This assignment is due Sunday 9.30 pm EST Complete  the following: Case Problem 4.1 A-F (page 154) Case Problem 4.2 A-D (page 155) Case Problem 5.1 A-E (page 208) Case Problem 5.2 A-E (page 209) Case Problem 13.1 A-E (page 543) Format  your submission consistent with APA guidelines. Case Problem 4.1 A-F (page 154) Case Problem 4.1 Coates’s Decision 1. LG 2 2. LG 4 On January 1, 2017, Dave Coates, a 23-year-old mathematics teacher at Xavier High School, received a tax refund of $1,100. Because Dave didn’t need this money for his current living expenses, he decided to make a long-term investment. After surveying a number of alternative investments costing no more than $1,100, Dave isolated two that seemed most suitable to his needs. Each of the investments cost $1,050 and was expected to provide income over a 10-year period. Investment A provided a relatively certain stream of income. Dave was a little less certain of the income provided by investment B. From his search for suitable alternatives, Dave found that the appropriate discount rate for a relatively certain investment was 4%. Because he felt a bit uncomfortable with an investment like B, he estimated that such an investment would have to provide a return at least 4% higher than investment A. Although Dave planned to reinvest funds returned from the investments in other vehicles providing similar returns, he wished to keep the extra $50 ($1,100 − $1,050) invested for the full 10 years in a savings account paying 3% interest compounded annually. As he makes his investment decision, Dave has asked for your help in answering the questions that follow the expected return data for these investments. Expected Returns End of Year A B 2017 $   50 $  0 2018 $   50 $150 2019 $   50 $150 2020 $   50 $150 2021 $   50 $200 2022 $   50 $250 2023 $   50 $200 2024 $   50 $150 2025 $   50 $100 2026 $1,050 $ 50 Questions a. Assuming that investments A and B are equally risky and using the 4% discount rate, apply the present value technique to assess the acceptability of each investment and to determine the preferred investment. Explain your findings. b. Recognizing that investment B is more risky than investment A, reassess the two alternatives, adding the 4% risk premium to the 4% discount rate for investment A and therefore applying a 8% discount rate to investment B. Compare your findings relative to acceptability and preference to those found for question  a . c. From your findings in questions  a  and  b , indicate whether the IRR for investment A is above or below 4% and whether that for investment B is above or below 8%. Explain. d. Use the present value technique to estimate the IRR on each investment. Compare your findings and contrast them with your response to question  c . e. From the information given, which, if either, of the two investments would you recommend that Dave make? Explain your answer. f. Indicate to Dave how much money the extra $50 will have grown to by the end o.

1. This assignment is due Sunday 9.30 pm EST
Complete
the following:
Case Problem 4.1 A-F (page 154)
Case Problem 4.2 A-D (page 155)
Case Problem 5.1 A-E (page 208)
Case Problem 5.2 A-E (page 209)
Case Problem 13.1 A-E (page 543)
Format
your submission consistent with APA guidelines.
Case Problem 4.1 A-F (page 154)
Case Problem 4.1 Coates’s Decision
1.
LG 2
2.
LG 4
On January 1, 2017, Dave Coates, a 23-year-old mathematics
teacher at Xavier High School, received a tax refund of $1,100.
Because Dave didn’t need this money for his current living
expenses, he decided to make a long-term investment. After
surveying a number of alternative investments costing no more
than $1,100, Dave isolated two that seemed most suitable to his
needs.
Each of the investments cost $1,050 and was expected to
provide income over a 10-year period. Investment A provided a
relatively certain stream of income. Dave was a little less
certain of the income provided by investment B. From his

2. search for suitable alternatives, Dave found that the appropriate
discount rate for a relatively certain investment was 4%.
Because he felt a bit uncomfortable with an investment like B,
he estimated that such an investment would have to provide a
return at least 4% higher than investment A. Although Dave
planned to reinvest funds returned from the investments in other
vehicles providing similar returns, he wished to keep the extra
$50 ($1,100 − $1,050) invested for the full 10 years in a savings
account paying 3% interest compounded annually.
As he makes his investment decision, Dave has asked for your
help in answering the questions that follow the expected return
data for these investments.
Expected Returns
End of Year
A
B
2017
$ 50
$ 0
2018
$ 50
$150
2019
$ 50
$150
2020
$ 50
$150
2021
$ 50
$200
2022
$ 50
$250
2023

