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e120 Practice Final_sum08

e120 Practice Final_sum08 - E120 Principles of Engineering...

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E120 Principles of Engineering Economics Summer 2008 Practice Final Problem 1 You believe that one month from now the XYZ Company will pay a dividend of $2 on its common stock. Thereafter you expect to receive dividends every quarter . The dividends are expected to grow at a rate of 1% per quarter in perpetuity. If you require an effective rate of return of 12% per year on your investment, how much should you be prepared to pay for the stock now? Explain. Problem 2 In 1999 the risk free interest rate is 5%. Suppose the expected rate of return required by the market for a portfolio with a beta of 1 is 12%. According to the capital asset pricing model: a) What’s the expected rate of return on the market portfolio? b) What would be the expected rate of return on a stock with β =0? c) Suppose you consider buying a share of stock at $40. The stock is expected to pay $3 dividends next year and you expect it to sell then for $41. The stock risk has been evaluated at β =0.5. Is the stock overpriced or under priced?
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