Calculation Of Expected Return And Portfolio Beta Using CAPM Model

Computation of annual interest rate

• According to the question, bank has given loan to Grain Plus Ltd at the rate of 4% which is 1% above Reserve Bank of Australia cash rate. Bank has also added a condition to maintain a minimum balance of 20% of loan amount in its current bank account.

Computation of annual interest rate:

Particulars	Amount in $
Funds Needed (a)	2,40,000 Save Time On Research and Writing Hire a Pro to Write You a 100% Plagiarism-Free Paper. Get My Paper
Interest Rate (RBA) (given)	3.00%
Interest rate (Bank) [1% + 3%]	4.00%
Minimum Balance required in bank ($ 2,40,000 * 20%)	48,000
Current balance in bank (given)	4,000
Additional Funds Required ($48,000 – $4,000) (b)	44,000
Total funds required (a + b)	2,84,000
Interest charged for 3 months ($2,84,000 * 4% * 3/12)	2,840
Annual Rate ($2,840/$2,40,000*12/3*100)	4.73%

• The company should accept the offer of the Bank if it offers lower interest rate than RBA cash rate. Since the interest rate is less than the cash rate of RBA Company can invest its unused loan amount in the term deposits and earn higher rate of interest on it. This will improve the utilization of the amount available with the company which is not currently in the use.

According to the given information answers are calculated at below:

1. Expected return of the Portfolio means the weighted average of returns of the individual securities constituting the portfolio.

Formula for calculating expected return of portfolio:

Where

r_p = Expected return of the portfolio

n = Total number of securities in a portfolio

X_i = Proportionate share of individual securities in a portfolio

r_i= Expected return of individual securities in a portfolio

Ans.r_p= (0.2*16%)+(0.3*14%)+ (0.15*20%)+(0.25*12%)+(0.1*24%)

r_p =15.80% 

1. Portfolio Beta (β) means the weighted average of Beta of individual securities included in the portfolio.

Portfolio Beta (β) is calculated as follows:

Where

β_p = Portfolio Beta

X_i = Proportionate share of individual securities in a portfolio

β_i = Value of Beta of individual securities in a portfolio

n= Total number of securities in a portfolio

Ans.β_p = (0.2*1)+(0.3*0.85)+(0.15*1.2)+(0.25*0.6)+(0.1*1.6)

β_p = 0.945

1. Security market line is the graphical representation of CAPM. It defines the relationship between Beta and return of individual securities.

Thus, Y-Axis indicates expected Return of individual securities and X-Axis indicates Beta of individual securities.

Thus, expected return based on CAPM for individual securities is calculated as follows:

r_i= R_f + β (R_m – R_f)

r_i= Expected return of individual securities in a portfolio

R_f = Risk Free rate = 7% (Given)

R_m = Expected rate of market portfolio = 15.5% (Given)

β = Beta of individual securities (Given)

R_m – R_f = Risk Premium i.e. 15.5% – 7% = 8.5%

Shares	Beta (β)	Expected Return (ri) as per CAPM
Harvey Norman Holdings Ltd	1.00	15.5%
National Australia Bank Ltd	0.85	14.23%
Qantas Airways Ltd	1.20	17.20%
Origin Energy Ltd	0.60	12.10%
BHP Billiton Ltd	1.60	20.60%

(Source: Refer PART B excel sheet for calculation).

Security market Line (SML):

Shares:

As per Expected return based on CAPM, it is concluded that BHP Billion Ltd is winner having highest 20.60% return and Origin Energy Ltd is loser having least 12.10% return.

As per Beta (β), it is concluded that Origin Energy Ltd is winner having least degree of risk that is 0.60 and BHP Billion Ltd is loser having highest degree of risk that is 1.60.

1. Answer of point (d) is only based on Expected return and Beta of the company which is not certain because for deciding which company is better and which is worst is also based on other factors like market share of return, solvency ratios, profitability ratios, capital structure ratios etc. of the company to determine which company is better for investment and which companies are not.

Part C

• Below is the calculation of required rate of return of ORICA LIMITED and NEWCRESTMINING LIMITED as per Capital Asset Pricing Model (CAPM):

CAPM model is used for set off relationship between risk and return. It is developedwith a goal of producing future returns to an investor from portfolio of assets. Thus, it is very useful for investment decisions.

Thus, expected return based on CAPM

r_i = R_f + β (R_m – R_f)

Where,

r_i= Required rate of return

R_f = Risk Free rate

R_m = Expected rate of market return

β = Beta

Ans. ORICA LIMITED:

R_f = 2.68% (Source: https://www.asx.com.au/).

R_m = 1.37% (Refer PART C excel sheet for calculation).

β = 0.4438 (Refer PART C excel sheet for calculation).

r_i = 2.68% + 0.4438(1.37% – 2.68%)

r_i = 2.10%

R_f = 2.68% (Source: https://www.asx.com.au/).

R_m = 0.36% (Refer PART C excel sheet for calculation).

β = 0.1618 (Refer PART C excel sheet for calculation).

r_i = 2.68% + 0.1618(0.36% – 2.68%)

r_i = 2.30%

(Refer PART C excel sheet for calculation).

