Fundamentals of Corporate Finance
10th Edition
ISBN: 9781260703931
Author: BREALEY, Richard
Publisher: MCGRAW-HILL HIGHER EDUCATION
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Textbook Question
Chapter 11, Problem 5QP
Risk Premiums and Discount Rates. Top hedge fund manager Sally Buffit believes that a stock with the same market risk as the S&P 500 will sell at year-end at a price of $50. The stock will pay a dividend at year-end of $2. What price should she be willing to pay for the stock today? Assume that risk-free Treasury securities currently offer an interest rate of 2%. Use Table 11.1 to find a reasonable discount rate.
TABLE 11.1
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The following graph plots the current security market line (SML) and indicates the return that investors require from
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be unchanged. The analyst uses the Capital Asset Pricing Model (CAPM). The following graph plots the current SML
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the new SML suggested by this analyst's prediction.
Happy Corp.'s new required rate of return is
The following graph plots the current security market line (SML) and indicates the return that investors require from holding stock from Happy Corp. (HC). Based on the graph, complete the table that follows:
CAPM Elements
Value
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Q1
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Q3
Required rate of return on Happy Corp. stock
Q4
An analyst believes that inflation is going to increase by 2.0% over the next year, while the market risk premium will be unchanged. The analyst uses the Capital Asset Pricing Model (CAPM). The following graph plots the current SML.
Calculate Happy Corp.’s new required return. Then, on the graph, use the green points (rectangle symbols) to plot the new SML suggested by this analyst’s prediction.
Happy Corp.’s new required rate of return is Q5.____
The SML helps determine the risk-aversion level among investors. The higher the level of risk aversion, the Q6.____ the slope of the SML.
Q7. Which of the…
You're considering purchasing Proctor and Gamble Stock. Suppose the risk-free interest rate is 5.0% and the stock market's expected return is 13.50%. Also, suppose that if the stock market's value rises by 1%, stock in Proctor and Gamble typically rises by 1%.
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