Question

how do you find (b) without knowing the risk free?

10:25 AM Mon Mar 30 123_Ch7quiz.pdf 17. Are that the free rate of return is 0.06, the expected rate of return on the market is 0.16, and that the CAPM holds (a) A share of stock sells for $50 today. It will pay a dividend of $6 per share at the end of the year and has a beta of 1.2. What do investors expect the stock to sell for at the end of the year? Recall, the holding period return when there are dividends is 1+r Rarf-B < marketichum -rf) DI ► 0.06 +12 + (ikke-o.be - 18% - 50 = $6 18-9 PEDILI-/R- 9 6 34/12 18-9 -/56 Gibol) / 18-0GB Se 6% (6) You are considering the purchase of a firm with an expected perpetual cash flow of $1000 (annually), but are unsure of its risk. Suppose you estimate and believe the beta of the stock to be 0.5. If the true value of beta is 1. by how much will you overpay for the firm (in relation to its fair market price)? Ret=rf + B (mkt ret -rf) cale returns of +0.51 BUSI 123 18. Suppose the rate of return on short-term government securities (perceived to be risk-free) is Dashboard Calendar To-do Notifications Inbox

Answer 1

Part b)

Step 1: Calculate Expected Return (CAPM) using Beta of .5 and 1

The expected return is calculated as below:

Expected Return with a Beta of .5 = Risk Free Rate + Beta*(Market Return - Risk Free Rate) = 6% + .5*(16% - 6%) = 11%

Expected Return with a Beta of 1 = Risk Free Rate + Beta*(Market Return - Risk Free Rate) = 6% + 1*(16% - 6%) = 16%

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Step 2: Calculate Current Stock Price at Different Expected Return Values

The current stock price at different expected return values is determined as follows:

Current Stock Price at Expected Return of 11% = Value of Perpetual Cash Flow/Expected Return = 1,000/11% = $9,091

Current Stock Price at Expected Return of 16% = Value of Perpetual Cash Flow/Expected Return = 1,000/16% = $6,250

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Step 3: Calculate Amount Overpaid

The amount that will be overpaid is arrived as below:

Amount Overpaid = Current Stock Price at Expected Return of 11% - Current Stock Price at Expected Return of 16% = 9,091 - 6,250 = $2,841 (answer)