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FINC 400 Principles Of Financial Management

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FINC 400 Principles Of Financial Management

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FINC 400 Principles Of Financial Management

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Course Code: FINC400
University: American Public University System

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Country: United States

Questions:
1. Calculate the average rate of return for each year from the above information.2. What is the arithmetic average rate of return earned by investing in Caswell’s stock over this period?
3.What is the geometric average rate of return earned by investing in Caswell’s stock over this period?4. Considering the beginning and ending stock prices for the five-year period are the same, which type of average rate of return best describes the annual rate of return earned over the period (arithmetic or geometric)?

Answers:
Answer to Question 1:

Particulars

Details

Units

Price at beginning of the year

A

 $ 698.51

Price after one year

B

 $ 301.99

Rate of return

(B-A)/A

-56.77%

Answer to Question 2:

Calculation of Average Rate of Return:-

Time

Caswell

Details

Average rate of return

1

 $      12

 

 –

2

 $        9

(9 – 12)/9 x 100

-25.00%

3

 $        7

(7 – 9)/9 x 100

-22.22%

4

 $        6

(6 – 7)/7 x 100

-14.29%

5

 $        8

(8 – 6)/6 x 100

33.33%

 

Calculation of Arithmetic Average Rate of Return:-

Particulars

Details

Units

Return for year 2

A

-25.00%

Return for year 3

B

-22.22%

Return for year 4

C

-14.29%

Return for year 5

D

33.33%

Arithmetic average rate of return

(A+B+C+D)/4

-7.04%

 

Calculation of Geometric Average Rate of Return:-

Particulars

Details

Units

Return for year 2

A

75.00%

Return for year 3

B

77.78%

Return for year 4

C

85.71%

Return for year 5

D

133.33%

Geometric average rate of return

[(A+B+C+D) * 1/4] – 1

-7.13%

With the help of geometric average rate of return, it is possible to gain a better overview regarding the actual average yearly rate of return made over a particular timeframe (Andreou, Louca & Panayides, 2014). For instance, in this case, it is assumed that the opening share price and closing stock price for the five-year period is identical. The arithmetic average depicted a negative return by averaging the average returns of all the years and hence, there might not be suitability in actual return. However, the compounding return of effect is considered in geometric average rate of return, which is the actual investment growth (Finkler et al., 2016). Hence, it is considered as a superior measure in contrast to arithmetic average of return.

Calculation of Annual Rate of Return at the end of Year 3:-

Time

Caswell

Details

Average rate of return

Year 2

 $                               9

 

 

Year 3

 $                               7

(7 – 9)/9 x 100

-22.22%

Answer to Question 3:

Particulars

Details

Units

Purchase price of common stock

A

 $              9.45

Closing price of common stock

B

 $            11.66

Dividend paid

C

 $              1.43

Cash return

D=B+C-A

 $              3.64

Rate of return

D/A

38.52%

Answer to Question 4:

Common Stock A

Common Stock B

Probability

Return

Probability

Return

                                                 0.20

10%

                   0.10

-7%

                                                 0.60

16%

                   0.40

5%

                                                 0.20

21%

                   0.10

13%

 

 

                   0.10

20%

Expected return

15.80%

Expected return

4.60%

 

Scenario

Probability

Return

Deviation from mean

Squared deviation

Probability x Squared deviation

For Common Stock A:

 

 

 

 

 

1

                              0.20

10%

5.80%

0.34%

                                0.0006728

2

                              0.60

16%

-0.20%

0.00%

                                0.0000024

3

                              0.20

21%

-5.20%

0.27%

                                0.0005408

Standard deviation for Stock A

3.49%

For Common Stock B:

 

 

 

 

 

1

                              0.10

-7%

11.60%

1.35%

                                0.0013456

2

                              0.40

5%

-0.40%

0.00%

                                0.0000064

3

                              0.10

13%

-8.40%

0.71%

                                0.0007056

4

                              0.10

20%

-15.40%

2.37%

                                0.0023716

Standard deviation for Stock B

6.66%

Based on the above tables, it could be found that Stock A provides a better return in contrast to Stock B. This is mainly due to the favorable scenarios due to which the investors are expected to obtain better return on investment (McKinney, 2015). On the other hand, the risk for Stock A is lower than that of Stock B. Hence, it is recommended that Stock A is a better option for investment in comparison to Stock B (Petty et al., 2015).  
References:
Andreou, P. C., Louca, C., & Panayides, P. M. (2014). Corporate governance, financial management decisions and firm performance: Evidence from the maritime industry. Transportation Research Part E: Logistics and Transportation Review, 63, 59-78.
Finkler, S. A., Smith, D. L., Calabrese, T. D., & Purtell, R. M. (2016). Financial management for public, health, and not-for-profit organizations. CQ Press.
McKinney, J. B. (2015). Effective financial management in public and nonprofit agencies. ABC-CLIO.
Petty, J. W., Titman, S., Keown, A. J., Martin, P., Martin, J. D., & Burrow, M. (2015). Financial management: Principles and applications. Pearson Higher Education AU.

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