case solutions fundamental of corporate finance 9e ross

The company does have a positive cash flow, but a large portion of the operating cash flow is already going to capital spending.. S&S is below the median industry ratios for the current

Case Solutions

Fundamentals of Corporate Finance

Ross, Westerfield, and Jordan

9th edition

THE McGEE CAKE COMPANY

1. The advantages to a LLC are: 1) Reduction of personal liability A sole proprietor has unlimitedliability, which can include the potential loss of all personal assets 2) Taxes Forming an LLC maymean that more expenses can be considered business expenses and be deducted from the company’sincome 3) Improved credibility The business may have increased credibility in the business worldcompared to a sole proprietorship 4) Ability to attract investment Corporations, even LLCs, canraise capital through the sale of equity 5) Continuous life Sole proprietorships have a limited life,while corporations have a potentially perpetual life 6) Transfer of ownership It is easier to transferownership in a corporation through the sale of stock

The biggest disadvantage is the potential cost, although the cost of forming a LLC can be relativelysmall There are also other potential costs, including more expansive record-keeping

2. Forming a corporation has the same advantages as forming a LLC, but the costs are likely to behigher

3. As a small company, changing to a LLC is probably the most advantageous decision at the currenttime If the company grows, and Doc and Lyn are willing to sell more equity ownership, thecompany can reorganize as a corporation at a later date Additionally, forming a LLC is likely to beless expensive than forming a corporation

CASH FLOWS AND FINANCIAL 

STATEMENTS AT SUNSET BOARDS

Below are the financial statements that you are asked to prepare

1. The income statement for each year will look like this:

Income statement

2. The balance sheet for each year will be:

Balance sheet as of Dec 31, 2008

In the first year, equity is not given Therefore, we must calculate equity as a plug variable Since total liabilities & equity is equal to total assets, equity can be calculated as:

Equity = $215,168 – 46,794 – 79,235

C­2  CASE SOLUTIONSEquity = $89,139

Balance sheet as of Dec 31, 2009

The owner’s equity for 2009 is the beginning of year owner’s equity, plus the addition to retained earnings, plus the new equity, so:

Equity = $89,139 + 24,326 + 15,600

Equity = $129,065

3 Using the OCF equation:

OCF = EBIT + Depreciation – Taxes

The OCF for each year is:

OCF2008 = $60,853 + 35,581 – 10,624

OCF2008 = $85,180

OCF2009 = $69,680 + 40,217 – 12,163

OCF2009 = $97,734

4 To calculate the cash flow from assets, we need to find the capital spending and change in net

working capital The capital spending for the year was:

Capital spending

– Beginning net fixed assets 156,975

And the change in net working capital was:

Change in net working capital

So, the cash flow from assets was:

Cash flow from assets

5 The cash flow to creditors was:

Cash flow to creditors

6 The cash flow to stockholders was:

Cash flow to stockholders

Answers to questions

1 The firm had positive earnings in an accounting sense (NI > 0) and had positive cash flow from

operations The firm invested $17,611 in new net working capital and $74,492 in new fixed assets.The firm gave $5,631 to its stakeholders It raised $3,094 from bondholders, and paid $8,726 tostockholders

2 The expansion plans may be a little risky The company does have a positive cash flow, but a large

portion of the operating cash flow is already going to capital spending The company has had to raisecapital from creditors and stockholders for its current operations So, the expansion plans may be tooaggressive at this time On the other hand, companies do need capital to grow Before investing orloaning the company money, you would want to know where the current capital spending is going,and why the company is spending so much in this area already

