Reference no: EM133068635

Renewals Ltd. is a firm with existing assets that generate earnings per share of $5.00. If the firm does not invest except to maintain existing assets, the earnings per share are expected to remain constant at $5.00 per year. However, starting next year the firm has the chance to invest $3.00 per share a year developing a newly discovered geothermal steam source of electricity generation. These investments are expected to generate a permanent 20% return per year. However, the source will be fully developed by the fifth year.

a) Calculate the stock price assuming investors require a 12% rate of return.

b) Show that the earnings/price ratio is .20 if the required rate of return is 20%.

2) Your friend James gladly told you that he invested $1000 in a technology company with an expected return of 30% and a standard deviation of 30%. Assume that is his total portfolio. Currently, the market portfolio has an expected return of 10% and a standard deviation of 5%. The risk-free rate of return is 2%. Assume the CAPM holds. Can you help James construct a better investment portfolio? Explain carefully with supporting calculations.