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Wolff Enterprises must consider several investment projects, A through E, using the capital asset pricing model (CAPM) and its graphical representation, the security market line (SML). Relevant information is presented in the following table
ITEM RATE OF RETURN BETA
Risk-free asset 9% 0.0
Market portfolio 14% 1.0
Project A - 1.5
Project B - 0.75
Project C - 2.00
Project D - 0.0
Project E - -0.50
a. Calculate (1) the required rate of return and (2) the risk premium for each project, given its level of nondiversifiable risk.
b. Use your findings in part a to draw the security market line (required rate of return relative to nondiversifiable risk)
c. Discuss the relative nondiversifiable risk of projects A through E.
d. Assume that recent economic events have caused investors to become less risk-averse, causing the market return to decline to 12%. Calculate the new required returns fcor assets A through E and draw the new security market line on the same graph you drew for b.
e. Compare your findings in parts a and b with those in part d. What conclusion can you draw about the impact of a decline in investor risk aversion on the required returns of risky assets?
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