3. $ 50
$200
2024
$ 50
$150
2025
$ 50
$100
2026
$1,050
$ 50
Questions
a.
Assuming that investments A and B are equally risky and using
the 4% discount rate, apply the present value technique to
assess the acceptability of each investment and to determine the
preferred investment. Explain your findings.
b.
Recognizing that investment B is more risky than investment A,
reassess the two alternatives, adding the 4% risk premium to the
4% discount rate for investment A and therefore applying a 8%
discount rate to investment B. Compare your findings relative to
acceptability and preference to those found for question
a
.
c.
From your findings in questions
a
and
b
, indicate whether the IRR for investment A is above or below
4% and whether that for investment B is above or below 8%.
Explain.

4. d.
Use the present value technique to estimate the IRR on each
investment. Compare your findings and contrast them with your
response to question
c
.
e.
From the information given, which, if either, of the two
investments would you recommend that Dave make? Explain
your answer.
f.
Indicate to Dave how much money the extra $50 will have
grown to by the end of 2026, assuming he makes no withdrawals
from the savings account.
Case Problem 4.2 A-D (page 155)
Case Problem
4.2
The Risk-Return Tradeoff: Molly O’Rourke’s Stock Purchase
Decision
Over the past 10 years, Molly O’Rourke has slowly built a
diversified portfolio of common stock. Currently her portfolio
includes 20 different common stock issues and has a total
market value of $82,500.
Molly is at present considering the addition of 50 shares of
either of two common stock issues—X or Y. To assess the
return and risk of each of these issues, she has gathered
dividend income and share price data for both over the last 10
years (2007–2016). Molly’s investigation of the outlook for
these issues suggests that each will, on average, tend to behave
in the future just as it has in the past. She therefore believes

5. that the expected return can be estimated by finding the average
HPR over the past 10 years for each of the stocks. The historical
dividend income and stock price data collected by Molly are
given in the accompanying table.
Stock X
Stock Y
Share Price
Share Price
Dividend
Dividend
Year
Income
Beginning
Ending
Income
Beginning
Ending
2007
$1.00
$20.00
$22.00
$1.50
$20.00
$20.00
2008
$1.50
$22.00

6. $21.00
$1.60
$20.00
$20.00
2009
$1.40
$21.00
$24.00
$1.70
$20.00
$21.00
2010
$1.70
$24.00
$22.00
$1.80
$21.00
$21.00
2011
$1.90
$22.00
$23.00
$1.90
$21.00
$22.00
2012
$1.60
$23.00
$26.00
$2.00
$22.00
$23.00
2013
$1.70
$26.00
$25.00

7. $2.10
$23.00
$23.00
2014
$2.00
$25.00
$24.00
$2.20
$23.00
$24.00
2015
$2.10
$24.00
$27.00
$2.30
$24.00
$25.00
2016
$2.20
$27.00
$30.00
$2.40
$25.00
$25.00
Questions
a.
Determine the HPR for each stock in each of the preceding 10
years. Find the expected return for each stock, using the
approach specified by Molly.
b.
Use the HPRs and expected return calculated in question
a

8. to find the standard deviation of the HPRs for each stock over
the 10-year period.
c.
Use your findings to evaluate and discuss the return and risk
associated with stocks X and Y. Which stock seems preferable?
Explain.
d.
Ignoring her existing portfolio, what recommendations would
you give Molly with regard to stocks X and Y?
Case Problem 5.1 A-E (page 208)
Case Problem
2.1
Traditional Versus Modern Portfolio Theory: Who’s Right?
1.
LG
5
2.
LG
6
Walt Davies and Shane O’Brien are district managers for Lee,
Inc. Over the years, as they moved through the firm’s sales
organization, they became (and still remain) close friends. Walt,
who is 33 years old, currently lives in Princeton, New Jersey.
Shane, who is 35, lives in Houston, Texas.
Recently, at the national sales meeting, they were discussing

