10.Return and Risk.doc

Exercise for PROJECT INVESTMENT EVALUATION:
You have been asked to develop a bid price. The contract will be for 8 years and will result in a guaranteed sale of $9,000 per year. Fixed costs will be $550,000 per year. The equipment for the production line has an installed cost of $2,700,000 and it can be sold for $450,000 at the end of the project. The equipment will be depreciated straight-line over the 8-year life of the project. You will need $800,000 in working capital which will be recovered at the end of the project. The variable production costs are $790 per canoe. If your tax rate is 34% and the discount rate is 14%, what is the lowest bid price that should be submitted for the contract? ( PVIFA 8,14% = )
RETURN & RISK
NPV approach
Discount rate
The relationship between risk levels and required discount rates.
CALCULATING RETURNS
Dividend or Interest Payment:
Dividend Yield = Dt+1
P1
Capital Gain or Loss:
Capital Gain Yield = Pt+1 – Pt
Pt
Return = Dt+1 + (Pt+1 – Pt)
Pt
EXAMPLE: CALCULATING RETURNS
You purchased a bond on January 1st, 2000 that had a face value of $1,000, an 8% annual coupon, and pounding.
You paid $ and you subsequently sold the bond at the end of December 2000 for $.
What was your percent rate of return for the year with this investment?
HISTORICAL RECORD
AVERAGE ANNUAL RETURNS
1949-97
TYPE OF
INVESTMENT AVERAGE RETURN
mon
Stocks %
Stocks
( in Can $)
Long Bonds
Treasury Bills
Small Stocks
INFLATON
Over the period from 1948-97, risk free investments earned %.
Using this risk free value, we can calculate the risk premium required for riskier investments over that same period.

AVERAGE ANNUAL RETURNS
& RISK PREMIUMS
1949-97
TYPE OF AVERAGE RISK
INVESTMENT RETURN PREMIUM
mon
Stocks % %
Stocks
( in Can $)
Long Bonds
Small Stocks
Treasury Bills
INFLATION -
AV