Each coursework group will be allocated two real-life companies that are publicly traded on a U.S. stock market. To find out the names of your group’s two companies, please visit the BMAN23000 Blackboard site: the names of the companies allocated to each coursework group, and the names of the students allocated to each coursework group, are given in the Group and Company Allocation file available from the BMAN23000 Blackboard site. The file indicates which of the two real-life companies you should treat as “Company A” and which as “Company B”.
Besides the company names, the Group and Company Allocation file also provides the companies’ identifiers: their PERMNO and GVKEY; these identifiers are used to collect company data from the databases as described below. No further data (besides that in the Group and Company Allocation file) is provided. It is the responsibility of each team (and all team members) to collect all necessary data required to complete the assignment.
Suitable databases are available and described below.
To complete this part, you will require data on your two companies’ monthly common-stock returns from January 2002 to December 2011. Required:
a) Suppose you are advising an investor who wants to invest all her wealth in the stock of just one of the two companies allocated to your coursework group (Company A or Company B). i) Provide brief descriptions of Company A and of Company B. ii) Next, compare and contrast the stock return performance of the two companies’ common stocks over the calendar period using monthly return data from Jan 2002 to Dec 2011. Specifically, calculate the mean, variance and standard deviation of the monthly returns of the two stocks separately.
iii) Briefly comment on your results and make a stock recommendation. b) Now suppose you are advising an investor who is considering investing all her wealth in a portfolio consisting of the two companies’ common stock held together. i) Calculate the mean, variance and standard deviation of the returns of portfolio comprising the two stocks with equal weights (i.e. 50:50). Next repeat the calculations for alternative portfolio weights, including 20:80, 40:60, 60:40, and 80:20. You may choose to construct additional portfolios (but remember the portfolio weights need to add to 100%). Report your results in a table. Compare and contrast your findings with those of the single-stock portfolios in part (aii).
ii) Illustrate your results in part (bi), along with the single-stock results in part (aii), in a graph plotting the trade-off between the mean and standard deviation of the portfolio returns. iii) In the trade-off graph in part (ii), indicate the efficient frontier (assuming the stocks of Company A and B are the only available assets). iv) Finally, identify the minimum variance portfolio in the tradeoff graph.
To do so, you can use trial and error, or the method outlined by Copeland, Weston and Shastri (Financial Theory and Corporate Policy, 4th International Edition, pp116-7; a copy of the relevant pages will be on the BMAN23000 Blackboard site). Report the portfolio weights of the minimum-variance portfolio, and the mean, variance and standard deviation of returns of the minimum-variance portfolio. v) Based on your findings in the previous parts, briefly explain to the investor how to choose her optimal portfolio assuming the two stocks are the only assets available to her. Also briefly indicate how your advice would change if other assets became available to the investor.
The senior management of Company A employ you to advise them on the cost of capital the company should use to calculate net present value and decide whether or not to undertake a new investment project. You may assume that the new project is comparable to the average of the company’s existing projects in all respects. Make sure you correctly identify which of your two companies is “Company A”. Note also that you were allocated randomly drawn and randomly paired companies. Therefore, Company B is probably not a useful comparable for Company A’s new project.
a) Calculate investors’ required returns on Company’s A’s equity. Remember, there are many ways of estimating investors’ required returns (see Lectures 1-2, Semester 2). You should use two alternative ways of calculating the required returns to check how sensitive your result is to using different methods; i.e. to check the robustness of your result. For example, you could use the Fama-French three-factor model in addition to the Security Market Line (SML), which uses a single factor (beta). See e.g. the article by Fama and French (1997) in the suggested readings below. b) Calculate Company’s A’s debt cost of capital.
The bond yield can be calculated as Yield = risk-free rate + credit spread. Data on the approximate credit spread for a given credit rating is provided in the section on Debt data below. For simplicity, you may assume that the only securities outstanding of the company are common stock (equity) and long-term debt. Note that the after-tax cost of debt is lower than the pre-tax cost of debt if there is a tax advantage of debt relative to equity (interest tax shield). c) Calculate the cost of capital (that is, the appropriate discount rate to calculate the net present value) of Company A’s new investment project.
d) Clearly explain your calculations and methods used in parts (a) to (c). Among other things, note explicitly whether your results are in terms of monthly or yearly returns (either or both are acceptable as long as clearly labeled). Briefly describe and justify the data and (proxy) measures you are using. State and discuss any assumptions you are making (including assumptions about the financing of the project). e) Briefly discuss any limitations of your analysis and how (given more time and information) you might refine your analysis in the future.
