1.We begin by breaking down the prices of these stocks using the dividend discount growth model.

(a)Report the stock price and book value per share, alongside the forecasted dividend and earnings pershare, using any reasonable estimate. Going by these statistics, which of your stocks looks more like anincome stock and which looks more like a growth stock?

(b)For each stock, calculate the payout ratio and return on book equity, and compute the growth ratethat this implies.

(c)For each stock, calculate the market capitalization rate, and break down the share price into thelevel earnings and growth opportunities components.

2.For the sake of simplicity, assume that in each year, each company has a single investment opportunityto plow back some percentage of its earnings to generate annual cash flows at a rate equal to the its currentreturn on book equity.

(a)For each company, consider the investment opportunity available next year (t = 1). Calculate thepayback period, internal rate of return, and net present value NP V1 of next year’s investment opportunity.Are these projects worth pursuing?

(b)Now consider each company’s investment opportunity at t = 2, with annual earnings permanentlyincreased by the cash flows from the year 1 investment. If the firm continues to plow back the sameproportion of earnings and earns the same return on equity, what is the net present value NP V2 of theproject?

(c)If each company continued to plow back earnings at the same rate and earn the same return onequity, what would be the present value of all its future growth opportunities? Does this match youranswer from #1?

3.We will now analyze the historical returns of your chosen stocks. You may choose any time period andfrequency you deem suitable, but make sure that all of your returns are reported as annualized rates. You willwant to use the adjusted closing price to automatically account for the effects of dividends and splits.

(a)For each stock as a well as a suitable market index, report the mean and standard deviation ofreturns.

(b)Find the variance-covariance matrix of the two stocks and the market index, and report the beta ofeach stock.

(c)We now consider the benefits of diversifying by constructing a portfolio consisting of both of yourstocks. For each value of x = {0, 0.1, 0.2, . . . , 1}, consider a portfolio with a proportion x of your wealthinvested in your first stock and 1?x invested in the second, and compute the mean and standard deviationof the portfolio return.

(d)Assume a risk free rate of rf = 0.01. In a well-diversified portfolio, only market risk matters, sothe risk premium of any stock should be proportional to its beta. If this were true, what should be thereturns you expect to earn from your two stocks, and how does this compare to their historical averages?