What is the expected return according to capm

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Reference no: EM132210784

Questions -

Q1. A share of stock with a beta of 0.75 now sells for $50. Investors expect the stock to pay a year-end dividend of $2. The T-bill rate is 4%, and the market premium is 7%.

a) What is the expected return according to CAPM?

b) Suppose investors believe the stock will sell for $52 at year-end. Is the stock a good or bad buy?

c) If the stock will sell for $52 at year-end, at what price will the stock reach an "equilibrium" at which it is perceived as fairly priced today? (Hint: use dividend model to calculate)

Q2. A project under consideration has an internal rate of return of 14% and a beta of 0.6. The risk-free rate is 4%, and the expected rate of return on the market portfolio is 14%.

a) What is the required rate of return on the project?

b) Should the project be accepted?

c) What is the required rate of return on the project if its beta is 1.6?

d) Should the project be accepted in this case?

Q3. Stock in ABC has a beta of 0.85. The market risk premium is 8%, and T-bills are currently yielding 5%. The company's most recent dividend is $1.60 per share, and dividends are expected to grow at a 6% annual rate indefinitely. If the stock sells for $37 per share,

a) What is the estimate of the company's cost of equity using CAPM?

b) What is the estimate of the company's cost of equity using the dividend discount model?

Q4. EFG Company issue a 30-year, 7% semiannual bond 7 years ago. The bond currently sells for 108% of its face value: $1,000. The company's tax rate is 35%.

a) What is EFG Company's pre-tax cost of debt?

b) What is the after-tax cost of debt?

Q5. RST Company has 8.5 million shares of common stock outstanding and 200,000 7.5% semiannual bonds outstanding, and the par value is $1,000 each. The common stock currently sells for $34 per share and has a beta of 1.20. The bonds have 15 years to maturity and currently sell for 93% of par. The market risk premium is 7%, T-bills are yielding 5%, and RST Company's tax rate is 35%.

a) What is the firm's market value capital structure? (The percentage of the debt and the percentage of the equity).

b) If RST Company is evaluating a new investment project that has the same risk as the firm's typical project, what rate should the firm use to discount the project's cash flows?

c) What is the value of the rate (WACC)?

Q6. RST Company (in Q5) considers taking up an investment project. They need to invest 30 million for the project. Assume that all the information of the firm is same as Q5 and total expenses are 70% of revenue with no depreciation expense.

a) What is the NPV break-even sales?

b) Calculate the rate of return of debtors and investors at the NPV break-even sales.

c) Are debtors and investors getting back the rate of return they expected?

Reference no: EM132210784

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