To complete the assignment, your group will need to collect various sorts of data which can be downloaded from the Wharton Research Data Services (WRDS) website, http://wrds.wharton.upenn.edu/. To sign in on WRDS, use the following:
Note the use of capitals and lower-case letters. At the end of the password is the number 1 (one) – not the lower-case letter l. To get accustomed to downloading data use the link to the support on the left hand side of the page. Then click on Query Demo which is under Basic Help. This leads you through an example of how to download data from COMPUSTAT. Most of the data you need will be on the CRSP data set, the COMPUSTAT North America data set, and the Fama-French data set. Please note the terms and conditions for use of the WRDS data.
Download the equity return data from the CRSP database. After signing in on WRDS, go to the Select a Data Set: window on the left of the screen, click on the down arrow and select CRSP. Always search by the PERMNO identifier when downloading data on your company from the CRSP data set. The PERMNO of each of your two companies is given in the Group and Company Allocation file. You will need to download the monthly holding period returns. Holding period returns are defined as follows: [pic]
where rit is the holding period return for company i for month t, pit is the price of company i at the end of month t, dit is any dividend declared ex div during month t adjusted to an end-of-month basis, and pit−1 is the price of company i at the start of month t (adjusted if necessary for any changes in capitalizations to make it comparable with pit). If you want to express returns in percent (%) you have to multiply the equation for the (decimal) holding return above by 100. Make sure you convert returns collected from different data sources to the same units (decimals or percent). In your baseline calculations use monthly return data from Jan 2002 to Dec 2011.
The total market value of the equity (market capitalization) can be calculated by multiplying the number of shares outstanding by the price of the shares. The number of shares and the share price are available from the CRSP data set. To go to the Fama-French data set on WRDS, go back to the WRDS home page: in the Select a Data Set: window (on the left of the screen) select Fama-French Portfolios and Factors. From the Fama-French data set, you can download the excess returns on the market (rm − rf ), the Fama-French factors, and the risk-free rate (rf ). Click on Factors-Monthly Frequency on the left-hand side of the page when in the Fama-French database on WRDS.
The data on debt can be downloaded from the COMPUSTAT North American database. On the WRDS home page, in the Select a Data Set: scroll-down menu on the left of the screen select Compustat; when the Compustat page comes up select Compustat Monthly Updates North America (on the left below the Select a Data Set: scroll-down menu). On the next screen, select either Fundamentals Quarterly (or Fundamentals Yearly) to select debt values; or select Ratings to collect credit ratings. (There may be a brief delay while the system displays results saved by other users in the past. Please ignore these save results.) To identify your company on Compustat, use the company’s GVKEY (not its PERMNO). Fundamentals Quarterly/Yearly: Scroll down to the window that allows you to select Quarterly Data Items; within the window scroll down again until you find the variable DLTTQ — long term debt – total; tick this variable and submit your query to download the data.
For simplicity, you may assume that long term debt – total is equivalent to the market value of debt for your company. It is important to note that the long term debt data is in Millions (because it is Compustat data); by contrast, the data on equity values (e.g. shares outstanding) is from CRSP and is in Thousands. Ratings: Select an appropriate credit rating for your company. For simplicity, you may assume that your company only has long-term debt, so the appropriate rating is S&P Long-Term Domestic Issuer Credit Rating. Note that there are no data on the time-series of bond returns for individual companies on the WRDS database.
