BUS FPX 4070 Assessment 3 Estimating Returns and Deciding on Refinancing

Student Name

Capella University

BUS-FPX4070 Foundations in Finance

Prof. Name

Date

Part 1: Estimating Returns

To estimate the expected return, one multiplies the probability of each economic scenario by the expected return for that scenario and sums the products. For this company, the expected return is calculated as follows:

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

To calculate the standard deviation, one first determines the variance. The variance is the sum of the probabilities of each scenario multiplied 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. Using the given information, the variance and standard deviation for this company are calculated as follows:

Variance = ( (0.20 \times (10\% – 21.2\%)^2) + (0.40 \times (18\% – 21.2\%)^2) + (0.40 \times (30\% – 21.2\%)^2) = 4.44\% )

Standard deviation = ( \sqrt{4.44\%} = 2.11\% )

BUS FPX 4070 Assessment 3 Estimating Returns and Deciding on Refinancing

The standard deviation provides insight into the variability or volatility of returns, aiding in understanding what to expect in terms of return. In this case, the standard deviation of ( 2.11\% ) suggests that actual returns are likely to deviate within plus or minus ( 2.11\% ) of the expected return of ( 21.2\% ). This indicates the presence of uncertainty or risk in returns, with the potential for actual returns to be higher or lower than expected.

Part 2: Deciding on Refinancing

Refinancing a mortgage is a significant decision that requires careful evaluation. In this scenario, the borrower holds a $100,000 mortgage at a 7% interest rate with 14 years remaining, contemplating refinancing at a 5.5% interest rate for 15 years, with $1,500 in closing costs.

One of the primary advantages of refinancing is the potential for savings through a lower interest rate. By reducing the interest rate by 1.5%, substantial savings over the loan’s duration can be achieved. However, it’s crucial to consider all associated costs, including closing costs and early payment fees.

To determine the viability of refinancing, a cost-benefit analysis is imperative. This involves comparing refinancing costs, including closing costs and early payment fees, against potential savings from the lower interest rate. For instance, if the borrower’s current monthly payment is $847, they would have $167,956 remaining over 14 years. Refinancing at a 5.5% interest rate would yield a $790 monthly payment and $142,127 over 15 years, saving $25,829.

Qualitative factors, such as an improved credit score or home equity, should also influence the decision. Ultimately, the decision to refinance hinges on individual financial circumstances and goals, necessitating careful consideration of costs and benefits.

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/

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.

BUS FPX 4070 Assessment 3 Estimating Returns and Deciding on Refinancing