Cash ratio = 0.15 times

Total asset turnover = $30,499,420 / $18,308,920

Total asset turnover = 1.67 times

Inventory turnover = $22,224,580 / $1,037,120

Inventory turnover = 21.43 times

Receivables turnover = $30,499,420 / $708,400

Receivables turnover = 43.05 times

Total debt ratio = ($18,308,920 – 10,069,920) / $18,308,920

Total debt ratio = 0.45 times

Debt-equity ratio = ($2,919,000 + 5,320,000) / $10,069,920

Debt-equity ratio = 0.82 times

Equity multiplier = $18,308,920 / $10,069,920

Equity multiplier = 1.82 times

Times interest earned = $3,040,660 / $478,240

Times interest earned = 6.36 times

C­6  CASE SOLUTIONS

2 Boeing is probably not a good aspirant company Even though both companies manufactureairplanes, S&S Air manufactures small airplanes, while Boeing manufactures large, commercialaircraft These are two different markets Additionally, Boeing is heavily involved in the defenseindustry, as well as Boeing Capital, which finances airplanes

Bombardier is a Canadian company that builds business jets, short-range airliners and fire-fightingamphibious aircraft and also provides defense-related services It is the third largest commercialaircraft manufacturer in the world Embraer is a Brazilian manufacturer than manufacturescommercial, military, and corporate airplanes Additionally, the Brazilian government is a partowner of the company Bombardier and Embraer are probably not good aspirant companies because

of the diverse range of products and manufacture of larger aircraft

Cirrus is the world's second largest manufacturer of single-engine, piston-powered aircraft ItsSR22 is the world's best selling plane in its class The company is noted for its innovative smallaircraft and is a good aspirant company

Cessna is a well known manufacturer of small airplanes The company produces business jets,freight- and passenger-hauling utility Caravans, personal and small-business single engine pistons

It may be a good aspirant company, however, its products could be considered too broad anddiversified since S&S Air produces only small personal airplanes

3. S&S is below the median industry ratios for the current and cash ratios This implies the companyhas less liquidity than the industry in general However, both ratios are above the lower quartile, sothere are companies in the industry with lower liquidity ratios than S&S Air The company mayhave more predictable cash flows, or more access to short-term borrowing If you created anInventory to Current liabilities ratio, S&S Air would have a ratio that is lower than the industrymedian The current ratio is below the industry median, while the quick ratio is above the industrymedian This implies that S&S Air has less inventory to current liabilities than the industry median.S&S Air has less inventory than the industry median, but more accounts receivable than theindustry since the cash ratio is lower than the industry median

The turnover ratios are all higher than the industry median; in fact, all three turnover ratios areabove the upper quartile This may mean that S&S Air is more efficient than the industry

The financial leverage ratios are all below the industry median, but above the lower quartile S&SAir generally has less debt than comparable companies, but still within the normal range

The profit margin, ROA, and ROE are all slightly below the industry median, however, notdramatically lower The company may want to examine its costs structure to determine if costs can

be reduced, or price can be increased

Overall, S&S Air’s performance seems good, although the liquidity ratios indicate that a closer lookmay be needed in this area

Below is a list of possible reasons it may be good or bad that each ratio is higher or lower than the industry Note that the list is not exhaustive, but merely one possible explanation for each ratio

Current ratio Better at managing current

Inventory turnover Better at inventory management,

possibly due to better procedures

Could be experiencing inventory shortages

Receivables turnover Better at collecting receivables May have credit terms that are too

strict Decreasing receivables turnover may increase sales.Total debt ratio Less debt than industry median

means the company is less likely

to experience credit problems

Increasing the amount of debt can increase shareholder returns Especially notice that it will increase ROE

Debt-equity ratio Less debt than industry median

means the company is less likely

to experience credit problems

Increasing the amount of debt can increase shareholder returns Especially notice that it will increase ROE

Equity multiplier Less debt than industry median

means the company is less likely

to experience credit problems

Increasing the amount of debt can increase shareholder returns Especially notice that it will increase ROE

increasing costs

The company may have more difficulty meeting interest payments in a downturn

Cash coverage Less debt than industry median

means the company is less likely

to experience credit problems

Increasing the amount of debt can increase shareholder returns Especially notice that it will increase ROE