In fact, you do not need (to construct) the time-series of bond returns to complete the assignment – you only need to download one observation of the credit rating and one observation of the debt value. See e.g. Berk and DeMarzo (Section 12.4, Chapter 12 in the second edition only) for details on how to calculate the debt cost of capital. The bond yield can be calculated as Yield = risk-free rate + credit spread. Data on the approximate credit spread (at start of 2012) for companies with a given credit rating are shown in the table below:
|For large manufacturing firms |For financial service firms | |Rating is |Spread is |Rating is |Spread is | |D |20.00% |D |16.00% | |C |12.00% |C |14.00% | |CC |10.00% |CC |12.50% | |CCC |8.00% |CCC |10.50% | |B- |6.00% |B- |6.25% | |B |4.00% |B |6.00% | |B+ |3.25% |B+ |5.75% | |BB |2.50% |BB |4.75% | |BB+ |2.00% |BB+ |4.25% | |BBB |1.50% |BBB |2.00% | |A- |1.00% |A- |1.50% | |A |0.85% |A |1.40% | |A+ |0.70% |A+ |1.25% | |AA |0.50% |AA |0.90% | |AAA |0.35% |AAA |0.70% |
Figures are in per cent per annum.
Source: Damodaran Online http://pages.stern.nyu.edu/~adamodar/ (accessed Jan. 2012). In the event that the rating of your company is not shown in the table above, you should use the spread for the next lower rating. Alternatively, you may search for, and use, other sources of information. In either case, please briefly explain your data and method in your report (e.g. in a short footnote).
Estimating equity betas
You can estimate the CAPM beta of Company A’s equity using the following regression: [pic] where rit is the monthly return on the company’s stock, rmt the monthly return on the market, rft the monthly return on a “risk-free” asset, and (it is the error term. In your baseline calculations use monthly return data from January 2002 to December 2011. In your calculations you should use the Fama-French data set as the source for market excess returns and the risk-free rate. Calculations can be done in Excel. You will need to ensure that the Analysis ToolPak has been added in. You can easily check this by clicking on Tools in the menu at the top of the screen in Excel. If it has been added, Data Analysis… will appear in the list. If Data Analysis… is not there, click on Add-Ins… and check (i.e., tick) the Analysis ToolPak box.
The Regression function in Excel can be found in the Data Analysis… part of the Tools menu. When you click on Regression, you will be asked to input a Y range and an X range. In the SML equation (of the CAPM), the Y range is your company’s excess return (rit – rft) while the X range is the excess return on the market (rmt – rft). See Lectures 1-2 (Semester 2) for more details including interpretations of the regression coefficients. Please remember to use the Help menu in Excel.
Please adhere to the School’s policy on coursework as outlined in the Assessed Coursework Rules on the MBS UG intranet: https://ughandbook.portals.mbs.ac.uk/Myassessment/Assessedcoursework.aspx . Provide a report of no more than eight (8) pages inclusive of everything: tables, references, appendices, etc. As outlined in the next section, you are required to attach a standardized cover sheet that can be downloaded from the BMAN23000 Blackboard site. The eight-page limit does not include this standardized cover sheet: you can submit up to eight pages PLUS the standardized cover sheet. You do not need an additional cover sheet or a table of contents.
There will be penalties for exceeding the page limit. Specifically, a penalty of five percentage points will be applied (i.e. five marks will be deducted from your group mark) for submitting a report that is one page over the limit. Two or more pages over the limit will attract a penalty of ten percentage points. You are required to adhere to the formatting outlined in the Assessed Coursework Rules. If you do not adhere to the prescribed formatting, a penalty of five percentage points will be applied to your group mark. In addition, your report will be reformatted (you may be asked to provide an electronic copy for this purpose), and if applicable, page-limit penalties will be applied to the re-formatted version.
Submitting the Coursework
The deadline for submission of the group report and the Individual Contribution form is 15.00 (3pm) on Thursday 9 May 2013. It is advisable to submit your report and form one or several days before the final deadline to avoid any last-minute rush and complications. For further details on coursework submission, the UG Office opening times, and the School’s policy on the late submission of coursework, please read the Assessed Coursework Rules on the MBS UG Intranet: https://ughandbook.portals.mbs.ac.uk/Myassessment/Assessedcoursework.aspx . Each group is required to submit TWO HARD COPIES of the report to the Undergraduate Office in Room D20, MBS East (i.e., Undergraduate Services, Manchester Business School, The University of Manchester, Room D20, MBS East, Booth Street West, Manchester M15 6PB, Tel. +44 (0) 161 275 4011), no later than 3pm on Thursday 9 May 2013. Each copy of the report must have a completed cover sheet.
