Groupbased assignment for Financial data analysis Essay

Groupbased assignment for Financial data analysis - Essay Example The report analyses the risk and return of these two companies. Then the cost structure of these companies is compared. The first part of the report focuses on calculating the means and the variances of the two companies. 'Mean' provides a measure of average return to investors while the 'variance' and hence the 'standard deviation' indicate risk. The second part of this report focuses on calculating the cost of capital for DGSE COMPANIES INC to aid the appraisal of a project under scrutiny. The cost of capital is the "opportunity cost of an investment; that is, the rate of return that a company would otherwise be able to earn at the same risk level as the investment that has been selected". CAPM will be used as the model. The equity cost of capital is found by accumulating the data relating to the company's and market returns at different points in time. The calculations yield a mean value of 0.026557 for DGSE COMPANIES INC and 0.014395 for PUBLIC SERVICE ENTRP GRP INC. These figures can be interpreted as for an investor investing $1 in DGSE COMPANIES INC and $1 in PUBLIC SERVICE ENTRP GRP INC, after a month he will get an average holding period return of 2.6 cents and 1.4 cents on his investments respectively. The Variance and the closely related Standard Deviation are measures of dispersions, which indicate how the possible values are spread around the mean and are an indicator of risk. For the purpose of calculations, the following formula is used for variance: As per the calculations, the monthly variance for DGSE COMPANIES INC is 0.0401 (4.01 %) and for PUBLIC SERVICE ENTRP GRP INC is 0.0050 (0.5%). The square roots of these figures give the monthly standard deviation which equals 0.200 (20%) and 0.0707 (7%), respectively. The Variance is indicative of volatility, hence the risk. It indicates how risky the investment is. A Comparison of risk and return of the two companies will give a clear idea. Table 1. RISK - RETURN RELATIONSHIP S.No Company Name Risk (%) Variance Return (%) - Mean 1 DGSE COMPANIES INC 4.01 2.6 2 PUBLIC SERVICE ENTRP GRP INC 0.5 1.4 The famous phrase "Higher the risk, higher the return" holds well in our case. Chart 1 Source: Primary Table 2. YEAR WISE RETURN COMPARISON YEAR DGSE PUBLIC 1997 0.0932 0.0212 1998 0.0418 0.0270 1999 0.0895 -0.0058 2000 0.0449 0.0401 2001 -0.0188 0.0034 2002 -0.0849 -0.0142 2003 0.0806 0.0318 2004 0.0199 0.0202 2005 -0.0269 0.0229 2006 0.0261 0.0063 Chart 2 Source: Primary CALCULATION OF MINIMUM VARIANCE PORTFOLIO S.No Company Name Risk (%) Variance Return (%) - Mean 1 DGSE COMPANIES INC 4.01 2.6 2 PUBLIC SERVICE ENTRP GRP INC 0.5 1.4 The total portfolio return considering equal proportion of each companies share is (0.5)*2.6 + (0.5)*1.4 = 2% By Trial and error method, the minimum variance portfolio is arrived at respective