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    HW WK6

    Uploaded by

    Kyle Kana
    The document contains sample questions and problems from finance chapters 10-11 on topics like the market risk premium, portfolio risk calculation using correlation and beta, CAPM required return calculation, weighted average cost of capital (WACC), and project valuation. Specifically, it provides examples of: 1) Calculating portfolio beta and required return given the individual stock betas and weights. 2) Computing a firm's required return using CAPM given its beta. 3) Solving for the cost of debt and WACC of a company. 4) Demonstrating that using a firm's WACC instead of a project-specific required return can lead to rejecting a positive NPV project.

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    Attribution Non-Commercial (BY-NC)
    Download as DOCX, PDF, TXT or read online from Scribd

    HW WK6

    Uploaded by

    Kyle Kana
    26 views5 pages
    The document contains sample questions and problems from finance chapters 10-11 on topics like the market risk premium, portfolio risk calculation using correlation and beta, CAPM required return calculation, weighted average cost of capital (WACC), and project valuation. Specifically, it provides examples of: 1) Calculating portfolio beta and required return given the individual stock betas and weights. 2) Computing a firm's required return using CAPM given its beta. 3) Solving for the cost of debt and WACC of a company. 4) Demonstrating that using a firm's WACC instead of a project-specific required return can lead to rejecting a positive NPV project.

    Original Description:

    Week 6 Homework

    Original Title

    HW-WK6

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    © Attribution Non-Commercial (BY-NC)

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    The document contains sample questions and problems from finance chapters 10-11 on topics like the market risk premium, portfolio risk calculation using correlation and beta, CAPM required return calculation, weighted average cost of capital (WACC), and project valuation. Specifically, it provides examples of: 1) Calculating portfolio beta and required return given the individual stock betas and weights. 2) Computing a firm's required return using CAPM given its beta. 3) Solving for the cost of debt and WACC of a company. 4) Demonstrating that using a firm's WACC instead of a project-specific required return can lead to rejecting a positive NPV project.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
    26 views5 pages

    HW WK6

    Uploaded by

    Kyle Kana
    The document contains sample questions and problems from finance chapters 10-11 on topics like the market risk premium, portfolio risk calculation using correlation and beta, CAPM required return calculation, weighted average cost of capital (WACC), and project valuation. Specifically, it provides examples of: 1) Calculating portfolio beta and required return given the individual stock betas and weights. 2) Computing a firm's required return using CAPM given its beta. 3) Solving for the cost of debt and WACC of a company. 4) Demonstrating that using a firm's WACC instead of a project-specific required return can lead to rejecting a positive NPV project.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
    of 5

    CH 10 Questions

    3.
    The market risk premium is a forward-looking tool and should always be positive. Because the
    market has risk, it will periodically have a negative return or a small positive return that is
    smaller than the T-bill rate. Thus, realized returns over a short period of time will sometimes
    show what appears to be a negative risk premium. However, historical risk premiums should be
    measured over long periods of time.

    7.
    Using standard deviation, you would need to determine how the fourth stock interacts with the
    three stocks already owned. To do this you would have to compute the correlation between the
    new stock and each of the three already held. Then, the portfolio standard deviation could be
    computed. If the new portfolio standard deviation is lower then the original portfolio standard
    deviation, then adding the new stock lowers the risk. Of course, the portions, or weights of all
    the stocks will matter. Determining whether adding a stock will increase or lower the risk of the
    portfolio is much easier using beta. If the beta of the fourth stock is higher than the beta of the
    portfolio, then it will increase the risk when added.


    14.
    A. semi-strong form
    B. strong form
    C. not efficient
    D. semi-strong form

    CH 10 Problems

    10-2
    Expected return = 0.235% + 0.610% + 0.2-30% = 7%


    10-5
    Average market risk premium = 15.8% 5.6% = 10.2%


    10-8
    Nanometrics required return = 4.5% + 4.05 (12% 4.5%) = 34.875%

    10-27
    For the portfolio, determine the total value of the portfolio and the weights of each stock in the
    portfolio:
    Total value = $40.80100 + $30.10150 + $57.4075 + $23.80200 = $17,660
    Amazon.com weight = $40.80100 / $17,660 = 23.1%
    Family Dollar weight = $30.10150 / $17,660 = 25.6%
    McKesson weight = $57.4075 / $17,660 = 24.4%
    Schering-Plough weight = $23.80200 / $17,660 = 26.9%
    Now compute the portfolio beta = 0.2313.8 + 0.2561.2 + 0.2440.4 + 0.2690.5 = 1.42
    So the portfolios required return = 3.5%+1.42(12%3.5%) = 15.5%