9. various company matters, as well as bringing each other up to
date on their families, when the subject of investments came up.
Each had always been fascinated by the stock market, and now
that they had achieved some degree of financial success, they
had begun actively investing.
As they discussed their investments, Walt said he thought the
only way an individual who does not have hundreds of
thousands of dollars can invest safely is to buy mutual fund
shares. He emphasized that to be safe, a person needs to hold a
broadly diversified portfolio and that only those with a lot of
money and time can achieve independently the diversification
that can be readily obtained by purchasing mutual fund shares.
Shane totally disagreed. He said, “Diversification! Who needs
it?” He thought that what one must do is look carefully at stocks
possessing desired risk-return characteristics and then invest all
one’s money in the single best stock. Walt told him he was
crazy. He said, “There is no way to measure risk conveniently—
you’re just gambling.” Shane disagreed. He explained how his
stockbroker had acquainted him with beta, which is a measure
of risk. Shane said that the higher the beta, the more risky the
stock, and therefore the higher its return. By looking up the
betas for potential stock investments on the Internet, he can
pick stocks that have an acceptable risk level for him. Shane
explained that with beta, one does not need to diversify; one
merely needs to be willing to accept the risk reflected by beta
and then hope for the best.
The conversation continued, with Walt indicating that although
he knew nothing about beta, he didn’t believe one could safely
invest in a single stock. Shane continued to argue that his
broker had explained to him that betas can be calculated not just
for a single stock but also for a portfolio of stocks, such as a
mutual fund. He said, “What’s the difference between a stock
with a beta of, say, 1.2 and a mutual fund with a beta of 1.2?
They have the same risk and should therefore provide similar
returns.”
As Walt and Shane continued to discuss their differing opinions

10. relative to investment strategy, they began to get angry with
each other. Neither was able to convince the other that he was
right. The level of their voices now raised, they attracted the
attention of the company’s vice president of finance, Elinor
Green, who was standing nearby. She came over and indicated
she had overheard their argument about investments and thought
that, given her expertise on financial matters, she might be able
to resolve their disagreement. She asked them to explain the
crux of their disagreement, and each reviewed his own
viewpoint. After hearing their views, Elinor responded, “I have
some good news and some bad news for each of you. There is
some validity to what each of you says, but there also are some
errors in each of your explanations. Walt tends to support the
traditional approach to portfolio management. Shane’s views are
more supportive of modern portfolio theory.” Just then, the
company president interrupted them, needing to talk to Elinor
immediately. Elinor apologized for having to leave and offered
to continue their discussion later that evening.
Questions
a.
Analyze Walt’s argument and explain why a mutual fund
investment may be overdiversified. Also explain why one does
not necessarily have to have hundreds of thousands of dollars to
diversify adequately.
b.
Analyze Shane’s argument and explain the major error in his
logic relative to the use of beta as a substitute for
diversification. Explain the key assumption underlying the use
of beta as a risk measure.
c.
Briefly describe the traditional approach to portfolio
management and relate it to the approaches supported by Walt
and Shane.

11. d.
Briefly describe modern portfolio theory and relate it to the
approaches supported by Walt and Shane. Be sure to mention
diversifiable risk, undiversifiable risk, and total risk, along with
the role of beta.
e.
Explain how the traditional approach and modern portfolio
theory can be blended into an approach to portfolio management
that might prove useful to the individual investor. Relate this to
reconciling Walt’s and Shane’s differing points of view.
Case Problem 5.2 A-E (page 209)
Case Problem
5.2
Susan Lussier’s Inherited Portfolio: Does It Meet Her Needs?
1.
LG
3
2.
LG
4
3.
LG
5
4.

