What would be the expected return for a self-financing

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Reference no: EM13616421

Each of the six firms in the table below is expected to pay the listed dividend payment every year in perpetuity.

Firm Dividend ($ million) Cost of Capital (%/Year)

S1 10 8

S2 10 12

S3 10 14

B1 100 8

B2 100 12

B3 100 14

a. Using the cost of capital in the table, calculate the market value of each firm.

b. Rank the three S firms by their market values and look at how their cost of capital is ordered.

What would be the expected return for a self-financing portfolio that went long on the firm with the largest market value and shorted the firm with the lowest market value? (The expected return of a self-financing portfolio is the weighted average return of the constituent securities.) Repeat using the B firms.

c. Rank all six firms by their market values. How does this ranking order the cost of capital?

What would be the expected return for a self-financing portfolio that went long on the firm with the largest market value and shorted the firm with the lowest market value?

d. Repeat part c but rank the firms by the dividend yield instead of the market value. What can you conclude about the dividend yield ranking compared to the market value ranking?

Reference no: EM13616421

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