The (blank) cover sheet you should use will be available on the BMAN23000 Blackboard site. The cover sheet must contain the coursework group number and all the registration numbers of the individuals in that group. Do not write your names anywhere on the report, as it will be marked anonymously. Each student should personally keep an electronic copy of the project and may be required to provide this at a later date. Separately from the group report, each member of a coursework group must submit ONE HARD COPY of the completed Individual Contribution form to the Undergraduate Office in Room D20, MBS East, no later than 3pm on Thursday 9 May 2013.
The (blank) Individual Contribution form can be downloaded from the BMAN23000 Blackboard site. The form must give your registration number and group number. A penalty of five percentage points will be applied (i.e. five marks will be taken off your individual mark) if you do not submit your individual contribution sheet (on time). It is your responsibility to make sure that the assignment is submitted on time and in the correct manner. The School accepts no responsibility for the loss of assignments not submitted in the appropriate way. Please note that plagiarism is a very serious offence. You should read the University guidelines on plagiarism.
Written feedback for each team will be available at the same time as the exam results. You will be able to see your team’s feedback form at the Undergraduate Office (D20, MBS East).
You will be allocated randomly by the course coordinator to a coursework group. Coursework groups will consist of approximately 6 students attending the same workshop. Occasionally the groups will have 5 or 7 members. Students who were not registered for a BMAN23000 workshop on Campus Solutions by the end of Week 2 (in Semester 2) were not allocated to a coursework group. Please check the Group and Company Allocation file on Blackboard. If your name does not appear on the file, you need to contact the Undergraduate Office (D20, MBS East) urgently. It is your responsibility to ensure that you are registered and allocated to a coursework group. If you are not allocated to a group, you may receive a mark of zero for the coursework.
Simple ground rules for group work
1. Exchange contact details (email addresses, mobile phone numbers, etc.).
2. Fix a schedule of meetings.
3. Ensure you attend every group meeting.
4. Agree an agenda.
5. Don’t allow one person to monopolize the meeting, though avoid unnecessary interruptions. If necessary, suggest giving others a chance to speak. 6. Encourage everyone to participate; invite ideas from quiet individuals. 7. Try to be constructive and only criticize ideas, not individuals. 8. Stick to a timetable—for meetings and for assigned tasks. 9. Ensure everyone understands what your group goal is and how you have agreed to achieve this. Document this in writing. Each group member should keep documentary evidence showing how they personally contributed to achieving the group goal. 10. Think about how the overall exercise can be divided into smaller tasks. 11. Coordinate the tasks:
• which tasks need to be completed before subsequent ones? • who wants to do which task?
• how do you assign tasks that nobody wants to do?
• is the workload equally shared?
The idea of the project is to simulate as closely as possible what happens in the team-based projects in the business world. Discussion of choices of calculation/methodology etc. should occur within the group in order to come to a group decision on the best way to proceed. You should realise that any disagreement or difficulties between group members is a problem for the whole group. It could result in a lower group mark. One aspect of group skills is overcoming these problems if they arise (it is no good complaining to your tutor or the course convenors.) Try to identify any problems early. Raise and discuss them before they become unmanageable.
Try to deal with them as group problems, not as individual, personal issues. Note that neither the lecturers nor the workshop leaders will sort out group problems for you: they are for the group to sort out (but see below on what ‘powers’ you have if you have a free rider). Keep evidence of your work and your contribution to the group report, such as copies of correspondence and draft work you completed, in case you are asked to proof that you did not free ride.
Required (for the individual part)
As part of your submission each group member must fill out and submit an Individual Contribution assessment form. These forms are to be submitted separately from the group report. They will be kept confidential, so the only way any of your teammates will know how you graded them is if you tell them. When completing the individual contribution form, you need to use your fellow group members’ individual “student group numbers” and not their names nor their registration numbers.
The Group and Company allocation file gives the individual “student group number” for each individual member of your coursework group. The file is available on Blackboard. You do NOT require the registration numbers of the other group members. You are required to rank each individual group member according to their contribution relative to the rest of the group. You will allocate each individual a grade. The grading range will be −−, −, 0, + and ++, where double minus (−−) is the lowest (worst) grade, and double plus (++) is the highest (best); you can think of these grades as fail through to first class. If you award a double minus (−−) you must explain in your Individual Contribution form why you awarded this.
How Do I Assess Performance?
