Question

1. AA Corporation’s stock has a beta of 8. The risk-free rate is 4.5% and the expected return on the market is 13.6%. What is the required rate of return on AA’s stock?

2. The market and Stock J have the following probability distributions:

Probability                          r_M                            r_J

0.2                                          12%                        16%

0.3                                          8                              7

0.5                                          20                           13

Calculate the expected rates of return for the market and Stock J.

3. Suppose you manage a $6 million fund that consists of four stocks with the following investments:

Stock                     Investment                        Beta

A                             $700,000                              1.70

B                             1,400,000                             -0.70

C                             1,300,000                             1.15

D                             2,100,000                             0.85

If the market’s required rate of return is 12% and the risk-free rate is 3%, what is the fund’s required rate of return?

4. Boehm Incorporated is expected to pay a $2.28 per share dividend at the end of this year

(i.e. D₁ = $2.28). The dividend is expected to grow at a constant rate of 10% a year. The required rate of return on the stock, r is 17%. What is the estimated value per share of Boehm’s stock?

5. Nick’s Enchiladas Inc. has preferred stock outstanding that pays a dividend of $9.10 at the end of each year. The preferred sells for $70 a share. What is the stock’s required rate of return

6. A company currently pays a dividend of $4 per share (D₀= $4). It is estimated that the company’s dividend will grow at a rate of 10% per year for the next 2 years, and then at a constant rate of 5% thereafter. The company’s stock has a beta of 1.6, the risk-free rate is 4% and the market risk premium is 2%. What is your estimate of the stock’s current price?

Answer 1

(1): Here we will have to use CAPM i.e. capital asset pricing model.

As per CAPM required rate of return = risk free rate + beta*(expected return on market – risk free rate)

= 4.5% + 8*(13.6% - 4.5%)

= 77.30%