Introduction to Corporate Finance

PART 2: VAlUATION, RISK AND RETURN

P6-23 The table below shows annual returns on Archer Daniels Midland (ADM) and Walmart. The last column of

the table shows the annual return that a portfolio invested 50% in ADM and 50% in Walmart would have

earned in 1993. The portfolio’s return is simply a weighted average of the returns of ADM and Walmart.

Year ADM Walmart 50-50 portfolio

1993 1.5% –22.7% –10.6% = (0.5 × 1.5% + 0.5 × –22.7%)

1994 37.4% –24.6%

1995 –11.2% –5.5%

1996 31.1% 8.0%

1997 10.0% 50.7%

1998 –15.3% 76.8%

1999 –23.5% 61.2%

2000 32.9% 9.5%

2001 1.9% 15.6%

2002 –12.1% –18.1%

2003 25.1% 11.1%

2004 49.1% –10.5%

2005 12.3% –8.2%

2006 31.0% 3.3%

2007 47.2% 0.3%

2008 –36.9% 15.0%

2009 10.8% 10.9%

2010 –1.5% 1.4%

a Plot a graph similar to Figure 6.7 showing the returns on ADM and Walmart each year.

b Fill in the blanks in the table above by calculating the 50-50 portfolio’s return each year from

1994–2010, then plot this on the graph you created for part (a). How does the portfolio return

compare to the returns of the individual shares in the portfolio?

c Calculate the standard deviation of ADM, Walmart and the portfolio, and comment on what you find.

P6-24 The table below shows annual returns for Merck and one of its major competitors, Eli Lilly. The

final column shows the annual return on a portfolio invested 50% in Lilly and 50% in Merck. The

portfolio’s return is simply a weighted average of the returns of the shares in the portfolio, as shown

in the example calculation at the top of the table

Year Eli Lilly Merck 50-50 portfolio

Year 1 15.4% 14.9% 15.1% = (0.5 × 15.4% + 0.5 × 14.9%)

Year 2 77.2% 76.4%

Year 3 32.6% 24.0%

Year 4 93.6% 35.5%

Year 5 29.1% 41.2%

Year 6 –24.3% –7.4%

Year 7 41.9% 41.7%

Year 8 –14.4% –35.9%

Year 9 –17.6% –1.1%

Year 10 13.1% –11.2%

Std. dev.