Finance Assignment: Analyzing Returns and Risks of Two Companies

This finance assignment analyzes the financial performance of two companies, Hard Ltd and Soft Ltd, over a period of 12 years. The analysis begins with calculating yearly returns and average returns for both companies and the market index. It proceeds to assess risk using standard deviation and beta, comparing the volatility of the stocks. The assignment then calculates the required rate of return using the CAPM model, and the compound annual growth rate. Finally, it determines the market value of shares using the dividend discount model and calculates the Weighted Average Cost of Capital (WACC) for each company. The assignment includes detailed calculations in the appendix and provides a comparative analysis of the two companies' financial metrics, offering insights into their performance and risk profiles.

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Question 1
The yearly returns from the share price are calculated using the formula:
Yearly returns = (current share price / last year share price)* last year share price
The yearly returns for Hard Ltd, Soft Ltd and market are presented below:
Year
Hard Ltd
Share
price($) Returns
Soft
Ltd
Share
price
($) Returns
Market
Index
(ASX
Index) Returns
2004 13.05 20.55 4660
2005 13.55 3.83% 21.15 2.92% 4790 2.79%
2006 13.9 2.58% 20.95 -0.95% 4850 1.25%
2007 13.12 -5.61% 18.75 -10.50% 4940 1.86%
2008 13.37 1.91% 17.1 -8.80% 4855 -1.72%
2009 13 -2.77% 19.35 13.16% 4790 -1.34%
2010 13.5 3.85% 20.1 3.88% 5030 5.01%
2011 13.9 2.96% 21.05 4.73% 5125 1.89%
2012 14.2 2.16% 22.15 5.23% 5035 -1.76%
2013 14.87 4.72% 23.85 7.67% 5110 1.49%
2014 14.9 0.20% 22.9 -3.98% 5250 2.74%
2015 14.95 0.34% 21.85 -4.59% 5255 0.10%
2016 15 0.33% 23.8 8.92% 5305 0.95%
Question 2
The average returns for the two companies and the market for the 12 years from 2005 to 2016
is given below:
Hard ltd Soft ltd Market
Average return 1.21% 1.47% 1.1%
From above we see that both Hard ltd and Soft ltd have higher returns as compared to the
market. Among the two companies, Soft ltd has even higher returns as compared to Soft Ltd.
Question 3

The standard deviation of returns for a stock = square root (sum(x-x2) / (n-1))
The standard deviation of returns of the two companies and the market is:
Hard ltd Soft ltd Market
Standard deviation = sqr.(0.00974/11)
= 0.0298
= sqr. (0.05843/11)
= 0.0729
= sqr. (0.00453/11)
=0.0203
The calculations have been given in the appendix
Question 4
Yes, the standard deviation of the market is smaller than the standard deviation of the two
companies. This is because the standard deviation measures the risk and a market index is
supposed to be least risky and hence the standard deviation is the lowest.
Question 5
The beta of Hard ltd is 1.05 whereas that of Soft Ltd is 1.21. soft Ltd has a higher beta which
means its stocks are more volatile as compared to Hard Ltd. Hence, it is more risky than Hard
Ltd. A beta of 1.21 means that when the market returns increase by 10%, the returns of stocks
of Soft ltd will increase more than the market by 12.1%. This risk is consistent with the
standard deviation also because Soft ltd has a higher standard deviation of 0.0729 whereas
Hard ltd has standard deviation of 0.0298 which means stocks of Hard ltd are less risky and
the same results are given by the company’s beta also.
Question 6
Portfolio beta = (weight of one stocks in portfolio * stock portfolio) + (weight of another
stocks in portfolio * stock portfolio)
= (0.45*1.05) + (0.55*1.21)
= 1.41

