Board of Directors Report for Bunyan Lumber Corporation Subject: Evaluation of Investment Opportunities and Risk-Return PrinciplesFrom: Financial ConsultantDate: 5/24/2024 This report addresses ...

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Board of Directors Report for Bunyan Lumber Corporation
Subject: Evaluation of Investment Opportunities and Risk-Return PrinciplesFrom: Financial ConsultantDate: 5/24/2024
This report addresses the questions posed by the board, working in conjunction with CFO Anita Rai, to analyze potential investments and related financial concepts.
a. Analysis of Market Risk and Performance
1. Determining Higher Market Risk:Market risk is often evaluated using the beta coefficient (?), which shows how a stock responds to market-wide movements.
A larger beta value signals greater exposure to market fluctuations.
For instance,
Aardvark Enterprises has a beta of 1.6,
Zebra Enterprises has a beta of 2.5
Conclusion: From this, Zebra can be seen as carrying more market-related risk than Aardvark, since 2.5 is noticeably higher than 1.6.
2. Expected Performance in a Strong Market:In a strong market with positive economic news and higher GDP figures, stocks with higher betas are expected to perform better. This is because they are more sensitive to overall market movements.
Conclusion: Zebra Enterprises forecasted to achieve better results. Its higher beta (2.5) means it should experience a larger percentage increase in its expected return compared to the market and to Aardvark Enterprises (beta 1.6) during a market upswing.
b. Calculation of Arithmetic and Geometric Returns
The formula for Arithmetic Mean Return is the simple average: (Sum of Returns) / Number of Years.The formula for Geometric Mean Return is: [(1+R1) × (1+R2) × ... × (1+Rn)]^(1/n) - 1
Aardvark Enterprises
Annual returns: 2019 = -18%, 2020 = 44%, 2021 = -22%, 2022 = 22%, 2023 = 34%
Total of returns = (-18 + 44 – 22 + 22 + 34) = 60%
Arithmetic mean = 60% / 5 = 12.0%
Geometric mean:
(0.82 × 1.44 × 0.78 × 1.22 × 1.34)^(1/5) - 1
= (1.477)^(0.2) - 1
= 1.0812 - 1 = 0.0812 ? 8.12%
Zebra Enterprises
Annual returns: 2019 = -24%, 2020 = 24%, 2021 = -4%, 2022 = 8%, 2023 = 56%
Total of returns = (-24 + 24 – 4 + 8 + 56) = 60%
Arithmetic mean = 60% / 5 = 12.0%
Geometric mean:
(0.76 × 1.24 × 0.96 × 1.08 × 1.56)^(1/5) - 1
= (1.524)^(0.2) - 1
= 1.0879 - 1 = 0.0879 ? 8.79%
Stock Arithmetic Return Geometric Return
Aardvark 12.00% 8.12%
Zebra 12.00% 8.79%
c. Standard Deviation and Total Risk
The standard deviation is a measure of total variability in returns, capturing both market-wide (systematic) and company-specific (unsystematic) risk. A larger value for standard deviation suggests greater fluctuations and therefore higher overall risk.
For Zebra Enterprises, the standard deviation is already provided as 30.19%.
Aardvark Enterprises Calculation
1. The average return from part (b) was 12%, or 0.12 in decimal form.
2. Next, subtract this mean from each annual return an