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Ch02_solutions

# Ch02_solutions - Chapter 2 Discounted Dividend Valuation...

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Chapter 2 – Discounted Dividend Valuation Solutions 1. For AOL Time Warner, the required return is r = R F + β [ E ( R M ) – R F ] = 4.35% + 2.50(8.04%) = 4.35% + 20.10% = 24.45% For J.P. Morgan Chase, the required return is r = R F + β [ E ( R M ) – R F ] = 4.35% + 1.50(8.04%) = 4.35% + 12.06% = 16.41% For Boeing, the required return is r = R F + β [ E ( R M ) – R F ] = 4.35% + 0.80(8.04%) = 4.35% + 6.43% = 10.78% 2. The five-factor APT model is of the form E ( R i ) = Τ -bill rate + (Sensitivity to confidence risk × 2.59%) – (Sensitivity to time horizon risk × 0.66%) – (Sensitivity to inflation risk × 4.32%) + (Sensitivity to business-cycle risk × 1.49%) + (Sensitivity to market- timing risk × 3.61%) For Terra Energy, the required return is r = 4.10% + (0.25 × 2.59%) – (0.30 × 0.66%) – (–0.45 × 4.32%) + (1.60 × 1.49%) + (0.80 × 3.61%) = 4.10% + 0.65% – 0.20% + 1.94% + 2.38% + 2.89% = 11.76% 3. The required return is given by r = R F + β [ E ( R M ) – R F ] = 0.045 + ( 0.2)(0.075) = 4.5% 1.5% = 3.0% Newmont Mining has a required return of 3 percent. When beta is negative, an asset has a CAPM required rate of return that is below the risk-free rate. 4. The equation for the single-period DDM is 1 1 0 1 D P V r + = + For Stock 1, 36 . 19 \$ 10 . 1 00 . 21 30 . 0 0 = + = V For Stock 2, 10 . 1 00 . 32 00 . 30 1 + = D , D 1 = 1.10(30.00) – 32.00 = \$1.00 For Stock 3, 1 2.70 92.00 1.12 P + = , P 1 = 92.00(1.12) – 2.70 = \$100.34 For Stock 4, r + + = 1 90 . 17 30 . 0 00 . 16 , 0.30 17.90 1 0.1375 13.75% 16.00 r + = = = 1

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