Reference no: EM131919252

Question:

Ryan, a financial analyst for DMC Products, a manufacturer of school benches, must evaluate the risk and return of two assets, X and Y. The firm is considering adding these assets to its diversified asset portfolio. To assess the return and risk of each asset, Ryan gathered data on the annual cash flow and beginning- and end-of-year values of each asset over the immediately pre- ceding 10 years, 1994-2003. These data are summarized in the accompanying table. Ryan's investigation suggests that both assets, on average, will tend to perform in the future just as they have during the past 10 years. He therefore believes that the expected annual return can be estimated by finding the average annual return for each asset over the past 10 years.

Return Data for Assets X and Y, 1994-2003

Year		Asset X			Asset Y
	Cash flow		Value	Cash flow		Value
		Beginning	Ending		Beginning	Ending
1994	$1,000	$20,000	$22,000	$ 1,500	$20,000	$20,000
1995	1,500	1/,000	21,000	1,600	20,000	20,000
1996	1,400	21,000	24,000	1,700	20,000	21,000
1997	1.700	24,000	22,000	1,800	21,000	21,000
1998	1,900	22,000	23,000	1,900	21,000	22,000
1999	1,600	13,000	26,000	2,000	22,000	23,000
2000	1,700	26,000	25,000	2,100	23,000	23,000
2001	2,000	25,000	24,000	2,200	23,000	24,000
2002	2,100	24,000	27,000	2,300	24,000	25,000
2003	2,200	27,000	30,000	2,400	25,000	25,000

Ryan believes that each asset's risk can be assessed in two ways: in isolation and as part of the firm's diversified portfolio of assets. The risk of the assets in isolation can be found by using the standard deviation and coefficient of varia- tion of returns over the past 10 years. The capital asset pricing model (CAPM) can be used to assess the asset's risk as part of the firm's portfolio of assets. Applying some sophisticated quantitative techniques, he estimated betas for assets X and Y of 1.60 and 1.10, respectively. In addition, he found that the risk- free rate is currently 7% and that the market return is 10%.

a. Calculate the annual rate of return for each asset in each of the 10 preceding years, and use those values to find the average annual return for each asset over the 10-year period.

b. Use the returns calculated in part a to find (1) the standard deviation and (2) the coefficient of variation of the returns for each asset over the 10-year period 1994-2003.

c. Use your findings in parts a and b to evaluate and discuss the return and risk associated with each asset. Which asset appears to be preferable? Explain.

d. Use the CAPM to find the required return for each asset. Compare this value ?with the average annual returns calculated in part a.

e. Compare and contrast your findings in parts c and d. What recommendations ?would you give Ryan with regard to investing in either of the two assets? Explain to Ryan why he is better off using beta rather than the standard deviation and coefficient of variation to assess the risk of each asset.