12. LG
6
Susan Lussier is 35 years old and employed as a tax accountant
for a major oil and gas exploration company. She earns nearly
$135,000 a year from her salary and from participation in the
company’s drilling activities. An expert on oil and gas taxation,
she is not worried about job security—she is content with her
income and finds it adequate to allow her to buy and do
whatever she wishes. Her current philosophy is to live each day
to its fullest, not concerning herself with retirement, which is
too far in the future to require her current attention.
A month ago, Susan’s only surviving parent, her father, was
killed in a sailing accident. He had retired in La Jolla,
California, two years earlier and had spent most of his time
sailing. Prior to retirement, he managed a children’s clothing
manufacturing firm in South Carolina. Upon retirement he sold
his stock in the firm and invested the proceeds in a security
portfolio that provided him with supplemental retirement
income of over $30,000 per year. In his will, he left his entire
estate to Susan. The estate was structured in such a way that in
addition to a few family heirlooms, Susan received a security
portfolio having a market value of nearly $350,000 and about
$10,000 in cash.
Susan’s father’s portfolio contained 10 securities: 5 bonds, 2
common stocks, and 3 mutual funds. The following table lists
the securities and their key characteristics. The common stocks
were issued by large, mature, well-known firms that had
exhibited continuing patterns of dividend payment over the past
five years. The stocks offered only moderate growth potential—
probably no more than 2% to 3% appreciation per year. The
mutual funds in the portfolio were income funds invested in
diversified portfolios of income-oriented stocks and bonds.
They provided stable streams of dividend income but offered
little opportunity for capital appreciation.
Bonds

13. Par Value ($)
Issue
S&P Rating
Interest Income ($)
Quoted Price ($)
Total Cost ($)
Current Yield (%)
40,000
Delta Power and Light 10.125% due 2029
AA
$4,050
$ 98.000
$39,200
10.33%
30,000
Mountain Water 9.750% due 2021
A
$2,925
$102.000
$30,600
9.56%
50,000
California Gas 9.500% due 2016
AAA
$4,750
$ 97.000
$48,500
9.79%
20,000
Trans-Pacific Gas 10.000% due 2027
AAA
$2,000
$ 99.000
$19,800
10.10%
20,000

14. Public Service 9.875% due 2017
AA
$1,975
$100.000
$20,000
9.88%
The Securities Portfolio That Susan Lussier Inherited
Common Stocks
Number of Shares
Company
Dividend per Share ($)
Dividend Income ($)
Price per Share ($)
Total Cost ($)
Beta
Dividend Yield (%)
2,000
International Supply
$2.40
$4,800
$22
$44,900
0.97
10.91%
3,000
Black Motor
$1.50
$4,500
$17
$52,000
0.85
8.82%

15. Mutual Funds
Number of Shares
Fund
Dividend per Share Income ($)
Dividend Income ($)
Price per Share ($)
Total Cost
Beta
Dividend Yield (%)
2,000
International Capital Income A Fund
$0.80
$1,600
$10
$20,000
1.02
8.00%
1,000
Grimner Special Income Fund
$2.00
$2,000
$15
$15,000
1.10
7.50%
4,000
Ellis Diversified Income Fund
$1.20
$4,800
$12

16. $48,000
0.90
10.00%
Total annual income: $33,400
Portfolio value: $338,000
Portfolio current yield: 9.88%
Now that Susan owns the portfolio, she wishes to determine
whether it is suitable for her situation. She realizes that the high
level of income provided by the portfolio will be taxed at a rate
(federal plus state) of about 40%. Because she does not
currently need it, Susan plans to invest the after-tax income
primarily in common stocks offering high capital gain potential.
During the coming years she clearly needs to avoid generating
taxable income. (Susan is already paying out a sizable portion
of her income in taxes.) She feels fortunate to have received the
portfolio and wants to make certain it provides her with the
maximum benefits, given her financial situation. The $10,000
cash left to her will be especially useful in paying brokers’
commissions associated with making portfolio adjustments.
Questions
a.
Briefly assess Susan’s financial situation and develop a
portfolio objective for her that is consistent with her needs.
b.
Evaluate the portfolio left to Susan by her father. Assess its
apparent objective and evaluate how well it may be doing in
fulfilling this objective. Use the total cost values to describe the
asset allocation scheme reflected in the portfolio. Comment on
the risk, return, and tax implications of this portfolio.
c.