Profit margin The PM is slightly below the

industry median It could be a result of higher quality materials

or better manufacturing

Company may be having trouble controlling costs

than the industry

Company may have newer assets than the industry

result of higher quality

Profit margin and EM are lower than industry, which results in the lower ROE

Now we can use the internal growth rate equation to get:

Internal growth rate = (ROA × b) / [1 – (ROA × b)]

Internal growth rate = [0.0840(.64)] / [1 – 0.0840(.64)]

Internal growth rate = 0564 or 5.64%

To find the sustainable growth rate, we need the ROE, which is:

ROE = NI / TE

ROE = $1,537,452 / $10,069,920

ROE = 1527 or 15.27%

Using the retention ratio we previously calculated, the sustainable growth rate is:

Sustainable growth rate = (ROE × b) / [1 – (ROE × b)]

Sustainable growth rate = [0.1527(.64)] / [1 – 0.1527(.64)]

Sustainable growth rate = 1075 or 10.75%

The internal growth rate is the growth rate the company can achieve with no outside financing of anysort The sustainable growth rate is the growth rate the company can achieve by raising outside debtbased on its retained earnings and current capital structure

So, the EFN is:

EFN = Total assets – Total liabilities and equity

EFN = $20,505,990 – 19,594,797

EFN = $911,193

The company can grow at this rate by changing the way it operates For example, if profit marginincreases, say by reducing costs, the ROE increases, it will increase the sustainable growth rate Ingeneral, as long as the company increases the profit margin, total asset turnover, or equity multiplier,the higher growth rate is possible Note however, that changing any one of these will have the effect

of changing the pro forma financial statements

3. Now we are assuming the company can only build in amounts of $5 million We will assume that thecompany will go ahead with the fixed asset acquisition To estimate the new depreciation charge, wewill find the current depreciation as a percentage of fixed assets, then, apply this percentage to thenew fixed assets The depreciation as a percentage of assets this year was:

Depreciation percentage = $1,366,680 / $16,122,400

Depreciation percentage = 0848 or 8.48%

The new level of fixed assets with the $5 million purchase will be:

New fixed assets = $16,122,400 + 5,000,000 = $21,122,400

So, the pro forma depreciation will be:

Pro forma depreciation = 0848($21,122,400)

Pro forma depreciation = $1,790,525

We will use this amount in the pro forma income statement So, the pro forma income statement willbe:

The pro forma balance sheet will remain the same except for the fixed asset and equity accounts Thefixed asset account will increase by $5 million, rather than the growth rate of sales

Balance sheet

So, the EFN is:

EFN = Total assets – Total liabilities and equity

EFN = $23,581,302 – 19,433,119

EFN = $4,138,184

Since the fixed assets have increased at a faster percentage than sales, the capacity utilization for next year will decrease

THE MBA DECISION

1. Age is obviously an important factor The younger an individual is, the more time there is for the(hopefully) increased salary to offset the cost of the decision to return to school for an MBA Thecost includes both the explicit costs such as tuition, as well as the opportunity cost of the lost salary

2. Perhaps the most important nonquantifiable factors would be whether or not he is married and if hehas any children With a spouse and/or children, he may be less inclined to return for an MBA sincehis family may be less amenable to the time and money constraints imposed by classes Other factorswould include his willingness and desire to pursue an MBA, job satisfaction, and how important theprestige of a job is to him, regardless of the salary

3. He has three choices: remain at his current job, pursue a Wilton MBA, or pursue a Mt Perry MBA

In this analysis, room and board costs are irrelevant since presumably they will be the same whether

he attends college or keeps his current job We need to find the aftertax value of each, so:

Remain at current job :

His salary will grow at 3.5 percent per year We must also remember that he will now only work for

37 years, so the present value of his aftertax salary is:

4. He is somewhat correct Calculating the future value of each decision will result in the option withthe highest present value having the highest future value Thus, a future value analysis will result inthe same decision However, his statement that a future value analysis is the correct method is wrongsince a present value analysis will give the correct answer as well

5. To find the salary offer he would need to make the Wilton MBA as financially attractive as the as thecurrent job, we need to take the PV of his current job, add the costs of attending Wilton, and the PV

of the bonus on an aftertax basis So, the necessary PV to make the Wilton MBA the same as hiscurrent job will be:

1. A bond with collateral will have a lower coupon rate Bondholders have the claim on the collateral,even in bankruptcy Collateral provides an asset that bondholders can claim, which lowers their risk

in default The downside of collateral is that the company generally cannot sell the asset used ascollateral, and they will generally have to keep the asset in good working order

2. The more senior the bond is, the lower the coupon rate Senior bonds get full payment in bankruptcyproceedings before subordinated bonds receive any payment A potential problem may arise in thatthe bond covenant may restrict the company from issuing any future bonds senior to the currentbonds

3. A sinking fund will reduce the coupon rate because it is a partial guarantee to bondholders Theproblem with a sinking fund is that the company must make the interim payments into a sinking fund

or face default This means the company must be able to generate these cash flows

4. A provision with a specific call date and prices would increase the coupon rate The call provisionwould only be used when it is to the company’s advantage, thus the bondholder’s disadvantage Thedownside is the higher coupon rate The company benefits by being able to refinance at a lower rate

if interest rates fall significantly, that is, enough to offset the call provision cost

5. A deferred call would reduce the coupon rate relative to a call provision with a deferred call Thebond will still have a higher rate relative to a plain vanilla bond The deferred call means that thecompany cannot call the bond for a specified period This offers the bondholders protection for thisperiod The disadvantage of a deferred call is that the company cannot call the bond during the callprotection period Interest rates could potentially fall to the point where it would be beneficial for thecompany to call the bond, yet the company is unable to do so

6. A make-whole call provision should lower the coupon rate in comparison to a call provision withspecific dates since the make-whole call repays the bondholder the present value of the future cashflows However, a make-whole call provision should not affect the coupon rate in comparison to aplain vanilla bond Since the bondholders are made whole, they should be indifferent between a plainvanilla bond and a make-whole bond If a bond with a make-whole provision is called, bondholdersreceive the market value of the bond, which they can reinvest in another bond with similarcharacteristics If we compare this to a bond with a specific call price, investors rarely receive thefull market value of the future cash flows

7. A positive covenant would reduce the coupon rate The presence of positive covenants protectsbondholders by forcing the company to undertake actions that benefit bondholders Examples ofpositive covenants would be: the company must maintain audited financial statements; the companymust maintain a minimum specified level of working capital or a minimum specified current ratio;the company must maintain any collateral in good working order The negative side of positivecovenants is that the company is restricted in its actions The positive covenant may force thecompany into actions in the future that it would rather not undertake

8. A negative covenant would reduce the coupon rate The presence of negative covenants protectsbondholders from actions by the company that would harm the bondholders Remember, the goal of

a corporation is to maximize shareholder wealth This says nothing about bondholders Examples ofnegative covenants would be: the company cannot increase dividends, or at least increase beyond aspecified level; the company cannot issue new bonds senior to the current bond issue; the companycannot sell any collateral The downside of negative covenants is the restriction of the company’sactions

9. Even though the company is not public, a conversion feature would likely lower the coupon rate Theconversion feature would permit bondholders to benefit if the company does well and also goespublic The downside is that the company may be selling equity at a discounted price

10 The downside of a floating-rate coupon is that if interest rates rise, the company has to pay a higher

interest rate However, if interest rates fall, the company pays a lower interest rate

Using this industry EPS, the industry payout ratio is:

Industry payout ratio = $0.40/$1.08 = 3715 or 37.15%

So, the industry retention ratio is

Industry retention ratio = 1 – 3715 = 6285 or 62.85%

CHAPTER 8  C­19  This means the industry growth rate is:

