Sample Final Exam Essay Example for Free

Sample Final Exam EssayThe alliance currently has internet per deal out of $8. 25. The conjunction has no growth and pays out all earnings as dividends. It has a new make which go forth require an investment of $1. 60 per share today (at time zero). The project will increase the earnings by $0. 40 per share indefinitely starting one year after the investment. Investors require a 10 percent harvest-feast on XYZ stock. Assume the firm just paid the dividend of $8. 25 yesterday. a) What is the revalue per share of the companys stock assuming the firm does not undertake the investment hazard? 5 pts) b) If the company does undertake the investment what is the value per share now? (10 pts) c) What will the value per share be 3 years from now? (5 pts) answer a) P = Dividend / R = 8. 25 / 0. 1 = $ 82. 5 b) NPVGO = (-1. 60 + 0. 40 / 0. 1) = $ 2. 40 So the stock price will be 82. 5 + 2. 40 = 84. 90 c) (8. 25 + 0. 40) / 0. 1 = 86. 5 Question 3 Portfolio Variance Suppose the jud ge returns and archetype deviation of stocks A and B are E(Ra) = 0. 13, E(Rb) = 0. 19, ? a = 0. 38, ? b = 0. 62 respectively. )Calculate the expected return and standard deviation for a portfolio that is composed of 45 percent A and 55 percent B when the correlation coefficient between the returns on A and B is 0. 5 (10 pts) b) How does the correlation coefficient between the returns on A and B affect the standard deviation of the portfolio? (3 pts) c) Provide a localise for the correlation coefficient where we obtain diversification benefits. (i. e, The portfolio standard deviation is less than the weighted average of the individual standard deviations of the stocks? ) Provide a range where we dont feature diversification benefits. 3 + 2 pts) d) For some values of correlation coefficient, we hind end achieve a portfolio standard deviation of almost zero. unfeigned or FALSE? ( 2 pts) Solution a) The expected return of the portfolio is the sum of the weight of apiece asset tim es the expected return of each asset, so E(RP) = wAE(RA) + wBE(RB) E(RP) = . 45(. 13) + . 55(. 19) E(RP) = . 1630 or 16. 30% The variance of a portfolio of two assets can be carryed as (pic = wpic(pic + wpic(pic + 2wAwB(A(B(A,B (pic = . 452(. 382) + . 552(. 622) + 2(. 45)(. 55)(. 38)(. 62)(. 50) (pic = . 20383So, the standard deviation is (P = (. 20383)1/2 = . 4515 or 45. 15% b) As Stock A and Stock B become less correlated, or more negatively correlated, the standard deviation of the portfolio decreases. c) corr lt 1 (strictly less), corr = 1 d) TRUE Question 4 CAPM and SML Suppose that you observe the following information. Assume these securities are correctly priced. Beta judge Return XYZ Corp 1. 4 0. 150 ABC Corp 0. 9 0. 115 a) What is the risk unaffectionate rate and the expected return on the market? 3 + 3 pts) b) What is the expected return on an asset with a beta 1. 6? (4 pts) c) What is the beta on a portfolio consisting of 30% XYZ, 30% ABC, 20% risk free asset and 20% market portfolio? (5 pts) d) If a security has beta 1. 8 and expected return 18%, is this security above or below SML? Over or under priced? ( 2 + 3 pts) Solution a) Here we have the expected return and beta for two assets. We can express the returns of the two assets utilize CAPM. If the CAPM is true, then the security market line holds as well, which means all assets have the same risk premium.Setting the reward-to-risk ratios of the assets equal to each other and solving for the risk-free rate, we find (. 15 Rf)/1. 4 = (. 115 Rf)/. 90 .90(. 15 Rf) = 1. 4(. 115 Rf) .135 . 9Rf = . 161 1. 4Rf .5Rf = . 026 Rf = . 052 or 5. 20% Now using CAPM to find the expected return on the market with both stocks, we find .15 = . 0520 + 1. 4(RM . 0520). 115 = . 0520 + . 9(RM . 0520) RM = . 1220 or 12. 20%RM = . 1220 or 12. 20% b) 5. 20% + 1. 6 (12. 20% 5. 20%) = 5. 20% + 11. 20% = %16. 40 c) 0. 30 * 1. 4 + 0. 30*0. 9 + 0. 2*1 +0. *0 = 0. 89 d) According to SML 5. 20% + 1. 8 (12. 20% 5. 20%) = 5. 20% + 12. 60% = 17. 80%. The security is above SML. It is underpriced. Question 5 1).For a multi-product firm, if a projects beta is different from that of the overall firm, then the(4 pts) A. CAPM can no longer be used. B. project should be discounted using the overall firms beta. C. project should be discounted at a rate commensurate with its let beta. D. project should be discounted at the market rate. E. project should be discounted at the T-bill rate. 2). elevate Construction Co. as 80,000 bonds outstanding that are selling at par value. Bonds with similar characteristics are yielding 8. 5%. The company also has 4 million shares of common stock outstanding. The stock has a beta of 1. 1 and sells for $40 a share. The U. S. Treasury bill is yielding 4% and the market risk premium is 8%. Jacks tax rate is 35%. What is Jacks weighted average cost of capital? (8 pts) A. 7. 10% B. 7. 39% C. 10. 38% D. 10. 65% E. 11. 37% Re = . 04 + (1. 1 ( . 08) = . 128 Debt 80,000 ( $1, 000 = $80m Common 4m ( $40 = $160m Total = $80m + $160m = $240m pic