FIN 500 Introduction to Finance

Module 6

Assignment 6

Instructions:

Please make your answers clear. You must show any and all work to receive full
credit. Submit your responses in the form of a PDF file.

Questions:

1. The dividend yield on the S&P 500 index is currently 1.5% per year. That is, if
you invest $100 in the portfolio of stocks underlying the index, during the next
year you will receive dividends that total to $1.50.
For simplicity, you can think of the index as being a stock with current price of
P0 and dividends of D1 = 0.015 × P0.
You are analyzing the link between the dividend payments of the S&P and the
return on your investment. Based on historical information, you believe that
your investment in the S&P 500 will yield annual returns of around 11.5%.

a) How fast would dividends have to grow in perpetuity for the S&P 500 to
give you 11.5% returns each year? (1pt)

Hint: What model or formula relates P0, D1, r, and g?

P0 = Div/(r-g)
r-g = Div/P0
g = r – (Div/P0)

g = 0.115 – (1.5/100) = 10%

the growth rate has to be 10%
2. The Shanghai Stock Exchange composite index on Jan 1, 2010 was at 3289.75,
and had a dividend yield of approximately 0.9%. For simplicity, treat the index
as a stock with P0 = 3289.75 and D1 = 29.60775.
The market consensus was that dividends would grow at the rate of g = 0.106
or 10.6% per year, which is equal to the growth rate of nominal GDP in China
in 2010. For simplicity, assume that Chinese GDP and dividends on the
Shanghai Stock Exchange composite index both grow at this rate in perpetuity.

a) Based on the date above, what is the implied return of an investment in the
Shanghai Stock Exchange composite index? (0.5 pts)

P=D/(r-g)
r-g = D/P
r = g + D/P

r = 0.106 + (29.60775/3289.75)
r = 0.115

b) If the expected rate of return on Chinese stocks remained at the same level
as you calculated in part a) but the market’s estimate of the dividend
growth rate decreased to 8% per year (the growth rate of GDP in 2012), the
Shanghai Composite Index will decline. What would be the new value of
the index? (0.5 pts)

P = D/(r-g)

P = 29.60775 / (0.115-0.08)

P = 845.9357143

3. Amazon’s stock price is currently (Jul 1, 2023) $127 per share with earnings per
share over the next year estimated to be $2.57. What is the net present value
of its growth opportunities (per share) if the required rate of return is 9
percent? (1 pt)
 P0 = (EPS1/r) + NPVGO

NPVGO = P0 - (EPS1/ r)

NPVGO = 127 – (2.57/0.09)

NPVGO = 98.44

Note, for this question, you may find information from the live session in Module
6 useful.

4. On May 9th, 2023, Airbnb (ABNB) announced that earnings were $0.18 per
share, beating analyst forecasts of $0.10, additionally actual revenue was
$1.82 billion, beating forecasts of $1.79billion. However, the stock price fell
from $126.60 on May 9 to $109.85 on May 10. Does this example indicate that
markets are not efficient? Explain your answer. (1 pt)

This crash happened (despite beating expectations) as a result of some

information that was released with the earning report:

In the earnings report it was stated that they are forecasting a lower
performance in the next quarter, and this new information was reflected onto
the share prices.

Case Questions:

For the next three questions you will have to read the case Warren E. Buffet,
2015. Please use your own words to answer the following questions in well-
composed sentences. You may refer to the case and internet, but please do not
copy verbatim from the case, internet, or other sources.

Note that this case will form the basis of the material in the Module 7 live session.

5. Please describe the main business of Berkshire Hathaway. (1 pt.) (up to 100
words)
 Berkshire Hathaway is a merger of to companies, and used to operate in the
textile industry. Currently, it can be described as a holding company. Its main
business involves insurance, diverse investments, and the ownership of
numerous subsidiary companies. The conglomerate operates in various sectors,
including insurance (GEICO, Berkshire Hathaway Reinsurance), energy
(MidAmerican Energy), manufacturing, services, and retail. Berkshire
Hathaway's business model focuses on acquiring well-managed companies with
sustainable competitive advantages, often holding them for the long term.

6. Based on the data in the case, what do you think of the investment performance
of Berkshire Hathaway? (2 pts.) (up to 200 words)
Note: Your answer should discuss the performance over
• The long run (from exhibit 3 this would be from 1976 – 2015)
From 1976 to 2015, Berkshire Hathaway, under Warren Buffett's
leadership, demonstrated outstanding performance. As shown in
Exhibit 3, the company's Class A shares significantly outperformed the
S&P 500 Index, achieving an annualized return of 22.8%, compared to
the S&P 500's 8.0%. This exceptional long-term performance reflects
Buffett's value-oriented investment strategy and the compounding of
wealth over several decades.

• The most recent five years, 2010-2015

Even in the most recent five years leading up to 2015, Berkshire
Hathaway continued to outpace the S&P 500. The Class A shares
achieved an annualized return of 12.8%, surpassing the S&P 500's 2.6%.
This performance indicates Berkshire's resilience and ability to navigate
market conditions successfully.

• The final year in the case – 2015.

In 2015, Berkshire Hathaway's financial statements reveal that it has
underperformed relative to the S&P 500 and that if at January $100
would be invested in both. While S&P would return a little over $100,
but Berkshire Hathaway would return about $97, which out be a loss.
7. From Yahoo Finance download the monthly adjusted close prices for Berkshire
Hathaway Class A shares (Ticker BRK-A) and the S&P 500 Index (Ticker: ^GSPC –
you may have to manually copy these) from July 1, 2015 until August 1, 2023
(note that in the yahoo output the first data point will be Jul 1, 2015 and the
final data point will be Jul 1, 2023)

a) Reproduce a diagram similar to Exhibit 3 but for 2015-2023 in the case in that
both the Berkshire Hathaway and S&P 500 Index prices are normalized to
100 on Jul 1, 2015. (1.5pts)

Berkshire Hathaway vs S&P 500 since July 2015

300

250

200

150

100

50

0
27-Dec-14 10-May-16 22-Sep-17 4-Feb-19 18-Jun-20 31-Oct-21 15-Mar-23 27-Jul-24

BRK-A S&P 500

b) Calculate the 8-year annualized returns for Berkshire Hathaway and the S&P
500 Index from 7/1/2015 to 7/1/2023. (1pt)

S0 = S 8 * (1+r)8

(S0/S 8)1/8 = 1+r

r = (S0/S 8)1/8-1

S&P 500 BRK-A

9.82% 11.68%
Please note that when using Yahoo finance, I could not load up to July 2023,
rather it would only allow me up until May 2023 so my numbers are a bit off
from the professor

c) What do you think of Berkshire Hathaway’s performance in this period? (0.5

pts) (up to 50 words).
It seems that Berkshire Hathaway has performed better than the S&P 500 by
1.86% of annualized rate since 2015.