The stock price in Year 5 with the industry required return will be:

Stock value in Year 5 = $3.11 / (.1167 – 0775) = $79.54

This means the total value of the stock today is:

P0 = $1.149/1.1167 + $1.76/1.11672 + $2.07/1.11673 + $2.45/1.11674 + ($2.89 + 79.54) / 1.11675

P0 = $53.28

3. Using the revised industry EPS, the industry PE ratio is:

Industry PE = $13.09 / $1.08 = 12.15

Using the original stock price assumption, Ragan’s PE ratio is:

Ragan PE (original assumptions) = $76.75 / $4.54 = 16.90

Using the revised assumptions, Ragan’s PE = $53.28 / $4.54 = 11.74

Obviously, using the original assumptions, Ragan’s PE is too high The PE using the revisedassumptions is close to the industry PE ratio Using the industry average PE, we can calculate a stockprice for Ragan, which is:

Stock price implied by industry PE = 12.15($4.32) = $55.18

4. If the ROE on the company’s projects exceeds the required return, the company should retainearnings and reinvest If the ROE on the company’s projects is lower than the required return, thecompany should pay dividends This makes logical sense Consider a company with a 10 percentrequired return If the company can keep retained earnings and reinvest those earnings at 15 percent,shareholders would be better off since the dividends in future years would be more than needed forthe required return

BULLOCK GOLD MINING

1. An example spreadsheet is:

D8>(D9+D10+D11+D12),(4+(-D8-D9-D10-D11-D12)/D13),IF(-D8>(D9+D10+D11),(3+(-D8-D9-2. Since the NPV of the mine is positive, the company should open the mine We should note, it may beadvantageous to delay the mine opening because of real options, a topic covered in more detail in alater chapter

3. There are many possible variations on the VBA code to calculate the payback period Below is aVBA program from http://www.vbaexpress.com/kb/getarticle.php?kb_id=252

Function PAYBACK(invest, finflow)

Dim x As Double, v As Double

Dim c As Integer, i As Integer

P = i - 1

Z = x / v PAYBACK = P + Z Exit Function End If

i = i + 1 Loop Until i > c

PAYBACK = "no payback"

End Function

Sales = New sales – Lost sales – Lost revenue

So, the cash flows of the project are:

Payback period = 3.156 years

2. The profitability index is:

Profitability index = [($741,573 / 1.12) + ($7,113,373 / 1.122) + ($11,572,373 / 1.123) +

($13,316,123 / 1.124) + ($20,180,810 / 1.125)] / $21,500,000 Profitability index = 1.604

3. The project IRR is:

IRR: –$21,500,000 = $741,573 / (1 + IRR) + $7,113,373 / (1 + IRR)2 + $11,572,373 / (1 + IRR)3 +

CONCH REPUBLIC ELECTRONICS, 

PART 2

1 Here we want to examine the sensitivity of NPV to changes in the price of the new PDA The

calculations for sensitivity to changes in price are similar to the original cash flows The onlydifference is that we will change the price of the PDA We will use a price of $370 per unit, butremember that the price we choose is irrelevant: The final answer we want, the sensitivity of NPV to

a one dollar change in price will be the same no matter what price we use The projections with thenew prices are:

The sales figure for the first two years will be the sales of the new PDA, minus the lost sales of theexisting PDA, minus the lost dollar sales from the price reduction of the existing PDA, or:

Sales = New sales – Lost sales – Lost revenue

So, the cash flows of the project under this price assumption are:

CHAPTER 11  C­27  And the sensitivity of changes in the NPV to changes in the price is:

ΔNPV/ΔP = ($15,148,716.18 – 12,983,611.62) / ($370 – 360)

ΔNPV/ΔP = $216,510.46

For every dollar change in price of the new PDA, the NPV of the project changes $216,510.46 in thesame direction

2 Here we want to examine the sensitivity of NPV to changes in the quantity sold The calculations for

sensitivity to changes in quantity are similar to the original cash flows The only difference is that we

will change the quantity sold of the new PDA We will increase unit sold by 100 units per year.