• Below is the Share valuation of ORICA LIMITED and NEWCREST MINING LIMITED as per Dividend Growth Model:

Formula:

Where,

V_E = Market price per share excluding dividend

D₀ = Current year dividend i.e.2016

G = Growth rate of dividends

K_e = Expected rate of return as per CAPM

Ans. ORICA LIMITED

D₀ = $ 8.00 (Source: https://www.orica.com/).

G = -9.2% (Refer PARTC excelsheet for calculation).

K_e = 2.10% (calculated above)

V_E = $8.00 (1+ (-9.2%))

2.10% – (-9.2%)

V_E = $ 64.30

NEWCREST MINING LIMITED

D₀ = $ 7.50 (Source: https://www.newcrest.com.au/).

G = 4.14% (ReferPART C excel sheet for calculation).

K_e = 2.30% (calculated above).

V_E = $7.50 (1 + 4.14%)

2.30% – 4.14% 

V_E = $ 0 (i.e. there cannot be a negative value of Equity that’s why we take $ 0 value of equity)

(Refer PART C excel sheet for calculations). 

• Below is the calculation of monthly holding period return (%) for ORICA LIMITED and NEWCREST MINING LIMITED:
• Monthly holding period return (%) for ORICA LIMITED from 01 October 2015 to 30 September 2016.

Date	Close Price of ORICA LTD	Monthly Return of ORICA LTD
01-09-2016 01-08-2016 01-07-2016 01-06-2016 02-05-2016 01-04-2016 01-03-2016 01-02-2016 01-01-2016 01-12-2015 02-11-2015 01-10-2015	15.2 14.76 14.15 12.33 13.6 15.3 15.37 14.25 14.22 15.5 15.8 16.48	3% 4% 15% -9% -11% 0% 8% 0% -8% -2% -4% 0%

(Source: https://au.finance.yahoo.com/).

• Monthly holding period return (%) for NEWCREST MINING LIMITED from 01 July 2015 to 30 June 2016.

Date	Close Price of NEWCREST MINING LTD	Monthly Return of NEWCREST MINING LTD
01-06-2016 02-05-2016 01-04-2016 01-03-2016 01-02-2016 01-01-2016 01-12-2015 02-11-2015 01-10-2015 01-09-2015 03-08-2015 01-07-2015	23 19.07 18.97 16.96 17.5 12.88 12.97 10.91 12.31 12.7 11.2 11.27	21% 1% 12% -3% 36% -1% 19% -11% -3% 13% -1% 0%

Based on CAPM model, Dividend Discount model, holding period return and share price, following are the evaluations drawn:

• CAPM model describes the relationship between systematic risk and return and used to determine the minimum required rate of return of securities so that investors can purchase and hold the securities.

Thus, from the basis of above calculation, it can be concluded that Systematic Return (β) of Newcrest Mining Limited is lower than Orica Limited and also Expected rate of return of Newcrest Mining limited is higher than Orica Limited which means Newcrest Mining limited is good for the investment based on CAPM Model.

• As per Dividend Growth Model, it can be seen that there is a positive growth rate in dividend in Newcrest Mining Limited as compare to Orica Limited which means Newcrest Mining Limited will provide a good value of investment to an investor in future.
• After comparing the Holding period return of both companies, it is concluded that Newcrest mining limited provide higher holding period return over Orica limited in 2016. This shows that Newcrest mining limited provide the good return to an investor.
• It can be seen from following graph that the share price of ORICA LIMITED has shown a low growth as compare to NEWCREST MINING LIMITED.

As per above analysis, it is recommended that NEWCREST MINING LIMITED will create more value to an investor for future years.

Conclusion

Thus, the overseas investor should park their funds of AUD 120 million for period of 10 years in Newcrest Mining Limited.

References

ASX LIMITED (ASX .AX). (2016). Historical data. Retrieved on 13 April 2017 from https://au.finance.yahoo.com/quote/ASX.AX/history?period1=1435689000&period2=1467225000&interval=1mo&filter=history&frequency=1mo.

ASX LIMITED (ASX .AX). (2016). Historical data. Retrieved on 13 April 2017 from https://au.finance.yahoo.com/quote/ASX.AX/history?period1=1443637800&period2=1475173800&interval=1mo&filter=history&frequency=1mo.

ORICA. (2016). Shareholder information: Dividend History. Retrieved on 13 April 2017 from https://www.orica.com/Investors/Shareholder-Information#dividend.

NEWCREST MINING LIMITED. (2016). Dividends. Retrieved on 13 April 2017 from https://www.newcrest.com.au/investors/dividend-history.

ASX. (2016). ASX Annual Report 2016. Retrieved on 13 April 2017 from https://search.asx.com.au/s/search.html?query=risk+free+rate&collection=asx-meta&profile=web.

Orica Limited (ORI.AX). (2016).Historical data. Retrieved on 13 April 2017 from https://au.finance.yahoo.com/quote/ORI.AX/history?period1=1443637800&period2=1475173800&interval=1mo&filter=history&frequency=1mo.

Newcrest Mining Limited (NCM.AX). (2016). Historical data. Retrieved on 13 April 2017 from https://au.finance.yahoo.com/quote/NCM.AX/history?period1=1435689000&period2=1467225000&interval=1mo&filter=history&frequency=1mo.