Strathclyde University

Finance & Financial Management

Assignment
Each coursework group is required to choose two real-life companies (Company A &
Company B) that are publicly traded on the main market of the London stock exchange.
The two companies can be selected from the FTSE 100 Index. The list of companies that
constitute the FTSE 100 Index can be downloaded from the following website:
http://www.morningstar.co.uk/uk/equities/indexstockprices.aspx?index=FTSE_100
Please note that the list can also be downloaded from, for example, Yahoo Finance or
Datastream. One of the companies (Company A) you select must not be from the financial
sector (e.g., cannot be a bank or an insurance company). Further, neither company (A or B)
can be an investment fund (e.g., you should not use Aberdeen Asset Management Plc as
one of the two companies).
It is the responsibility of each team (and all team members) to collect all necessary
data required to complete the assignment.

Part 1
To complete this part, you will require data on your two companies’ monthly (or weekly)
common-stock returns from January 2008 to December 2017. Or weekly common-stock
returns for the period January 2013 to December 2017. If weekly returns are used then the
answers to the questions below should be based on weekly data.
Required:
(a) Suppose you are advising an investor who is considering investing all his/her wealth in
the stock of just one of the two companies chosen by your coursework group
(Company A or Company B).
(i) Provide brief descriptions of Company A and of Company B.
(ii) Next, compare and contrast the stock return performance of the two
companies’ common stocks over the calendar period using monthly (or
weekly) return data from January 2008 to December 2017. Specifically,
calculate the mean, variance and standard deviation of the monthly returns
of the two stocks separately.
(iii) Briefly comment on your results and make a stock recommendation.
(b) Now suppose you are advising an investor who is considering investing all his/her
wealth in a portfolio consisting of the two companies’ common stock held together.

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 (i) Calculate the mean, variance and standard deviation of the returns of
portfolio comprising the two stocks with equal weights (i.e. 50:50). Next
repeat the calculations for alternative portfolio weights, including 10:90,
20:80, 40:60, 60:40, 80:20, and 90:10. You may choose to construct other
additional portfolios (but remember the portfolio weights need to add to
100%). Report your results in a table. Compare and contrast your findings
with those of the single-stock portfolios in part (aii).
(ii) Illustrate your results in part (bi), along with the single-stock results in part
(aii), in a graph plotting the trade-off between the mean return and standard
deviation of the portfolio returns.

(iii) In the trade-off graph in part (ii), indicate the efficient frontier (assuming
the stocks of Company A and B are the only available assets).
(iv) Finally, try to identify the minimum variance portfolio in the tradeoff
graph. To do so, you can use trial and error, or the method outlined in the
notes that you can find in MyPlace. Report the portfolio weights of the
minimum-variance portfolio, and the mean, variance and standard deviation
of returns of the minimum-variance portfolio.
(v) Based on your findings in the previous parts, briefly explain to the investor
how to choose his/her optimal portfolio assuming the two stocks are the
only assets available to him/her. Also briefly indicate how your advice
would change if other assets (e.g., risk-free asset) became available to the
investor.

Part 2
The senior management of Company A have asked you to advise them on the cost of capital
the company should use to calculate the net present value and decide whether or not to
undertake a new investment project. You may assume that the new project is comparable to
the average of the company’s existing projects in all respects.

It is worth stressing that that Company A cannot be from the financial sector and also
cannot be an investment fund.

Required:
(a) Calculate investors’ required rate of return on Company’s A’s equity.
Remember, there are many ways of estimating investors’ required returns. You should
use two alternative methods of calculating the required returns to check how sensitive
your result is to using different methods; i.e. to check the robustness of your result. For
example, you could use the Capital Asset Pricing Model (CAPM) which uses a single
factor (beta) and the Dividend Constant Growth Model.
(b) Calculate Company’s A’s debt cost of capital.
The bond yield (cost of debt) can be calculated as Yield = risk-free rate + credit
spread. If you cannot find data on the approximate credit spread for a given credit
rating of your chosen company then you can simply use the latest rate that your
company is paying on its newly issued debt (you can use the latest published financial

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 Statements of your chosen company to find the latest rate the company is paying on
its debt). For simplicity, you may assume that the only securities outstanding of
your chosen company are common stock (equity) and long-term debt. Note that the
after-tax cost of debt is lower than the pre-tax cost of debt if there is a tax
advantage of debt relative to equity (interest tax shield).
(c) Calculate the cost of capital (that is, the appropriate discount rate to calculate the net
present value) of Company A’s new investment project.

