contrary lower dispersion signifies low SD of the stock. It is further used to measure the risk of the investment (Draper and Smith 2014). It provides the investors the details regarding whether the stock shall be considered for investment or not. Both the stocks SD are higher than the SD of market index. However, from the above table it is identified that the stock Construction Ltd is most risky as compared to market index and stock of Financial Ltd (Kenney 2013). Answer 3 Coefficient of variation Market IndexFinancial LtdConstruction Ltd Coefficient of variation1.83931.76263.8080
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5CORPORATE FINANCE CV (coefficient of variation) is ratio of Standard deviation to mean. Higher CV signifies that the dispersion level around mean is high and on the contrary lower CV signifies low dispersion level around mean (McAuliffe 2015). It also measures the trade-off between the return and risk. From the above table it can be stated that the risk return trade off for Financial Ltd is better as compared to Construction Ltd and Market Index. Further, the risk return trade off for Construction Ltd is in worse position (Calzada and Scariano 2013). Answer 4 Correlation coefficient between construction Ltd and Financial Ltd is 0.72882. Hence, it can be stated that there is positive correlation between 2 stocks (Corder and Foreman 2014). Answer 5 Standard deviation of portfolio Financial LtdConstruction Ltd Standard deviation0.027460.05956 Weight0.50.5 Correlation0.7288 Variance0.0017 Standard Deviation of portfolio4.09% SD of the portfolio represents the risk of the portfolio and it measures the portfolio’s total risk. The general concept of investment is that the diversification helps in reducing the overall risk of the portfolio and the SD of portfolio becomes lower (Kung and Schmid 2015). The individual SD of Financial Ltd is 2.74% whereas the same for Construction Ltd is 5.96%. However, the SD of the portfolio for 2 stocks in combination reduced to 4.09% (Peterson and Kim 2013).
6CORPORATE FINANCE Answer 6 Beta coefficient Financial LtdConstruction Ltd Beta0.058-0.099 Beta measures the share price’s sensitivity with regard to the market price movement. Further, it measures the systematic risk that is the inherent risk under the financial system. It is the major input under the capital asset pricing model for computing the required return rate of the stock. The beta for Construction Ltd is -0.099 that signifies that if the market goes up, the investment for Construction Ltd will decrease. On the other hand, the beta of Financial Ltd is 0.058. Less than 1 beta is signifying that the stock of the company less volatile as compared to market (Mertler and Reinhart 2016). Answer 7 Financial Limited – Risk free rate (Rf) = 3% Market return (Rm) = 7.26% Beta (β) = 0.058 Cost of equity (Ke) = Rf+β* (Rm– Rf) Ke= 3 + 0.058 (7.26-3) = 3.2470% Therefore, rate of return (r) = 3.2470%
7CORPORATE FINANCE Value of stock = D1/ (Re- g) where, D1= Dividend for next year, g = growth rate, Re= rate of return (Gleason, Bruce Johnson and Li 2013) Therefore, stock value = 1.03 / (0.03247-0.04) = - $ 136.79 Share price = - $ 136.79 Construction Limited – Risk free rate (Rf) = 3% Market return (Rm) = 7.26% Beta (β) = -0.099 Cost of equity (Ke) = Rf+β* (Rm– Rf) Ke= 3 – 0.099 (7.26-3) = 2.578% Therefore, rate of return (r) = 2.578% Value of stock = D1/ (Re- g) where, D1= Dividend for next year, g = growth rate, Re= rate of return (Baresa, Bogdan and Ivanovic 2013) Therefore, stock value = 0.62 / (0.02578-0.06) = - $ 18.12 It can be identified from the above calculation that both the company’s shares are trading at discount. However, share price of Construction Ltd is high as compared to Financial Ltd.
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8CORPORATE FINANCE Reference Baresa, S., Bogdan, S. and Ivanovic, Z., 2013. Strategy of stock valuation by fundamental analysis. UTMS Journal of Economics, 4(1), p.45. Calzada, M.E. and Scariano, S.M., 2013. A synthetic control chart for the coefficient of variation.Journal of Statistical Computation and Simulation,83(5), pp.853-867. Corder, G.W. and Foreman, D.I., 2014.Nonparametric statistics: A step-by-step approach. John Wiley & Sons. Draper, N.R. and Smith, H., 2014.Applied regression analysis(Vol. 326). John Wiley & Sons. Gleason, C.A., Bruce Johnson, W. and Li, H., 2013. Valuation model use and the price target performance of sell‐side equity analysts.Contemporary Accounting Research,30(1), pp.80- 115. Kenney, J.F., 2013.Mathematics of statistics. D. Van Nostrand Company Inc; Toronto; Princeton; New Jersey; London; New York,; Affiliated East-West Press Pvt-Ltd; New Delhi. Kung, H. and Schmid, L., 2015. Innovation, growth, and asset prices.The Journal of Finance,70(3), pp.1001-1037. McAuliffe, R.E., 2015. Coefficient of variation.Wiley Encyclopedia of Management. Mertler, C.A. and Reinhart, R.V., 2016.Advanced and multivariate statistical methods: Practical application and interpretation. Taylor & Francis. Peterson, R.A. and Kim, Y., 2013. On the relationship between coefficient alpha and composite reliability.Journal of Applied Psychology,98(1), p.194.