Remember that the quantity we choose is irrelevant: The final answer we want, the sensitivity ofNPV to a one unit per year change in sales The projections with the quantity are:

The sales figure for the first two years will be the sales of the new PDA, minus the lost sales of the existing PDA, minus the lost dollar sales from the price reduction of the existing PDA, or:

Sales = New sales – Lost sales – Lost revenue

So, the cash flows of the project under this quantity assumption are:

For a one unit per year change in quantity sold of the new PDA, the NPV of the project changes

$456.91 in the same direction

3 The advantage of the actively managed fund is the possibility of outperforming the market, which

the fund has done six of the last eight years The major disadvantage is the likelihood ofunderperforming the market In general, most mutual funds do not outperform the market for anextended period of time, and finding the funds that will outperform the market in the futurebeforehand is a daunting task One factor that makes outperforming the market even more difficult isthe management fee charged by the fund

4. The returns are the most volatile for the small cap fund because the stocks in this fund are theriskiest This does not imply the fund is bad, just that the risk is higher, and therefore, the expectedreturn is higher You would want to invest in this fund if your risk tolerance is such that you arewilling to take on the additional risk in expectation of a higher return

The higher expenses of the fund are expected In general, small cap funds have higher expenses, inlarge part due to the greater cost of running the fund, including researching smaller stocks

5 Since we are given the average return for each fund over the past 10 years, we should use the

average risk-free rate over the same period So, using the information from Table 10.1, the 10-yearaverage risk-free rate is:

Risk-free rate = (.0486 + 0480 + 0598 + 0333 +.0161 +.0094 +.0114 + 0279 + 0497 + 0452) / 10Risk-free rate = 0349 or 3.49%

The Sharpe ratio for each of the mutual funds and the company stocks are:

Bledsoe S&P 500 Index Fund = (11.48% – 3.49) / 15.82% = 5048

Bledsoe Small-Cap Fund = (16.68% – 3.49) / 19.64% = 6714

Bledsoe Large Company Stock Fund = (11.85% – 3.49) / 15.41% = 5422

Bledsoe Bond Fund = (9.67% – 3.49) / 10.83% = 5703

S&S Air stock = (18% – 3.49) / 70% = 2072

The Sharpe ratio is most applicable for a diversified portfolio, and is least applicable for the

company stock

CHAPTER 12  C­31  

6. This is a very open-ended question The asset allocation depends on the risk tolerance of theindividual However, most students will be young, so in this case, the portfolio allocation should bemore heavily weighted toward stocks

In any case, there should be little, if any, money allocated to the company stock The principle ofdiversification indicates that an individual should hold a diversified portfolio Investing heavily incompany stock does not create a diversified portfolio This is especially true since income comesfrom the company as well If times get bad for the company, employees face layoffs, or reducedwork hours So, not only does the investment perform poorly, but income may be reduced as well

We only have to look at employees of Enron or WorldCom to see the potential for problems withinvesting in company stock At most, 5 to 10 percent of the portfolio should be allocated to companystock

Age is a determinant in the decision Older individuals should be less heavily weighted towardstocks A commonly used rule of thumb is that an individual should invest 100 minus their age instocks Unfortunately, this rule of thumb tends to result in an underinvestment in stocks

THE BETA FOR AMERICAN STANDARD

NOTE: The example below shows the results from May 2008 The actual answer to the case will change based on current market conditions

1 The information used for the analysis is presented below Note that the risk-free rate (3-month T-bill

rate) is expressed as an annual rate It is necessary to find the monthly rate, so this rate is divided by

