Principles of Corporate Finance (Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)
12th Edition
ISBN: 9781259144387
Author: Richard A Brealey, Stewart C Myers, Franklin Allen
Publisher: McGraw-Hill Education
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Chapter 22, Problem 23PS
a.
Summary Introduction
To discuss: The effects of increase in PVGO.
b.
Summary Introduction
To discuss: The reasons on whether cost of capital be correct hurdle rate for investments.
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A) What expected return should an investor expect from investments in common stock? You are given the following information: Risk free rate of return = 4%; market risk premium = 11%; Beta of the stock (assume CAPM holds) = 0.72.
B) Stock A with beta of 0.8 offers a 11% return while stock B with a beta of 1.2 offers a 15% return. What is the risk-free rate? What is the common market return? Assume CAPM holds.
If the interest rate is approximately equal to the growth rate of dividends, the price of a stock will be close to
Select one:
a. infinity
O b. It is impossible to tell based on the information above
O c.
100000
O d. 0
Problem 1
You are given the following information about stock X and the market portfolio, M:
Riskless Asset (f)
Stock X
Market Portfolio (M)
E(r)
0.04 (4%)
?
0.10
σ
0.00
0.30
0.20
You are not given the expected return of stock X. The correlation of the returns on the stock X and
the market portfolio is equal to 0.4.
a) What is the beta (6) of stock X?
b) Assuming the CAPM holds, what is the expected return on stock X?
c) You have $1,000 to invest in some combination of the risk-free asset, stock X, and the market
portfolio. You are thinking of investing $300 in the risk free asset, $400 in stock X, and $300
in the market portfolio. What is the overall expected return, standard deviation and beta of
this portfolio?
Chapter 22 Solutions
Principles of Corporate Finance (Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)
Ch. 22 - Expansion options Look again at the valuation in...Ch. 22 - Prob. 2PSCh. 22 - Prob. 3PSCh. 22 - Prob. 4PSCh. 22 - Prob. 5PSCh. 22 - Prob. 6PSCh. 22 - Real options True or false? a. Real-options...Ch. 22 - Prob. 8PSCh. 22 - Prob. 9PSCh. 22 - Expansion options Look again at Table 22.2. How...
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- Question 1 Suppose you have the following expectations about the market condition and the returns on Stocks X and Y. Market Condition Probability Return on Stock X Return on Stock Y Bear Market 0.3 -3% -5% Normal Market 0.5 3% 5% Bull Market 0.2 8% 15% a) What are the expected returns for Stocks X and Y, E(rX) and E(rY)? b) What are the standard deviations of the returns for Stocks X and Y, σX and σY?arrow_forward3arrow_forwardYou are comparing Stock A to Stock B. Given the following information, what is the difference in the expected returns of these two securities? State of Economy Probability of State of Economy Rate of Return if State Occurs Stock A Stock B Normal .75 .13 .16 Recession .25 −.05 −.21arrow_forward
- Problem 2. Suppose that the index model for stocks A and B is estimated from excess returns with the following results: RA = 2.00% + 1.10RM + A RB = -0.60% + 0.90RM + eB The R-squared of the estimate for stock A is 0.35 and the R-squared of the estimate for stock B is 0.40. The standard deviation of the market is OM = 30%. Assume you create portfolio P with weights of 120% in A and -20% in B. These weights mean that you go long stock A and short stock B. a) What is the standard deviation of the portfolio? [Hint: R-squared is the variance explained by the market risk B²o divided by the variance in the stock o}.] b) What is the beta of the portfolio? c) What is the firm-specific variance of the portfolio? (Round to 3 decimals.)arrow_forwardK (Expected rate of return and risk) Syntex, Inc. is considering an investment in one of two common stocks. Given the information that follows, which investment is better, based on the risk (as measured by the standard deviation) and return? Common Stock A Probability 0.20 0.60 0.20 Common Stock B Return 13% 17% 18% Probability 0.10 0.40 0.40 0.10 (Click on the icon in order to copy its contents into a spreadsheet.) Return -7% 5% 16% 21% www a. Given the information in the table, the expected rate of return for stock A is 16.40 %. (Round to two decimal places.) The standard deviation of stock A is 1.74 %. (Round to two decimal places.) b. The expected rate of return for stock B is 9.8 %. (Round to two decimal places.) The standard deviation for stock B is 6.12 %. (Round to two decimal places.)arrow_forwardhow much of your capital (what weight) would you invest in stock A to maximize your portfolio's expected return per unit risk (maximize the Sharpe Ratio)?arrow_forward
- Suppose your expectations regarding the stock price are as follows: State of the Market Probability Ending Price HPR (includingdividends) Boom 0.30 $ 140 53.5 % Normal growth 0.28 110 17.5 Recession 0.42 80 −12.0 Use the equations E(r)=Σsp(s)r(s)E(r)=Σsp(s)r(s) and σ2=Σsp(s) [r(s)−E(r)]2σ2=Σsp(s) [r(s)−E(r)]2 to compute the mean and standard deviation of the HPR on stocks. (Do not round intermediate calculations. Round your answers to 2 decimal places.)arrow_forwardQ4, all partsarrow_forwardThe beta coefficient A stock’s contribution to the market risk of a well-diversified portfolio is called Q1. ______risk. It can be measured by a metric called the beta coefficient, which calculates the degree to which a stock moves with the movements in the market. Q2. Based on your understanding of the beta coefficient, indicate whether each statement in the following table is true or false: Statement True False Over time, a stock with a beta of 1.0 produces a return that goes up and down with a 1:1 relationship with the return on the market. Beta measures the volatility in stock movements relative to the market. A stock that is more volatile than the market will have a beta of less than 1.0. Q1. Option 1 Unsystematic or Option 2 Relevant. Please provide true or false answers. Thank you!arrow_forward
- Can you assist with question 7.arrow_forward11. Changes to the security market line 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 Risk-free rate (rRFrRF) ________? Market risk premium (RPMRPM) __________? Happy Corp. stock’s beta ___________? Required rate of return on Happy Corp. stock ___________? An analyst believes that inflation is going to increase by 3.0% 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.arrow_forwardAnswer accurately ASAParrow_forward
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