BUS FPX 4070 Assessment 3 Estimating Returns and Deciding on Refinancing

BUS FPX 4070 Assessment 3 Estimating Returns and Deciding on Refinancing

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Capella University

BUS-FPX4070 Foundations in Finance

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Part 1: Estimating Returns

To estimate the expected return of a company, we use the probability of each economic scenario, multiply it by the return for that scenario, and then sum the resulting values. In this case, the calculation is as follows:

[ ( (0.20 \times 10\%) + (0.40 \times 18\%) + (0.40 \times 30\%) = 2\% + 7.2\% + 12\% = 21.2\% ) ]

This gives an expected return of 21.2%.

To calculate the standard deviation, we first need to determine the variance. The variance is calculated by multiplying the probability of each scenario by the squared difference between the expected return and the actual return for that scenario. The standard deviation is then obtained by taking the square root of the variance. The variance for this company is calculated as follows:

[ \text{Variance} = (0.20 \times (10\% – 21.2\%)^2) + (0.40 \times (18\% – 21.2\%)^2) + (0.40 \times (30\% – 21.2\%)^2) = 4.44\% ]

Then, the standard deviation is:

[ \text{Standard deviation} = \sqrt{4.44\%} = 2.11\% ]

This standard deviation indicates the variability of returns, helping to understand the potential deviation of actual returns from the expected return. In this case, the standard deviation of 2.11% suggests that returns are likely to fluctuate within ±2.11% of the expected return of 21.2%, reflecting a moderate level of risk.

Part 2: Deciding on Refinancing

Refinancing a mortgage is a critical financial decision that requires careful assessment. In this example, the borrower holds a $100,000 mortgage with a 7% interest rate and 14 years remaining, considering refinancing at a 5.5% interest rate for 15 years, with $1,500 in closing costs.

The primary benefit of refinancing is the reduction in the interest rate, which can lead to significant savings over the life of the loan. Reducing the interest rate by 1.5% can result in lower monthly payments and overall savings. However, it is essential to take into account all associated costs, such as closing fees and potential early payment penalties.

BUS FPX 4070 Assessment 3 Estimating Returns and Deciding on Refinancing

To determine the feasibility of refinancing, a cost-benefit analysis must be performed. This involves comparing the savings from the lower interest rate with the costs involved. For example, if the current monthly payment is $847, the borrower has $167,956 remaining over 14 years. By refinancing at a 5.5% interest rate, the borrower would pay $790 monthly over 15 years, reducing the total amount owed to $142,127, resulting in a savings of $25,829.

It is also important to consider qualitative factors, such as the borrower’s credit score or home equity, which can affect the decision. Ultimately, the choice to refinance should be based on the individual’s financial goals and circumstances, taking both costs and potential benefits into account.

Table: Summary of Refinancing Decision

References

Bankrate. (2021). Should I refinance my mortgage? Retrieved from https://www.bankrate.com/mortgages/when-to-refinance/

Consumer Financial Protection Bureau. (2021). What is refinancing? Retrieved from https://www.consumerfinance.gov/ask-cfpb/what-is-refinancing-en-196/

BUS FPX 4070 Assessment 3 Estimating Returns and Deciding on Refinancing

Brigham, E. F., & Ehrhardt, M. C. (2013). Financial management: Theory and practice. Cengage Learning.

Ross, S. A., Westerfield, R. W., & Jordan, B. D. (2016). Fundamentals of corporate finance. McGraw-Hill Education.

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