Final Exam Assignment Project

Exam PDF 3

Exam pdf 3:
Part 1: a: As the fixed cost being higher increases the operating leverage of the company.
This implies if the sales would increase by 10% and the company has an operating leverage
of 3 the profit would increase by 30% which would happen even if the sale falls by 10% the
profit would reduce by 30%. Operating leverage is calculated as Sales-(price –variable cost)/
Sales-(price –variable cost)- fixed cost. Hence fixed cost directly impacts the operating
leverage of the company, hence increases the risk which increases the Beta more than the
industry.
Part 2:d: Expected Return = RF +( Market Return – RF) * Beta of stock
Part 3: b : The highest return is provided by the small cap stocks also since they are the most
risky while the lowest from the US t bills being the least risky
Part 4: d: The expected return is given by Expected return * probability of each state
Part 5: c:
13% is the mean value of the probability distribution, while we would be required to calculate
the Return^2*Probability for each period.
BOOM = 0.2^2 * 0.5 = 0.02
NORMAL = 0.1^2 * 0.4 = 0.004
Recession = -0.1^2 * 0.1 = 0.001
Sum of the values = 0.02 + 0.004 + 0.001 = 0.025
Probability = (0.025 – 0.13^2)^0.5 = (0.025 – 0.0169)^0.5 = (0.081)^0.5 = 9%
Part 6: d: Expected Return = 3.84% +(7.78 * 0.75) = 9.675% = 9.68%
Part 7: d: We initially calculate the weights of the debt and equity from the WACC formula