(d) Clearly explain your calculations and methods used in sections (a) to (c). Among other
things, note explicitly whether your results are in terms of monthly, weekly or yearly
returns (either is acceptable as long as clearly stated). Briefly describe and justify the
data and (proxy) measures you are using. State and discuss any assumptions you are
making (including assumptions about the financing of the project).
(e) Briefly discuss any limitations of your analysis and how (given more time and
information) you might improve your analysis in the future.

Collecting data
To complete the assignment, your group will need to collect various sorts of data which can
be downloaded from different sources (e.g., Yahoo Finance, the website of the company,
Datastream). Please e-mail me if your group cannot find the required data.

Equity data
Download the equity return data from Yahoo Finance or Datastream. You will need to
calculate the monthly (or weekly) holding period returns for your chosen company and
the FTSE 100 Index. Holding period returns are defined as follows:

p 
r  it d it 1
it it 1 
 p
where rit is the holding period return for company i for month t, pit is the price of
company i at the end of month t, dit is any dividend declared ex div during month t
adjusted to an end-of-month basis, and pit−1 is the price of company i at the start of
month t (adjusted if necessary for any changes in capitalizations to make it comparable
with pit).

If you want to express returns in percent (%) you have to multiply the equation for the
(decimal) holding return above by 100. Make sure you convert returns collected from
different data sources to the same units (decimals or percent).

In your baseline calculations use monthly return data from January 2008 to December 2017
or from January 2013 to December 2017 (if weekly returns are used)
The total market value of the equity (market capitalization) can be calculated by
multiplying the number of shares outstanding by the market price of the shares. You
need to find the total number of outstanding shares of the company and the current
market share price (e.g., share price on 28 February 2018) of your chosen company

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Debt data
The data on debt can be extracted from the company’s financial statements, Yahoo
Finance, or Datastream. You need to extract the data relating to the Long-term debt.
Credit Rating: (If your company has credit rating)
Ratings: Select an appropriate credit rating for your company. For simplicity, you may
assume that your company only has long-term debt. Note that there may not be any data
on the time-series of bond returns for individual companies. In fact, you do not need (to
construct) the time-series of bond returns to complete the assignment – you only need to
download one observation of the credit rating (if rating data is available) and one
observation of the debt value.
The bond yield (cost of debt) can be calculated as Yield = risk-free rate + credit spread.
Data on the approximate credit spreads for companies with a given credit rating can be
found in various places on the internet. Ideally you should use spreads at the end of 2015,
but current values can be used instead (bearing in mind any changes in spreads since the
last financial year of your chosen company). In the event that you cannot find spreads for
the specific rating of your company, you can use the spread for the next lower or higher
rating. Please explain, discuss and justify your data and methods on spreads (and on all
other data/methods) in your report in Part 2 (e).

Estimating equity betas

rit rft  i (rmt rft)   it

where rit is the monthly return on the company’s stock, rmt the monthly return on the
market (FTSE 100 Index), rft the monthly return on a “risk-free” asset, and it is the error
term.

In your baseline calculations use monthly return data from January 2008 to December
2017.
Calculations can be done in Excel. You will need to ensure that the Analysis ToolPak has
been added in. You can easily check this by clicking on Tools in the menu at the top of the
screen in Excel. If it has been added, Data Analysis… will appear in the list. If Data
Analysis… is not there, click on Add-Ins… and check (i.e., tick) the Analysis ToolPak box.
The Regression function in Excel can be found in the Data Analysis… part of the Tools
menu.

When you click on Regression, you will be asked to input a Y range and an X range. In the
SML equation (of the CAPM), the Y range is your company’s excess return (rit – rft) while
the X range is the excess return on the market (rmt – rft). Please remember to use the Help
menu in Excel.