17. If Susan decided to invest in a security portfolio consistent with
her needs—indicated in response to question a—describe the
nature and mix, if any, of securities you would recommend she
purchase. Discuss the risk, return, and tax implications of such
a portfolio.
d.
From the response to question b, compare the nature of the
security portfolio inherited by Susan with what you believe
would be an appropriate security portfolio for her, based on the
response to question c.
e.
What recommendations would you give Susan about the
inherited portfolio? Explain the steps she should take to adjust
the portfolio to her needs.
Case Problem 13.1 A-E (page 543)
Case Problem
13.1
Assessing the Stalchecks’s Portfolio Performance
1.
LG
3
2.
LG
4
Mary and Nick Stalcheck have an investment portfolio
containing four investments. It was developed to provide them
with a balance between current income and capital appreciation.

18. Rather than acquire mutual fund shares or diversify within a
given class of investments, they developed their portfolio with
the idea of diversifying across various asset classes. The
portfolio currently contains common stock, industrial bonds,
mutual fund shares, and options. They acquired each of these
investments during the past three years, and they plan to
purchase other investments sometime in the future.
Currently, the Stalchecks are interested in measuring the return
on their investment and assessing how well they have done
relative to the market. They hope that the return earned over the
past calendar year is in excess of what they would have earned
by investing in a portfolio consisting of the S&P 500 Stock
Composite Index. Their research has indicated that the risk-free
rate was 7.2% and that the (before-tax) return on the S&P 500
portfolio was 10.1% during the past year. With the aid of a
friend, they have been able to estimate the beta of their
portfolio, which was 1.20. In their analysis, they have planned
to ignore taxes because they feel their earnings have been
adequately sheltered. Because they did not make any portfolio
transactions during the past year, all of the Stalchecks’s
investments have been held more than 12 months, and they
would have to consider only unrealized capital gains, if any. To
make the necessary calculations, the Stalchecks have gathered
the following information on each investment in their portfolio.
Common stock
. They own 400 shares of KJ Enterprises common stock. KJ is a
diversified manufacturer of metal pipe and is known for its
unbroken stream of dividends. Over the past few years, it has
entered new markets and, as a result, has offered moderate
capital appreciation potential. Its share price has risen from
$17.25 at the start of the last calendar year to $18.75 at the end
of the year. During the year, quarterly cash dividends of $0.20,
$0.20, $0.25, and $0.25 were paid.
Industrial bonds
. The Stalchecks own eight Cal Industries bonds. The bonds
have a $1,000 par value, have a 9.250% coupon, and are due in

19. 2027. They are A-rated by Moody’s. The bonds were quoted at
97.000 at the beginning of the year and ended the calendar year
at 96.375%.
Mutual fund
. The Stalchecks hold 500 shares in the Holt Fund, a balanced,
no-load mutual fund. The dividend distributions on the fund
during the year consisted of $0.60 in investment income and
$0.50 in capital gains. The fund’s NAV at the beginning of the
calendar year was $19.45, and it ended the year at $20.02.
Options.
The Stalchecks own 100 options contracts on the stock of a
company they follow. The value of these contracts totaled
$26,000 at the beginning of the calendar year. At year-end the
total value of the options contracts was $29,000.
Questions
a.
Calculate the holding period return on a before-tax basis for
each of these four investments.
b.
Assuming that the Stalchecks’s ordinary income is currently
being taxed at a combined (federal and state) tax rate of 38%
and that they would pay a 15% capital gains tax on dividends
and capital gains for holding periods longer than 12 months,
determine the after-tax HPR for each of their four investments.
c.
Recognizing that all gains on the Stalchecks’s investments were
unrealized, calculate the before-tax portfolio HPR for their
four-investment portfolio during the past calendar year.
Evaluate this return relative to its current income and capital
gain components.
d.

20. Use the HPR calculated in question c to compute Jensen’s
measure (Jensen’s alpha). Use that measure to analyze the
performance of the Stalchecks’s portfolio on a risk-adjusted,
market-adjusted basis. Comment on your finding. Is it
reasonable to use Jensen’s measure to evaluate a four-
investment portfolio? Why or why not?
e.
On the basis of your analysis in questions a, c, and d, what, if
any, recommendations might you offer the Stalchecks relative to
the revision of their portfolio? Explain your recommendations.