Junior Sayou, a financial analyst for Chargers Products, a manufacturer of stadium

benches, must evaluate the risk and return of two assets, X and Y. The firm is considering

adding these assets to its diversified asset portfolio. To assess the return and risk

of each asset, Junior gathered data on the annual cash flow and beginning- and end-of year

values of each asset over the immediately preceding 10 years, 2000–2009. Junior’s investigation suggests that both assets, on average, will tend to perform in the future just as they have

during the past 10 years. He therefore believes that the expected annual return can be

estimated by finding the average annual return for each asset over the past 10 years.

Return Data for Assets X and Y, 2000–2009

Asset X Asset Y

Value Value

Year Cash flow Beginning Ending Cash flow Beginning Ending

2000 $1,000 $20,000 $22,000 $1,500 $20,000 $20,000

2001 1,500 22,000 21,000 1,600 20,000 20,000

2002 1,400 21,000 24,000 1,700 20,000 21,000

2003 1,700 24,000 22,000 1,800 21,000 21,000

2004 1,900 22,000 23,000 1,900 21,000 22,000

2005 1,600 23,000 26,000 2,000 22,000 23,000

2006 1,700 26,000 25,000 2,100 23,000 23,000

2007 2,000 25,000 24,000 2,200 23,000 24,000

2008 2,100 24,000 27,000 2,300 24,000 25,000

2009 2,200 27,000 30,000 2,400 25,000 25,000

Junior believes that each asset’s risk can be assessed in two ways: in isolation and

as part of the firm’s diversified portfolio of assets. The risk of the assets in isolation

can be found by using the standard deviation and coefficient of variation of returns

over the past 10 years. The capital asset pricing model (CAPM) can be used to assess

the asset’s risk as part of the firm’s portfolio of assets. Applying some sophisticated

quantitative techniques, Junior estimated betas for assets X and Y of 1.60 and 1.10,

respectively. In addition, he found that the risk-free rate is currently 7% and that the

market return is 10%.

To Do

a. Calculate the annual rate of return for each asset in each of the 10 preceding

years, and use those values to find the average annual return for each asset over

the 10-year period.

b. Use the returns calculated in part a to find (1) the standard deviation and

(2) the coefficient of variation of the returns for each asset over the 10-year

period 2000–2009.

c. Use your findings in parts a and b to evaluate and discuss the return and risk

associated with each asset. Which asset appears to be preferable? Explain.

d. Use the CAPM to find the required return for each asset. Compare this value

with the average annual returns calculated in part a.

e. Compare and contrast your findings in parts c and d. What recommendations

would you give Junior with regard to investing in either of the two assets?

Explain to Junior why he is better off using beta rather than the standard deviation

and coefficient of variation to assess the risk of each asset