BMMF5103 Answer Scheme Formated 1 2013 2 
BMMF5103 – SUGGESTED ANSWERS:
PART A
Question 1
a.
(i). E(r) = .05(-.5) + .10(-.15) + .2(.05) + .3(.15) + .2(.25) + .15(.40) = .125 = 12.5%
(ii). Var =.05(-.50 - .125)2 + .1(-.15 - .125)2 + .2(.05 - .125)2 + .3(.15 - .125)2 + .2(.25 - .125)2 + .15(.40 .125)2 = .0428
Stddev = (.0428)1/2 = .2069
(iii) C.V. = .2069/.125 = 1.6552
b.
First find the portfolio’s beta:
15% = 6% + (6%)bp
9% = 6%bp bp = 1.5.
Let bc be the beta of the company for which she works. The portfolio’s beta is a weighted average of the individual betas of the stocks in the portfolio.
Therefore, 1.5 = ($5,000/$20,000)1.2 + ($15,000/$20,000)bC.
1.5 = 0.3 + 0.75bc
1.2 = 0.75bc bc = 1.6.
c.
The unsystematic risk is the company-specific risk whereas the systematic risk is the market-specific risk. The former can be diversifiable away through the formation of portfolios comprising of assets that are negatively correlated with one another. The later continues to remain in the system and its presence is acknowledged by beta. The sources of unsystematic risk include the firm' s financing decisions and the firm' s operations. A higher beta increases the required rate of return.
Question 2
a.
Equity = 0.25($6,000) = $1,500.
Current ROE =
New ROE =
NI
$240
=
= 16%.
E
$1,500
$300
$1,500
= 0.20 = 20%.
∆ROE = 20% - 16% = 4%.
1
b.
This question requires working backwards through the income statement from net income to sales. The income statement will look like this:
Sales
CGS (60%)
EBIT
Interest
EBT
Tax (40%)
NI
c.
d.
$1,250,000
$ 500,000
100,000
$ 400,000
$500,000/(1 - 0.6)
$100,000 + $400,000
(Given)
$240,000/(1 - 0.4)
$ 240,000
Liquid assets are those that can be sold quickly with little or no loss in value. A firm that has sufficient liquidity will be less likely to experience financial distress.
Most income statements contain some noncash items, so these must be accounted for when calculating cash flows. More importantly, however, since GAAP is used to create income statements, revenues and
PART A
Question 1
a.
(i). E(r) = .05(-.5) + .10(-.15) + .2(.05) + .3(.15) + .2(.25) + .15(.40) = .125 = 12.5%
(ii). Var =.05(-.50 - .125)2 + .1(-.15 - .125)2 + .2(.05 - .125)2 + .3(.15 - .125)2 + .2(.25 - .125)2 + .15(.40 .125)2 = .0428
Stddev = (.0428)1/2 = .2069
(iii) C.V. = .2069/.125 = 1.6552
b.
First find the portfolio’s beta:
15% = 6% + (6%)bp
9% = 6%bp bp = 1.5.
Let bc be the beta of the company for which she works. The portfolio’s beta is a weighted average of the individual betas of the stocks in the portfolio.
Therefore, 1.5 = ($5,000/$20,000)1.2 + ($15,000/$20,000)bC.
1.5 = 0.3 + 0.75bc
1.2 = 0.75bc bc = 1.6.
c.
The unsystematic risk is the company-specific risk whereas the systematic risk is the market-specific risk. The former can be diversifiable away through the formation of portfolios comprising of assets that are negatively correlated with one another. The later continues to remain in the system and its presence is acknowledged by beta. The sources of unsystematic risk include the firm' s financing decisions and the firm' s operations. A higher beta increases the required rate of return.
Question 2
a.
Equity = 0.25($6,000) = $1,500.
Current ROE =
New ROE =
NI
$240
=
= 16%.
E
$1,500
$300
$1,500
= 0.20 = 20%.
∆ROE = 20% - 16% = 4%.
1
b.
This question requires working backwards through the income statement from net income to sales. The income statement will look like this:
Sales
CGS (60%)
EBIT
Interest
EBT
Tax (40%)
NI
c.
d.
$1,250,000
$ 500,000
100,000
$ 400,000
$500,000/(1 - 0.6)
$100,000 + $400,000
(Given)
$240,000/(1 - 0.4)
$ 240,000
Liquid assets are those that can be sold quickly with little or no loss in value. A firm that has sufficient liquidity will be less likely to experience financial distress.
Most income statements contain some noncash items, so these must be accounted for when calculating cash flows. More importantly, however, since GAAP is used to create income statements, revenues and