12

free

Risk-MonthlyRisk-free

Stockprice Return

S&P500

S&P 500return

Stock riskpremium

S&P riskpremiumMay-03 $53.91 963.59

Jun-03 0.0107 0.00089 $52.40 -0.0280 974.5 0.0113 -0.0289 0.0104Jul-03 0.0092 0.00077 $49.58 -0.0538 990.31 0.0162 -0.0546 0.0155Aug-03 0.009 0.00075 $50.20 0.0125 1008.01 0.0179 0.0118 0.0171Sep-03 0.0095 0.00079 $50.75 0.0110 995.97 -0.0119 0.0102 -0.0127Oct-03 0.0094 0.00078 $48.50 -0.0443 1050.71 0.0550 -0.0451 0.0542Nov-03 0.0092 0.00077 $47.87 -0.0130 1058.2 0.0071 -0.0138 0.0064Dec-03 0.0093 0.00078 $45.64 -0.0466 1111.92 0.0508 -0.0474 0.0500Jan-04 0.009 0.00075 $46.97 0.0291 1131.13 0.0173 0.0284 0.0165Feb-04 0.0088 0.00073 $50.80 0.0815 1144.94 0.0122 0.0808 0.0115Mar-04 0.0093 0.00078 $50.48 -0.0063 1126.21 -0.0164 -0.0071 -0.0171Apr-04 0.0094 0.00078 $53.25 0.0549 1107.3 -0.0168 0.0541 -0.0176May-04 0.0094 0.00078 $52.63 -0.0116 1120.68 0.0121 -0.0124 0.0113Jun-04 0.0102 0.00085 $53.78 0.0219 1140.84 0.0180 0.0210 0.0171Jul-04 0.0127 0.00106 $49.16 -0.0859 1101.72 -0.0343 -0.0870 -0.0353Aug-04 0.0133 0.00111 $49.90 0.0151 1104.24 0.0023 0.0139 0.0012Sep-04 0.0148 0.00123 $41.75 -0.1633 1114.58 0.0094 -0.1646 0.0081Oct-04 0.0165 0.00138 $41.45 -0.0072 1130.2 0.0140 -0.0086 0.0126Nov-04 0.0176 0.00147 $42.73 0.0309 1173.82 0.0386 0.0294 0.0371Dec-04 0.0207 0.00173 $47.53 0.1123 1211.92 0.0325 0.1106 0.0307Jan-05 0.0219 0.00183 $49.05 0.0320 1181.27 -0.0253 0.0302 -0.0271Feb-05 0.0233 0.00194 $49.40 0.0071 1203.6 0.0189 0.0052 0.0170Mar-05 0.0254 0.00212 $48.70 -0.0142 1180.59 -0.0191 -0.0163 -0.0212Apr-05 0.0274 0.00228 $46.74 -0.0402 1156.85 -0.0201 -0.0425 -0.0224May-05 0.0278 0.00232 $46.91 0.0036 1191.5 0.0300 0.0013 0.0276Jun-05 0.0284 0.00237 $46.85 -0.0013 1191.33 -0.0001 -0.0036 -0.0025Jul-05 0.0297 0.00248 $49.98 0.0668 1234.18 0.0360 0.0643 0.0335

