Question

P7-11. You analyze the prospects of several companies and come to the following concluso expected return on each: 18% 4000 480 Stock Expected Return 720 3480 Starbucks Sears 8% 6,000 Microsoft 16% 12,000 1920 Limited Brands 12% 3,000 360 You decide to invest $4,000 in Starbucks, $6,000 in Sears, $12,000 in Microsoft, and $3,000 in Limited Brands. What is the expected return on your portfolio?

help

Answer 1

Stock	Expected Return
Starbucks	18%
Sears	8%
Microsoft	16%
Limited Brands	12%

We will first calculate the weight of each stock in the portfolio

Amount invested in Starbucks = $4000

Amount invested in Sears = $6000

Amount invested in Microsoft = $12000

Amount invested in Limited Brans = $3000

Total amount invested in the portfolio = $4000 + $6000 + $12000 + $3000 = $25000

Weight calculation

Weight of Starbuck in the portfolio = W1 = Amount invested in Starbucks/Total amount invested in the portfolio = $4000/$25000 = 0.16

Weight of Sears in the portfolio = W2 = Amount invested in Sears/Total amount invested in the portfolio = $6000/$25000 = 0.24

Weight of Microsoft in the portfolio = W3 = Amount invested in Microsoft/Total amount invested in the portfolio = $12000/$25000 = 0.48

Weight of Limited Brands in the portfolio = W4 = Amount invested in Limited Brands/Total amount invested in the portfolio = $3000/$25000 = 0.12

Returns

Expected return on Starbucks = R1 = 18%

Expected return on Sears = R2 = 8%

Expected return on Microsoft = R3 = 16%

Expected return on Limited Brands = R4 = 12%

Portfolio

We have the following data of weights and returns

W1 = 0.16, W2 = 0.24, W3 = 0.48, W4 = 0.12

R1 = 18%, R2 = 8%, R3 = 16%, R4 = 12%

Expected return of portfolio is calculated using the formula:

Expected return of portfolio = E[RP] = W1*R1 + W2*R2 + W3*R3 + W4*R4 = 0.16*18% + 0.24*8% + 0.48*16% + 0.12*12% = 2.88% + 1.92% + 7.68% + 1.44% = 13.92%

Answer -> Expected return on portfolio = 13.92%