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The North Bend Bait Company is contemplating an investment to get it into the production and sale of the spinning rods and reals. Heretofore, it has produced only artificial baits. The financial manager of the company, Burno Litzenberger, feels that the only way to analyse the merits of the project is with the capital asset pricing model approach. Fortunately, Super Splash Spinning Corporation, a publically held company, produces only spinning fishing equipment. Litzenberger feels that it is appropriate to use this company as a bench mark for measuring risk.
Neither North Bend Bait nor Super Splash employs any leverage. The actual returns to the investors in Super Splash over the last 10 years were those shown in the following table. Also shown are 1-year return for Standard and Poor's 500-Stock Index and the risk-free rate.
Super Splash Market Index Risk-free rate 20X0 0.14 0.11 0.05 20X1 0.21 0.17 0.07 20X2 -0.06 -0.02 0.06 20X3 0.3 0.25 0.08 20X4 0.24 0.18 0.06 20X5 0.34 0.28 0.07 20X6 -0.12 -0.08 0.07 20X7 0.32 0.27 0.09 20X8 0.19 0.14 0.07 20X9 -0.1 0.00 0.08 Average Return 0.146 0.13 0.07 Litzenberger believe that the annual average return for the market index and average annual return for the risk-free rate over the 10-year period are reasonable proxies for the returns likely prevail in the future.
a-Compute the beta for the Super Splash Spinning Corporation ?
b- What is the required return for the project ?What assumptions are critical ? ( Note: To solve, you may use the technique described in the special section "Calculating Betas Manually).
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