Some Words of Warning
1. Personal feelings must be put to one side. Don’t forget, you have to justify why someone was worth a −−. If your reasons for awarding these are wholly unreasonable, they could be counted against you. 2. Free riders will receive a mark of zero. If you do nothing for the assignment, you can expect a mark of zero because you will be deemed not to have done the assignment. Please note that just turning up to one or two meetings and not saying anything counts as not doing the assignment. To avoid a mark of zero, you have to contribute. See below for further details.
Please note that when filling in the ‘Individual Contributions’ form, use your teammates’ STUDENT GROUP NUMBERS, not their names or registration numbers. 1. Was the individual cooperative/indifferent/uncooperative in drawing up a plan of how the work should proceed? 2. Did the individual attend all/some/none of the meetings?
3. Did the individual contribute anything in the meetings? 4. Was the contribution (if any) in meetings always negative or was the individual constructive in trying to help solve problems? 5. Was any criticism personal or was it constructive criticism of ideas? 6. Did the individual contribute to the computations or the writing of the report or both? 7. Was the individual cooperative in getting the work done or was getting them to contribute like trying to get blood out of a stone? 8. Was the individual a good ‘team player’?
Free Rider Problems
A question that may arise is ‘what can we do person X who has done nothing, despite requests.’ The answer is straightforward: on the Individual Contribution form, you have it within your power to award a −− (double minus) to person X. Remember to give person X’s student group number – not name or registration number). Recall that if you award a −−, you have to explain why.
How are the individual contribution marks used?
The individual contribution sheets will be examined to check that all the group members contributed to the project. A group member who receives double minus (−−) from all or most of the other group members will receive a coursework mark of zero. Anyone at risk of being awarded a mark of zero will be contacted by the course convenors and given the chance to defend themselves. In order to proof your contribution (if necessary), please keep evidence of your involvement. This includes saving relevant email correspondence and keeping copies of work you did. You could keep minutes of meetings, written details of work allocation, deadlines for work to be completed, and receipts of completed work. If you cannot prove that you contributed (after getting double minus marks from all or most other group members), you will receive a mark of zero. It is the convenors who determine whether someone was a free rider and receives a mark of zero based on all available evidence.
For information on the kinds of criteria that will be used in assessing the projects, please see details of assessment criteria in your programme handbook. Please note the School policy on plagiarism and on late submission as outlined in the Assessed Coursework Rules on the MBS UG Intranet. Also be aware of the penalties (outline above) for exceeding the page limit, using non-standard formatting, and for failure to submit a completed Individual Contribution form. Please note that the teaching staff on this course will not read or comment on any drafts of the project before it is officially handed in.
Questions concerning the coursework can be posted on the BMAN23000 Blackboard discussion forum. The forum will be monitored by teaching assistants in consultation with the course lecturers. There are some rules relating to the forum: • Do not expect the forum to be a place where you can engage in question and answer sessions with members of staff. The forum is a place where students can engage in staff-monitored discussion with other students about issues and difficulties relating to the project. • The forum is not a substitute for thinking: do not expect other to do your thinking for you. • Questions posted on the forum that have already been answered will not be answered again. It is up to you to search through questions and responses that have already been posted to see if your particular question/issue has been already addressed. • Do not expect questions to be answered as soon as they are posted. • Please use the web support for WRDS to learn how to download data before turning to the forum.
In addition to the reading associated with the lectures and workshops, and the course textbook Berk J. and P. DeMarzo Corporate Finance, 2nd edition (Note that the material in Chapter 12 of the 2nd edition is important and not available in the first edition). you may find the following useful:
Brealey, R. A. and S. C. Myers. Principles of Corporate Finance, 9th ed. Chapters 9-10. Copeland, T., Weston, J. and K. Shastri. Financial Theory and Corporate Policy, 4th International Edition, pp116-7. Fama, E.F. and K.R. French, 1997, Industry costs of equity, Journal of Financial
Economics 43, 153–193. Articles in academic journals including the Fama-French article (above) can be downloaded from the John Rylands Library: http://www.library.manchester.ac.uk/searchresources/electronicjournals/ . ———————–
 Remember, someone who disagrees with an idea you have, or criticizes an idea you have, is not necessarily criticizing you personally.