Reference no: EM133071539
1. Consider the following information about returns of two stocks:
|
State
|
Probability
|
Stock A
|
Stock B
|
|
Boom
|
0.3
|
25.00%
|
-2.50%
|
|
Good
|
0.4
|
15.00%
|
5.00%
|
|
Level
|
0.2
|
10.00%
|
10.00%
|
|
Slump
|
0.1
|
-5.00%
|
15.00%
|
a.) What are the expected return and standard deviation of stock A and stock B?
b.) If you invest 50% of your money in stock A and 50% of your money in stock B, what are the portfolio's expected return and standard deviation (Hint: Considering the four states of the economy)?
c.) Use the results of a-b to explain the benefit of diversification.
2. Answer the following questions regarding bond, ordinary share and preference share.
a.) Develop a table and a timeline to illustrate the differences between bonds and ordinary shares.
b.) Explain why investors consider preference shares to be a particular type of debt rather than equity.
3. Consider an investment that costs $50,000 and has a cash inflow of $20,000 every year for four years. The required return is 12%, and the required payback is three years.
a.) What are the payback period, NPV and IRR of the investment project?
b.) Should we accept the project based on the payback period and NPV? Next, list and explain payback's advantages and disadvantages compared with NPV.
4. A corporation has 10,000 bonds outstanding with a 4% annual coupon rate, ten years to maturity, a $1,000 face value, and a $1,100 market price. The company's 100,000 preference shares pay a $2 annual dividend and sell for $20 per share. The company's 500,000 ordinary shares sell for $35 per share and have a beta of 1.5. The risk-free rate is 3%, and the market return is 8%. Finally, the tax rate is 20%.
a.) What is the company's weighted average cost of capital (WACC)?
b.) List and explain the conditions of using WACC as a discount rate for a new investment project.