Aug-05 0.0322 0.00268 $49.56 -0.0084 1220.33 -0.0112 -0.0111 -0.0139

Sep-05 0.0344 0.00287 $49.84 0.0056 1228.81 0.0069 0.0028 0.0041Oct-05 0.0342 0.00285 $50.28 0.0088 1207.01 -0.0177 0.0060 -0.0206Nov-05 0.0371 0.00309 $51.76 0.0294 1249.48 0.0352 0.0263 0.0321Dec-05 0.0388 0.00323 $52.07 0.0060 1248.29 -0.0010 0.0028 -0.0042Jan-06 0.0389 0.00324 $52.39 0.0061 1280.08 0.0255 0.0029 0.0222Feb-06 0.0424 0.00353 $52.00 -0.0074 1280.66 0.0005 -0.0110 -0.0031Mar-06 0.0443 0.00369 $54.50 0.0481 1294.87 0.0111 0.0444 0.0074Apr-06 0.0451 0.00376 $56.75 0.0413 1310.61 0.0122 0.0375 0.0084May-06 0.046 0.00383 $57.92 0.0206 1270.09 -0.0309 0.0168 -0.0348Jun-06 0.0472 0.00393 $57.50 -0.0073 1270.2 0.0001 -0.0112 -0.0038Jul-06 0.0479 0.00399 $57.23 -0.0047 1276.66 0.0051 -0.0087 0.0011Aug-06 0.0495 0.00413 $57.75 0.0091 1303.82 0.0213 0.0050 0.0171Sep-06 0.0496 0.00413 $59.92 0.0376 1335.85 0.0246 0.0334 0.0204Oct-06 0.0481 0.00401 $62.05 0.0355 1377.94 0.0315 0.0315 0.0275Nov-06 0.0492 0.0041 $63.10 0.0169 1400.63 0.0165 0.0128 0.0124Dec-06 0.0494 0.00412 $63.28 0.0029 1418.3 0.0126 -0.0013 0.0085Jan-07 0.0485 0.00404 $66.57 0.0520 1438.24 0.0141 0.0479 0.0100Feb-07 0.0498 0.00415 $65.70 -0.0131 1406.82 -0.0218 -0.0172 -0.0260Mar-07 0.0503 0.00419 $65.10 -0.0091 1420.86 0.0100 -0.0133 0.0058Apr-07 0.0494 0.00412 $66.38 0.0197 1482.37 0.0433 0.0155 0.0392May-07 0.0487 0.00406 $65.62 -0.0114 1530.62 0.0325 -0.0155 0.0285Jun-07 0.0473 0.00394 $63.55 -0.0315 1503.35 -0.0178 -0.0355 -0.0218Jul-07 0.0461 0.00384 $65.02 0.0231 1455.27 -0.0320 0.0193 -0.0358Aug-07 0.0482 0.00402 $65.34 0.0049 1473.99 0.0129 0.0009 0.0088Sep-07 0.042 0.0035 $70.26 0.0753 1526.75 0.0358 0.0718 0.0323Oct-07 0.0389 0.00324 $75.51 0.0747 1549.38 0.0148 0.0715 0.0116Nov-07 0.039 0.00325 $79.28 0.0499 1481.14 -0.0440 0.0467 -0.0473Dec-07 0.0327 0.00273 $77.18 -0.0265 1468.36 -0.0086 -0.0292 -0.0114Jan-08 0.03 0.0025 $76.10 -0.0140 1378.55 -0.0612 -0.0165 -0.0637Feb-08 0.0275 0.00229 $75.70 -0.0053 1330.63 -0.0348 -0.0075 -0.0371Mar-08 0.0212 0.00177 $77.51 0.0239 1322.7 -0.0060 0.0221 -0.0077Apr-08 0.0126 0.00105 $70.70 -0.0879 1385.59 0.0475 -0.0889 0.0465May-08 0.0129 0.00108 $72.15 0.0205 1394.35 0.0063 0.0194 0.0052

Using the Excel functions for the average return and standard deviation, the table below shows theaverages and standard deviations for each of the series

2 Jensen’s alpha represents the excess return not explained by the beta of the stock A positive alpha

plots above the Security Market Line and has a return in excess of its systematic risk The residual isthe error in the estimation, and is the portion of the return not explained by the market model

3. The relevant output from Excel for this period is:

5. The beta for Colgate-Palmolive on Yahoo! Finance at the time was 0.16, which is similar to theseestimates Possible reasons for the difference could be different data For example Yahoo! Financeuses 36 months of returns, but they do not specify the risk-free rate, or the market proxy the use