    CH 11 Questions

    4.
    You would want to use the CAPM when you can estimate the firms beta with a good deal of
    certainty: you would only want to use the constant-growth model if the firms stock is expected
    to experience constant dividend growth.

    7.
    Given that the new line of business will comprise so much of the firms operations, it probably
    isnt appropriate to count on the current, existing operations to pay off the debt. Therefore, the fir
    should probably compute a new required rate of return for this firms debt.

    CH 11 Problems
    11-3
    Solving equation for i
    D
    :

    ( )
    ( )
    10
    10
    1
    1
    1
    $1, 000
    Solve $970 $82.50 for
    1
    D
    D
    D
    D
    i
    i
    i
    i
    (

    (
    +

    (
    = +
    `
    (
    +

    (

    )

    Yields i
    D
    = .087115, or 8.7115%

    11-6

    1
    0
    $11
    $137
    .0803, or 8.03%
    P
    D
    i
    P
    =
    =
    =

    11-7
    2, 000, 000 $27
    2, 000, 000 $27 1, 000, 000 $14.50 10, 000 .98 $1, 000
    $54, 000, 000
    $78, 300, 000
    .6897, or 68.97%
    E
    E P D

    =
    + + + +
    =
    =

    11-9
    2, 000, 000 $27
    2, 000, 000 $27 1, 000, 000 $14.50 10, 000 .98 $1, 000
    $9, 800, 000
    $78, 300, 000
    .1252, or 12.52%
    E
    E P D

    =
    + + + +
    =
    =




    11-11
    2, 000, 000 $27
    2, 000, 000 $27 1, 000, 000 $14.50 10, 000 .98 $1, 000
    $14, 500, 000
    $78, 300, 000
    .1852, or 18.52%
    E
    E P D

    =
    + + + +
    =
    =

    11-14
    ( ) WACC 1
    6, 500, 000 $14
    14%
    6, 500, 000 $14 $10, 000, 000 25, 000 $1, 000 .9
    $10, 000, 000
    10%
    6, 500, 000 $14 $10, 000, 000 25, 000 $1, 000 .9
    25, 000 $1, 000 .9
    6, 500, 000 $14 $10, 000, 000 25,
    E P D C
    E P D
    i i i T
    E P D E P D E P D
    = + +
    + + + + + +

    =
    + +
    +
    + +

    +
    + +
    ( )
    ( )
    7.25% 1 .34
    000 $1, 000 .9
    $91, 000, 000
    14%
    $91, 000, 000 $10, 000, 000 22, 500, 000
    $10, 000, 000
    10%
    $91, 000, 000 $10, 000, 000 22, 500, 000
    22, 500, 000
    7.25% 1 .34
    $91, 000, 000 $10, 000, 000 22, 500, 000
    ..7368 14% .0810


    =
    + +
    +
    + +
    +
    + +
    = + ( ) 10% .1822 7.25% 1 .34
    11.9973%
    +
    =






    11-24
    ( )
    | |
    ( )
    | |
    ( )
    | |
    ( )
    | |
    For Project A:
    4% 0.5 7%
    7.5%
    For Project B:
    4% 1.2 7%
    12.4%
    For Project C:
    4% 1.4 7%
    13.8%
    For Project D:
    4% 1.6 7%
    15.2%
    E f E M f
    E f E M f
    E f E M f
    E f E M f
    i i E i i
    i i E i i
    i i E i i
    i i E i i
    |
    |
    |
    |
    ( = +

    = +
    =
    ( = +

    = +
    =
    ( = +

    = +
    =
    ( = +

    = +
    =

    If Project As expected return of 8% had been compared to the project-specific required
    return of 7.5%, it would have been accepted. Therefore, Project A would have been
    incorrectly rejected if the firm-wide WACC had been used as its benchmark.

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