The portfolio beta is higher than the individual beta of both the stocks of Hard ltd and Soft
ltd. Beta measures the market risk and this market risk cannot be diversified. The systematic
risk affects the whole market and hence cannot be reduced (Sutton, 2009)
Question 7
The formula for required rate of return as per CAPM is given below:
Re = Rf + β (Rm - Rf )
Required rate of return for Hard Ltd. = 0.04 + 1.05(0.138-0.04)
= 14%
Required rate of return for Soft Ltd. = 0.04 + 1.21(0.138-0.04)
= 16%
Assumption: we have taken the market return as 13.8% which is the change in market index
from 2004 to 2016 as the average returns were very low and would have given a negative
market risk premium.
Question 8
The compound annual growth rate formula = (EV / BV)1/n – 1
Growth rate for Hard Ltd. = (1.45/1.07)1/5 – 1
= 6.3%
Growth rate for Soft Ltd = (2.25/1.55)1/5 – 1
= 7.7%
Question 9
Market value of share using dividend discount model = D1 / (Ke –g)
Market value of Hard Ltd share = (1.45* 1.063) / (0.14-0.063)
= $20
Market value of Soft Ltd share = (2.25* 1.077) / (0.14-0.077)

= $38
Question 10
WACC = wd*kd + we*ke
WACC for Hard Ltd. = (0.65*0.09) + (0.35* 0.14)
= 10.75%
WACC for Soft Ltd = (0.60*0.08) + (0.40* 0.16)
= 11.2%
Bibliography
Sutton, A. (2009, July 26). Portfolio Diversification and Risk: The Basics of Beta. Retrieved September
20, 2017, from Seeking Aplha: https://seekingalpha.com/article/151352-portfolio-
diversification-and-risk-the-basics-of-beta
Appendix
Question 3
Standard deviation of Hard Ltd
Year
Hard
Ltd
Share
price($) Returns
Differenc
e of
return and
average
return Square of differences
2004 13.05
2005 13.55 3.83% 2.62% 0.00069
2006 13.9 2.58% 1.37% 0.00019
2007 13.12 -5.61% -6.82% 0.00465
2008 13.37 1.91% 0.70% 0.00005
2009 13 -2.77% -3.98% 0.00158
2010 13.5 3.85% 2.64% 0.00070

2011 13.9 2.96% 1.75% 0.00031
2012 14.2 2.16% 0.95% 0.00009
2013 14.87 4.72% 3.51% 0.00123
2014 14.9 0.20% -1.01% 0.00010
2015 14.95 0.34% -0.87% 0.00008
2016 15 0.33% -0.87% 0.00008
Total 0.00974
Standard deviation of Soft Ltd.
Year
Soft Ltd Share price
($) Returns
Difference of return
and average return
Square of
differences
2004 20.55
2005 21.15 2.92% 1.45% 0.00021
2006 20.95 -0.95% -2.42% 0.00059
2007 18.75 -10.50% -11.98% 0.01434
2008 17.1 -8.80% -10.27% 0.01056
2009 19.35 13.16% 11.68% 0.01365
2010 20.1 3.88% 2.40% 0.00058
2011 21.05 4.73% 3.25% 0.00106
2012 22.15 5.23% 3.75% 0.00141
2013 23.85 7.67% 6.20% 0.00384
2014 22.9 -3.98% -5.46% 0.00298
2015 21.85 -4.59% -6.06% 0.00367
2016 23.8 8.92% 7.45% 0.00555
Total 0.05843
Standard deviation of market returns
Year
Market
Index
(ASX
Index) Returns
Differenc
e of return
and
average
return
Square of
differences
2004 4660
2005 4790 2.79% 1.68% 0.00028
2006 4850 1.25% 0.15% 0.00000
2007 4940 1.86% 0.75% 0.00006
2008 4855 -1.72% -2.83% 0.00080
2009 4790 -1.34% -2.44% 0.00060
2010 5030 5.01% 3.91% 0.00153
2011 5125 1.89% 0.78% 0.00006
2012 5035 -1.76% -2.86% 0.00082
2013 5110 1.49% 0.38% 0.00001

2014 5250 2.74% 1.63% 0.00027
2015 5255 0.10% -1.01% 0.00010
2016 5305 0.95% -0.15% 0.00000
Total 0.00453